36. SaaS Startup Investing (Mamoon Hamid)

The Full Ratchet Podcast on iTunesNick Moran Angel List

Mamoon Hamid of The Social+Capital Partnership joins Nick to cover SaaS Startup Investing. We will address questions including:

  • Hamid SaaS Startup InvestingIn your words, can you describe what a SaaS startup is and the key elements that define a SaaS company?
  • Can you give an example of what is and what is not SaaS?
  • Can you provide an overview of the SaaS segment and a brief history of its evolution and growth?
  • How does a SaaS company evolve its business model to increase revenue per customer and move from a freemium model to strong revenue, per-seat, model?
  • What are some of the traditional metrics that SaaS companies measure and manage and directionally, what level or amount are you looking to see for each?
  • What additional or new metric(s) do you look at and why?
  • What advice would you have for founders of SaaS companies regarding the way they structure and present their material?
  • How do you evaluate very early-stage companies that don’t have much historical revenue data or traction to produce these metrics?

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Before we kick-off today’s episode, we’re going to start with a little trivia.  To preface this, I am planning on attending the PreMoney Conference, out in San Francisco, hosted by the folks at 500 Startups.  The conference is on June 12 this year and I was chatting with the organizers of the event.  They were kind enough to offer a free ticket to a Full Ratchet listener.  I’ve already purchased my own ticket for $500, I think it’s gone up since then.  So I’d suspect that the value is around $700 or more.  This will be my first year attending, but I hear it’s a fantastic gathering with some of the best speakers in the Angel Investing and early-VC world.  One of which is Naval Ravikant, founder of AngelList.  Naval and I have recently been trading emails about a variety of specifics related to the mechanics of startup investing, and so the trivia question I’m going to ask will be related to that.   And if you listened to the recent Episode 32 of the Full Ratchet, you probably have some good insight and can figure it out.  So, if you’re interested in attending the PreMoney conference and you’d like a free ticket, just e-mail me, nick@fullratchet.net, with your answer to the following question.  I will randomly select a winner from those who were correct and will reveal the winner and the detailed answer next week.
So here it is…
An LP invests $100k in a Venture Fund and another $100k in a Syndicate.  The Venture Fund is a standard 2/20 structure.  The Syndicate lead takes a 15% carry and AngelList takes their 5% carry.
  • Both the fund and the syndicate invest in the same 10 companies at the same terms
  • Both the fund and syndicate invest at the same time in each company
  • The fund invests the same amount in each company
  • The syndicate invests the same amount in each company
  • Out of the 10 investments made, five fail completely
  • Two of 10 return at ~1x
  • Two return at ~3x
  • And one company has an out-sized return, yielding a total portfolio return of 5x on invested cash, for both the fund and the syndicate.
So the question is…  Does the LP make a larger return on the $100k invested in the fund or the $100k invested in the Syndicate?
Shoot me an email nick at fullratchet dot net and let me know what you think.  Is the better returner the fund or the syndicate?  And if you can explain why, great, but I don’t require an explanation for you to be eligible for the free ticket to Pre-Money.  I will announce the winner next week.


Answer:  Economics of Syndicate vs Venture Fund 

Guest Links:

Key Takeaways:

 1- What is SaaS?

SaaS started out as companies referred to as ASP’s, Application Service Providers. This was software that was one version, with a single configuration, that scaled across large numbers of customers. And on the business model-side the key factor that makes for a SaaS company, is that the software can be used in exchange for a recurring fee, similar to rent. It is not available for purchase nor is there some sort of performance dollars, revenue share or advertising fees. As long as a user pays for the recurring fee for their seat, they have the right to use the software.

2- The success and growth of Software as a Service

Why did SaaS companies get traction and disrupt traditional enterprise software? Mamoon discussed two main reasons. 1- By paying per seat per month, a company’s TCO, total cost of ownership, was much more palatable and scalable with use. They could roll out a SaaS program to select group for peanuts instead of adopting an Enterprise solution, with mass installation requirements, for hundreds of millions of dollars. Essentially, it is a way to reduce significant risk and time-wasted while, in parallel, assessing the value that a tool contributes to your business before making a big bet on it. And, in particular, for small companies, this was a great way to scale their usage of the software commensurate the growth of their business. 2- The second main reason that was cited for the success of SaaS businesses had to do with user adoption. In some cases, SaaS companies have used a bottoms-up approach, instead of a top-down. What’s meant by this is that the individual user adopts and incorporates the SaaS software into their daily work-flow before the business leadership has made any decision or potentially even before the leadership is even aware that the platform exists. Through a freemium model that encourages a user to get other users to adopt, the SaaS platform can form a large user base, within a company, and become embedded. It is at this point, once a critical mass of employees is dependent on the SaaS program, that the enterprise must make a decision on how to move forward. And, in order to unlock more features, enhanced efficiency or greater usage from the SaaS program, then the enterprise starts to pay a per seat license fee.

3- Advice for SaaS founders and early-stage SaaS investors…

We discussed how many early-stage startups will not have a long enough track record to present meaningful metrics. But even if a startup doesn’t have the traction and numbers-to-date, they absolutely can frame their forecasts and their projections through the appropriate ratios and demonstrate to investors that they understand how to manage this type of business. What comps and similar SaaS businesses are you basing your model on? When is your Series A fundraise projected to occur and does your forecast reflect a fundable SaaS company at that time? And, it’s not just about the fundraising process. More importantly, these metrics reveal the strengths and weaknesses of a business. If a founder is managing the business to these metrics and their Quick Ratio is two, instead of Mamoon’s preferred four or greater, what’s the source of the low quick ratio. First they can ask if it’s a growth issue or a churn issue. Then if, for instance, it’s a churn issue, is it lost customers or retraction of dollars per customer? This can allow better outcome-focused management and reveal the source of challenge areas and allow them to be assessed and counter-measured.

Tip of the Week:   SaaS Metrics to Measure & Manage