I originally wrote this post way, way back in the first year of SaaStr and have updated it every 2 years or so, because it’s an important thing to think about as a founder. Especially now in 2023, when venture capital again is scarcer, and more expensive, and far harder to close than it was during the go-go times for SaaS of 2021 and late 2020.
Let’s take a look at 3 B2B acquisitions from a few years back as an example.
Let’s first start with the $35m acquisition of TokBox after 11 years and the $220m acquisition of SpringCM after 13 years. I know a little about both companies — and both are good products from good companies that well deserved their acquisition prices or even more:
But the outcomes for the founders after 11 and 13 years are probably tough. Both were sold for about 1.5x the amount raised. 1.5x means everyone makes a little bit of money, but no one really makes enough.
Does this make ventureevil or something because these deals probably didn’t make all the founders multi-millionaires? Of course not. Venture capital is risk capital, and the VCs here for the most partalso didn’t make much money either. But it’s important to understand how the math works here — and how it figures into how much to raise.
My simple advice when you raise capital: assume you have to return a liquidity event (sale or IPO) of at least 10x the amount you raise for raising venture capital to be worth it.
Valuations change from round to round. Later stage investors will expect lower ROI, seed investors will be looking for a lot more. How do you make sense of it all?
Just Multiply Amount of Venture Capital Raised Times 10. That is What You Must Sell or IPO For — For it All to Really Work Out.
Now take Cisco buying Duo Security for $2.35b? That was about 20x that $120m they’d raised. An incredible outcome:
So my advice: worry less about valuations and venture mechanics, and just stick with this simple math when you decide to raise $X of capital:
- Raise a $1m seed? You’ll need to sell for $10m to make everyone OK.More is better, but less is going to create issues. A $2m seed, you need a $20m+ exit for everyone to be OK. Probably $50m+ for everyone to be happy.
- Raise a $10m Series A? It’s going to have to be at least a $100m sale to get everyone around the table to say good job (or at least just to say yes). Ideally, $200m+.
- Raise $100m? That’s a billion+ IPO you’ve just committed to, sir.As it should be. Don’t raise this much if you aren’t convinced it will take you to $100m+ ARR.
We can stop there, but it gets more helpful to think about the types of potential exits, especially in SaaS.
First, you’ll notice a lot of BigCos. talking about “tuck-in” acquisitions that can attach to existing revenue streams. It makes sense — if you can add something to Office rather than building something in a new segment, it should be pretty high ROI. These “tuck-in” acquisitions though tend to top out at around $100m or so. That’s about all the Big Guys are willing to invest in their old products via M&A. So bear in mind, if you raise more than $10m, you’re probably giving up a good economic outcome in tuck-in opportunity. See, e.g, the TokBox example above. Giving this option up may well be fine, just be aware of it.
What’s between $100m and $1b in acquisition prices? New growth areas. E.g. Salesforce bought Datorama ($800m), Krux ($700m – the SaaStr story here and below), BuddyMedia and Radian6 all for healthy nine-figure sums to build out AI, Analytics and Marketing Cloud respectively in a hurry. These are the same spaces VCs want to invest tons of capital, too, so it’s all synergistic. But where I think you have to be careful is you can raise a lot of capital, but you aren’t really in a new growth area for the BigGuys, even if your ARR is solid. This can happen a lot in SaaS. PE may still buy you, but the M&A offers here are fewer. So be thoughtful about overfunding yourself here.
Which can leave you with nothing but an IPO or bust. Great work if you can get it. But it can be good to have options along the way.
T-Shirt Image from Zazzlehere.
If most founders knew that eventually, they’d have to get to $1B in ARR for the math to pencil out
Would they ever raise more than a few million in venture capital at all?
— Jason ✨Be Kind✨ Lemkin (@jasonlk) July 27, 2022
FAQs
My simple advice when you raise capital: assume you have to return a liquidity event (sale or IPO) of at least 10x the amount you raise for raising venture capital to be worth it. Valuations change from round to round. Later stage investors will expect lower ROI, seed investors will be looking for a lot more.
What happens when you raise venture capital? ›
VC funding means ceding some control over your startup, and committing to hypergrowth, transparency, and accountability. Look beyond dilution; the board seats you cede could shape your company's direction and weaken your say in key decisions.
What does 10x valuation mean? ›
A 10x valuation system refers to a method where a company's investors are willing to pay up to 10 times the company's current worth due to its potential for rapid growth and profitability.
How do venture capital funds raise money? ›
To get your first fund up and running, you'll need access to a pool of money you can use to make investments. Typically, VCs raise a fund by soliciting contributions from outside investors. These third-party investors become limited partners in the fund.
What does it mean to 10x your business? ›
10x means to maximize and expand your results ten times over, rather than just by 10%. Anyone can make an increase in sales, get more leads, and create better content by 10%, but why would you want to do what anyone can do?
What are the 4 C's of venture capital? ›
Let's not invite that risk, and instead undertake conviction, compliance, confidence and consequences as an industry. It can not only help us preserve the best parts of the current industry, but also lead to better investments and a healthier innovation sector.
Why not to raise venture capital? ›
VCs will not make your business a success, and often over-sell their value to entrepreneurs. I'm also a proponent of raising smaller rounds from angel investors in your space, who can add credibility, insights, introductions and more without selling a huge chunk of your company.
Can I pay myself with seed money? ›
Yes, it is possible to use business seed funding to pay yourself a salary. However, there are several factors to consider before doing so. In this answer, I will outline the key points to keep in mind when using seed funding to pay yourself a salary.
What is venture capital in simple words? ›
What is venture capital in simple words? Venture capital is money invested in a business, usually a start-up, that is seen as having strong growth potential. It is typically provided by investors who expect to receive a high return on their investment.
What is the 10X strategy? ›
The 10X Rule says that 1) you should set targets for yourself that are 10X greater than what you believe you can achieve and 2) you should take actions that are 10X greater than what you believe are necessary to achieve your goals. The biggest mistake most people make in life is not setting goals high enough.
A Growth Strategy Equals a Growing Business. The “10x” concept originated in the internet technology (IT) world to describe engineers who are 10 times (10x) as productive as the worst engineer in a company. Professionals from digital marketing to athletic performance have adapted the term to describe strategic growth.
What is the 10X approach? ›
What does 10x Mean — At a Glance. The 10X Rule essentially revolves around what is considered that Principle of Massive Action — this concept that any time you put an exceedingly great amount of effort into anything you do, you're guaranteed to achieve exceedingly great results.
Where do venture capitalists get their money? ›
Venture capitalists make money in two ways. The first is a management fee for managing the firm's capital. The second is carried interest on the fund's return on investment, generally referred to as the “carry.” Management fees.
How do venture capitalists get paid? ›
Venture capitalists make money from the carried interest of their investments, as well as management fees. Most VC firms collect about 20% of the profits from the private equity fund, while the rest goes to their limited partners. General partners may also collect an additional 2% fee.
Is Shark Tank a venture capitalist? ›
The sharks are venture capitalists, meaning they are "self-made" millionaires and billionaires seeking lucrative business investment opportunities. While they are paid cast members of the show, they do rely on their own wealth in order to invest in the entrepreneurs' products and services.
What is the 2 20 rule in VC? ›
VCs often use the shorthand phrase “two and twenty” to refer to the 2% of annual management fees a venture fund might take and the 20% carried interest (or “performance fee”) it would charge.
What is the 2 and 20 rule in venture capital? ›
The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.
What is meant by a 6 on 9 venture capital deal? ›
One of my competitors put forward a “6 on 9” deal, in other words $6 million invested at a $9 million pre-money valuation to own 40% of the company. But my competitor inserted a larger option pool than I did – 30% – so the founders would only receive 30% of the company as compared to my deal that gave them 34%.
What is the 1 investor rule? ›
How the One Percent Rule Works. This simple calculation multiplies the purchase price of the property plus any necessary repairs by 1%. The result is a base level of monthly rent. It's also compared to the potential monthly mortgage payment to give the owner a better understanding of the property's monthly cash flow.
