Episode 729 | 9 Things I’ve Learned Investing in 170+ SaaS Companies

Rob Walling:
Welcome back to another episode of Startups For, the Rest, Of Us. I’m your host, Rob Walling, and in this episode I talk through lessons that I’ve learned investing in more than 170 companies, specifically through my startup accelerator TinySeed. And if you’re a B2B SaaS founder who’s looking for the right amount of money, mentorship, community advice for me and our amazing mentors, you can head to TinySeed dot com slash apply. Applications are open right now for about the next two weeks, and I’d love to see you apply. Now between TinySeed and mine and Sherry’s personal investments, we are over 190 companies, but I wanted to limit the percentages, the numbers, the takeaways to only those where TinySeed has written a check in the past. I guess the first check was written about five years ago, and so that gives us a pretty tight timeframe and a more cohesive decision-making approach because we’ve been much more deliberate about the types of businesses that we fund. 

So today’s episode is stemmed from a question I got in a private slack group by man where someone said, you’re basically five years, we’re six years from the announcement of TinySeed almost, but we are just over five years from the first check being written. And he asked, are there any patterns or takeaways that you’re noticing across these 170 plus companies? And that’s what I’m going to share today. Now, I want to make a note. I have almost two dozen of these takeaways and that’s too long for a podcast episode. It would run well over an hour. So what I did is I split off six of them and I put them in a YouTube video on the microcom channel, and it has a name similar to this. It probably just came out a couple days ago, and it’s six things that I’ve learned investing in more than 170 companies over five years, something like that. So if you head to microcomp.com/youtube, it should be one of the last couple videos published, or you can look in the show notes of this podcast and click through directly to that video. If you want to get the other takeaways that I didn’t include in this podcast. 

I am going to list these in no particular order. They just came to me in this order as I was trying to think of what are the patterns that we’ve seen. First one is the survivability of B2B SaaS and maybe specifically within our portfolio because obviously we are pretty picky, pretty cosy about the companies we let in, but broader than that B2B SaaS in general, once you get a little bit of traction, it doesn’t fail very often. So more than 170 investments, approximately 2% of those have been written off, have shut down, not sold, and basically moved on to their next act. So very, very small, what I’d call a failure rate, much, much smaller than you would see in a traditional more risky venture fund. Now, I want to couch this. It’s still early. We funded, I don’t know, approximately 45 companies in the past 12 months. 

And so obviously the failure rate of those would be much lower because they haven’t had time to fail. So I don’t want to act like for eternity for the next 10 20 years, there’s going to be a 2% failure rate, but we did start writing checks five years ago, and even among those companies, a failure rate is still extremely low. The other number that I found interesting, and I just confirmed these in our as of this morning, is that 4% of TinySeed companies have exited, meaning sold for enough cash that TinySeed at least got our money back. And in some cases, as you’ve heard with Iran GRE’s exit on this podcast, we received many, many times our money back, but 4% have exited, 2% have been written off. So there’s still a lot of companies in play, and as I said before, it’s still early. 

I mean, we are in the first inning in terms of B2B SaaS taking five years when a traditional startup might take two years because the long slow SaaS ramp of death just takes a long time for things to unfold. Now, my second takeaway is just how valuable SaaS is. You’ve heard me say this on this show where I talk about if you’re over say 2 million in annual recurring revenue and you’re still growing at 40, 50% a year, whatever it is, you can sell at a four to seven x multiple. And so this is all loose numbers. Please don’t I get quoted on Twitter saying this stuff, but I’m just trying to give you a general idea, but let’s say a five x multiple. So if I add 1000 MRR to my company this month, that is 12 KARR multiply that times a five x multiple if I were to sell it, and I’m adding $60,000 in theory to my net worth every single month that I had one K of MRR. 

So now think about adding 5K of MRR, which many, many tiny C companies are doing 5K times 12 is 60 times five is $300,000 to the value of that company. So I’ve been talking about how valuable SaaS is for many, many years. There’s a reason that I began focusing on SaaS, what 12 was it? 12, 13 years ago? And part of it’s the recurring revenue, part of it’s the cheat codes, the net negative churn, but a big part of it is it’s just really, really valuable and that value can be seen in the profits you take out or it can be seen in the exits. So in our coined this term that I really like, it’s called the TinySeed millionaire rate. And what it is is of all the companies that are no longer in operation, so this includes those that have sold and those that have been written off that have shut down of all of those. 

So I told you before, it’s 4% exits, 2% written off. So 6% of those companies, 43% of the founders are now millionaires. Let that sink in for a minute. I’m not saying 43% of the exited companies made the founders millionaires. I’m saying 43% of all companies that are no longer autonomously operating, meaning they’ve either sold or they’ve shut down, 43% of those founders are now millionaires. Now, that doesn’t mean TinySeed one in all of those exits because imagine if we invest at for round numbers, let’s say TinySeed invest at a million dollar valuation or 1.2, whatever it is, and someone sells their company for $2 million and they’re a single founder, they are now a millionaire and TinySeed received whatever it is, not quite two x back on our money. That’s not a home run for us as an investment fund investing in bootstrapped SaaS, we do have to return a lot more than two X to our investors or a bit more than two x. 

And given that some companies will fail, we obviously need higher returns, but that doesn’t discount the fact that the TinySeed millionaire rate is 43%. If you’ve known me for any length of time, you know me as someone who is truly out to help raise the tide, help raise all boats, obviously with TinySeed, with MicroConf, it’s a for-profit entity. Everything I do makes money, but I’m genuinely here to help people and it brings me no end to joy to know that that many individuals join TinySeed received are mentorship, our advice, our investment, and are now millionaires and they can move on to their next act. I’m sure someone in the audit is saying, oh, a million bucks isn’t what it used to. And it’s like, I get it. They can’t live for the rest of their life on that. But I would say that if this is your first startup or if you don’t already have a million dollars in your bank account, that a million dollars is absolutely life changing money. 

It’s not never have to work again, money, but it does change your life. It changes the way that you can think about the financial safety of yourself and your family. And every time I think about this number, I smile ear to ear, I’m just so happy the TinySeed is having this impact. People ask me, why do you still do what you do? You could write off into the sunset or you could just write books or you could just record podcasts. This is why, this is exactly why I still record 52 episodes of this a year, 26 YouTube videos, why I’m kind of on track to ship a book every 18 to 24 months because I love doing things that have an impact on people. And to me, while the end goal of everything is not wealth, it’s not all about money. This is changing people’s lives and I’m here for it. 

The third learning is something I mentioned on this podcast. It was a prediction for this year, and it’s that vertical and orthogonal SaaS appear to have fewer headwinds than horizontal SaaS. You know what horizontal is? It’s like competing against MailChimp where it’s every SMB, every business in the entire country can use it. Versus vertical is where you build MailChimp for realtors, for example, and orthogonal is if you were to build a piece of software that focuses on a specific role or title at a company. So applicant tracking systems, for example, target HR directors, so that’s orthogonal, vertical and have their own because they’re niche, right? The idea is that when we think of niche, we think of vertical only. And so I’ve started using this term orthogonal to describe this other way to niche in to slice it. And what we’re seeing is in general, horizontal companies are competing with big venture funded incumbents, really successful folks where there’s a lot of money in the space and it’s hard to differentiate, and you don’t really know who your ideal customer profile is. 

You kind of have an idea, but you don’t know exactly where to find them. There’s no in-person event you can afford to go to. There’s no ad targeting say on Facebook or Instagram where you’re targeting by demographics and psychographics that will work for horizontal. I shouldn’t say there isn’t any, but it’s very, very hard to do. Versus if you know exactly who your customer is, whether it’s this type of business or this role at a company, it is easier to do cold outreach and ads and just all the marketing approaches become easier. And you don’t have to be the best marketer in the world, you just have to be the best marketer in your niche. And that’s the difference that we see. And so I’m not going to go through exact numbers here. Obviously we don’t give out our performance numbers in public, but in general, the trend is that we do see vertical and orthogonal SaaS companies not only growing faster, they tend to have lower churn. 

Honestly, if they’re doing well in these spaces, there are net negative churn and it’s still early, but it does seem like the exit multiples are higher because there is more appetite from acquirers, from strategics and private equity to go after these niche plays, presumably because they also know their numbers, they know how hard it is to market, and they know what negative churn can do for a business. And so with all that in mind, the metrics are better, blah, blah, blah. So it’s still early. And here’s the thing. I know someone on the internet is going to come and post, but that’s not true across all 10,000 SaaS companies. Look, my one counter example is going to try to disprove up. I’m not trying to state a physical law like gravity in this podcast. What I’m doing is I’m looking at trends across things that we are seeing. These are not statements of fact. I’m not saying that every horizontal product TinySeed has is not growing, is nothing like that. It is trends, it’s numbers, it’s bell curves. So yes, you can do your post and say, I’m a horizontal, and look, I have net negative turn. Great. I ran a relatively horizontal play called Drip, and that had net negative turn too. So that was a great business. So I’m not saying don’t start horizontal either. I’m just telling you vertical and orthogonal. There’s some real advantages to doing that. 

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He really exceeded my expectations. Chaz said he definitely used lemon.io again when he’s looking for a senior level engineer to learn more and get a 15% discount on your first four weeks of working with a developer head to lemon.io/startups. That’s lemon.io/startups. Takeaway number four is we’ve done some, it’s really back of the napkin surveys, show of hands where I’ve said, okay, the original thesis of TinySeed was some people will want to grow quickly, be ambitious and sell for some number. They have in mind 10, 15, 20 million or more as we’ve seen, versus run a company for years, decades and take out profits. What we didn’t know is what the breakdown would be. Is it 50 50 to more people want to take up profits? With my show of hands surveys that I’ve done in several TinySeed Zooms, it appears that it’s about 15%, maybe 20 that want to grow a company for the longterm and take out profits. 

So it is the, call it the super majority that do want to have that big exit. And I think there are reasons for this, right? We are choosing for more ambitious founders. Like if you want to be a lifestyle bootstrapper and truly run a 10, 20, $30,000 a month company and pull it all out, that’s great, but the numbers don’t work for TinySeed to invest in you. And so I do think a much bigger chunk of those folks, whether you call, I call ’em lifestyle, you could call ’em indie hackers, although I think that is actually a different definition, but you get the idea those folks really do want a lifestyle business, and that’s great. I’ve had some of those, but the idea of joining TinySeed and taking funding and then wanting to do that is obviously a super minority of folks. I do think there’s some selection bias in that for sure. 

And I also think that when people hear me do this analysis where I went through the whole one K goes to 12 KARR times five is 60 grand, and someone puts a check in front of you that you’re like, I don’t really want to sell. And they’re like, cool, here’s your relatively early stage business and here’s $3 million. Suddenly things really shift. Things really shift. I remember the first time I saw a seven figure number written down in an email for a potential acquirer to acquire one of my companies, and I was like, this is it. If I say yes to this, I am set for a very, very long time, and this will be absolutely life changing. I remember almost being in a weird, it’s not euphoric state, but it’s hair stands up on the back of your neck and kind of lose time and even kind of can hear ringing in your ear. 

It was that. I was like, whoa. I was so shocked how in theory I had been thinking, oh yeah, if we sell this company someday, of course it’ll sell for a lot. But the moment that I saw that number, it changed everything. I was like, that’s real. That could really be cash in my bank account. And I think that as folks think about that, especially if you are either a first time founder or a founder who’s never had a big exit who has $50,000 in their bank account and a couple hundred grand a retirement account, and you realize that, yeah, maybe I could see this for the long term. Maybe I could grow this company for 10 years, but if I sell now, I’m set for life and I can work on whatever I want forever. The calculus really changes. So whatever way you choose, if you’re listening to this, maybe you’re thinking about, I want to be able to retire for three to six months, as most entrepreneurs do before they get back in the game, or you want to run it for the longterm, that’s okay. 

I’m just calling out some patterns that I’m seeing with our companies. The fifth takeaway is I looked at only our seven and eight figure a RR companies. So if companies doing millions or north of 10 million in annual recurring revenue, and I found that the founder count for these types of companies are very close to being in line with all the founders across the ecosystem from the state of independent SaaS reports. So in this example, 53% of seven and eight figure TinySeed companies are single founders, 33% are two founders, 14% have three or more founders. And just to compare again, the successful TinySeed companies, 53% are single founders and in the broader state of independence, SaaS, MicroConf, startups, the rest of us ecosystem, 51% are solar founders. So 53 versus 51 with two founders, it’s 33 versus 34, and with three or more founders, it’s 14 versus about 15 and a half. 

So the route, why do I bring this up then? Well, I don’t think founder count, at least in this analysis, has that much of a difference on success. I know that growth numbers in the state of independent SaaS show that for some reason there’s an anomaly with three founder companies. I’m still curious to figure out why that is, but I find it fun to often compare to the broader ecosystem with this much smaller and tighter dataset that we have. My sixth learning, really it’s just a thing to share, is that we have had to turn down many deals where we have made offers or we’re about to make offers, but their cap tables were ruined. So an example of this is founder left and took their equity and whether they own a third or half the company, they didn’t have vesting in place. And now the company is kind of unfundable. 

If you come to us and we’re typically the first money into a company and the founders own less than 70%, that’s not a good sign. And sometimes we are the second money in. So there are exceptions to that, but certainly you want the founders to own 80%, 70 to 80% and up. And so we’ve seen companies where again, there’s one or two founders left and they own like 50% of the equity and they can’t raise funding in the future. They’re basically working to put money in someone else’s pocket. It’s just a really bad scene. The other thing we’ve seen is that there are some really sharky investors out there that give extremely low valuations, or they have these exploding terms where if you raise before paying them back, then suddenly they own three times the equity that their original document said. And these investment terms can make the company uninvestible unfortunate, but we’ve especially seen it in Europe where an angel will invest at, I dunno, I’m trying to think of an example. 

There was $50,000 check for 25% of the company, so they invested a $200,000 valuation and that it’s just rough. So now you have this investor who’s not doing anything, not providing a value add, and it’s on the cusp for us of like, Ooh, would we be willing to do that? But realistically, I’m just giving you examples of ways that it’s easy to torture cap table. Be careful. We are less picky, I would say, than bigger venture funds if they see that, they just walk away. So with your ownership percentages, which is what I’m referring to with cap table, you just want to be careful with that. I’ve been shocked at the number that we have seen, and it’s common enough that we ask for the cap table after the first round. If we do a verbal interview and then you go to the second round, we just say, give us a spreadsheet with your cap table. 

And probably half the cases, I have a question about it, who is this person? What did they contribute? If someone owns 10%, 12% of your company, I’m always like, how did this happen? It also shows a judgment thing. If someone’s like, oh, they helped us a few years back and they did some design work and gave us some advice, and so they got 12% of your company. Like that to me shows a questionable judgment is maybe a strong, maybe a lack of knowledge of the space of how things work, but it’s at least something that we have to dig into to be sure that you don’t make that mistake in the future. A next thing that we’ve seen is subsequent fundraising. So when you join TinySeed, you do not commit to raising additional funds. You just keep the option to do so if, if it makes sense for you. 

And within the first few years, it was about a third of our companies went on to raise additional funding after the 2022 crash where funding valuations hit 10 year lows and money is just not as easily accessible. I think it’s probably closer to about a quarter, like 25% of TinySeed companies, and this is not, you have to discount the prior year that we’ve invested. Like the most recent year, probably zero to a handful of those companies have even thought about fundraising because they still have the TinySeed money, they’re in the batch year. But we look at anybody who’s a year or 18 months prior to now, what percentage and ballpark. I would say it’s around that one In four mark, we had a company apply with six co-founders. That was an interesting one. They had a lot of products were very scattered and we weren’t able to fund them. 

Can you imagine? I mean, none of them owned more than 16% of the company and making decisions would be very, very challenging. So that was a red flag of frankly, decision making. When we got into that, then we saw a company apply with zero founders. There was actually one founder of course working on it, but they owned 25% of this early stage company. So I am kind of like, are they really a founder when they are basically working for someone else? To me, that feels like a nice equity grant to an employee. He called himself a founder, but in essence, this is one of those cap tables that we could not fund because a founder working for 25% equity, it just doesn’t make sense. Alright, to wrap things up, the most common topics that I advise on the people pull me into one-on-one conversations during my office hours are the following four things. 

Number one, raising prices or fixing, changing, correcting pricing. It’s not always about raising sometimes the value metrics off. Sometimes they just don’t feel right about the pricing, so we talk through it. The second is, I’m at a plateau or I’m about to hit a plateau. How do I break through it? And those are the conversations that have fueled this mythical doc that I’ve put together, which is just a bulleted list of all the plateau reasons that I know of with B2B SaaS that someday I’ll figure out a way to package it up in a way that’s actually helpful. But plateaus are a common thing. Someone wrote into this podcast I believe, and said, I heard the most bootstrap SaaS companies plateau at 20 or 30 K. Why is that? And the answer is, that’s not true. It’s not that most do. I see SaaS companies plateauing early because they don’t have product-market fit. 

I see them plateauing at 20 or 30 K because they only have one marketing approach and the top of funnel is her churn is too high, and I see them plateauing it a million a RR because their churn is too high or they’ve tapped out the market or there’s all these reasons and then they can plateau at 3 million because competitors, blah, blah, blah. So lots of different reasons for plateauing and it is a very common topic of conversation. The third one unfortunately, is co-founder disputes where one co-founder is living, wants to leave, thinks the other should leave, is asking for advice about a buyout or should they just walk away? Should they give some equity back? It gets really complicated. It is like a divorce because folks have worked together, have been friends, have built and started something that is valuable, sometimes not valuable enough. 

If it was worth $20 million, then maybe you sell it and split the money. But if it’s worth half a million or a million and you’ve spent years working on it, do you really want to liquidate that to the what’s going to be the lowest bidder because you’re not going to get a great price for it and distribute a few hundred thousand dollars to each person that they get taxed on. It is tough. So I don’t mediate co-founder disputes per se. I’m not a mediator. We do have folks that we recommend our founders talk to if they need that, but I definitely am someone that people talk to about advice. Hey, here’s going on. How should I think about it? What are my options? That’s usually the big one is what are my or our options in this case? And of course, now I have a whole laundry list of options when these things come up. 

And the fourth one that folks get my advice on is raising funding or selling a company. And usually it’s not like, how do I raise funding? How should I think about this? Should I raise funding or sell the company? There are questions then about what are next steps and how should I think about it? What are typical valuations? All of that. But as you can see, I get brought in at big strategic points. Now, I also get brought in, I got brought in for some great just nitpicky questions the other day of per seat licensing advice on how to optimize a marketing channel, what marketing, let’s brainstorm marketing channels to go after next. But if I’m grouping them, it really is those four that I mentioned. As a reminder, I have six more learnings that I did not mention in this episode that I mentioned over on the YouTube channel. 

You can click the link in the show notes or go to MicroConf dot com slash YouTube and look for a video of approximately the same title as this episode. And another reminder, if you are a SaaS founder and you want the right amount of funding advice, mentorship community TinySeed dot com slash apply. Applications are open now, and if you are an accredited investor and you’re interested in investing in companies like this, the tiny C millionaire rate is 43% on companies no longer in operation. So obviously we’re having some success. Head over to tiny c.com/invest can fill out a form. There it goes, straight to my good friend, Einar Vollset, whom you’ve heard on this podcast before. Thanks so much for joining me for this week’s episode. It’s great to have you this week and every week. This is Rob Walling signing off from episode 729.