There's a moment in time in every SaaS company where money doesn't really matter anymore. You have enough to hit your goals.
And there's a much earlier moment in time where every single dollar matters.
Between the two is the art of investing your balance sheet as a SaaS CEO
— Jason ✨Be Kind✨ Lemkin  🇮🇱 (@jasonlk) July 24, 2021
A ways back, I met with a sales leader I’ve known for years, and he told me The Most Curious Story. Â His SaaS CEO asked him to stop selling so much.
“Slow down.  You are doing too good of a job,” the CEO said. “We can’t afford it.”
Now … how could this be? Â Well, it does make sense, when you understand the scenario, a combination of two things:
First, this SaaS company has a mix of freemium customers and sales-driven customers (with higher ACV, lower churn). Â The freemium ones really have no acquisition costs at this point (the main lead source is mini-brand). Â The sales-driven customers are very profitable on a CAC basis, since their lead cost is $0, and so the ‘Magic Number’ or CAC/CLTV ratio is very favorable. Â But … still … the sales team’s commissions consume cash in the very, very short term.
and
Second, this SaaS company had a very tight balance sheet. Â About $1m in cash for a $5m ARR business.
And here, they just couldn’t safely invest. Â Because every $10k, $20k, $50k customer they closed … Hooray!! … but … that sales commission, just put them into Danger mode on the balance sheet. Â Even though in 4 months, they’d be in the Black here … for years to come …
A crying shame, really.
We get that, but what’s the “right” answer? Â Many of us can’t raise a $50m Series Seed, and many others of us don’t want to get diluted to 0.0001% ownership.
I think in SaaS, and I learned this from an insight from Josh Stein at DFJ (first VC in Box, SugarCRM, etc.) at a board we’re on together, what I’m going to inelegantly call “The 0.5x Balance Sheet Rule.”
Which is, once you are post-Initial Scale, past $3m-$4m in ARR or so, even if you have 80%+ gross margins and a very efficient sales and marketing engine … once your cash dips below 50% of your ARR … you’ll have stress, and importantly — underinvest. Â And this is the worst time to underinvest. Â Because when you get here, every great hire starts to be accretive (more on that here) — as measured in 12 months or less. Â But you need enough capital to make these hires and let them pay for themselves in 12 months or less.
I made this mistake myself, with hindsight. Â I was proud we got cash-flow positive at $4m ARR or so, and shortly thereafter, I figured out the “everyone great is accretive thing” and told all the managers to hire whomever they want. Â But … I should have gone further. Â At ~$7m in ARR I think we had about $1.5m in cash on the balance sheet, plus some venture debt. Â If I’d had $5m+ on the balance sheet, I would have made far, far more investments. Â At $7m in ARR and cash-flow positive, I didn’t have to worry about failing. Â But I still had to worry about the costs of making data-driven, well-thought-through, but unproven mistakes.
Now I’ve watched this in action again and again, and Josh Stein is 100% spot-on. Â Having 100% of your ARR on the balance sheet is a luxury. Â Do that if you can. Â But at least, once you’re at Initial Scale, make sure you maintain 50% of your ARR on the balance sheet. Â It will destress all your investments. Â Let you really go for it. Â And let you be OK if the amazing team you’ve hired makes a few more mistakes on the way to $100m in ARR.
As CEO/founder, once you’re at even just $3m or so in ARR, and have a few good VPs on the team … really your #1 job is to empower them. Â They need enough of a safety net, and enough runway, to do amazing things.
“Slow down, you’re selling too much.” Â It can happen, at least, as a construct, to anyone. Â Don’t let it be you.
It’s also a good rule for folks able to bootstrap to scale that are past the point they really need capital per se. If you’ve gotten to, say, $4m ARR, and are growing quickly … why raise any VC money at all? You don’t need to. Atlassian waited. Qualtrics waited. It’s just, you probably don’t have $2m of cash on the balance sheet at $4m in ARR if you’ve bootstrapped. So I’d raise at least enough to fund the growth and hires your team deserves. Or at least, give it a lot of serious thought.
A rough rule, but a good rule:
If you are in growth mode, to hire the team you need, and scale at the rate you want … you need at least half your ARR on your balance sheet
I.e., if you are $6M ARR, you need >=$3m in the bank to invest in hiring, etc.
If you have less, raise
— Jason ✨Be Kind✨ Lemkin  🇮🇱 (@jasonlk) January 24, 2021
Right now, we’re even flooded with unicorns that can’t meet this test. They raised $100m, but spend almost all of it. And now they don’t have the capital to grow.
Net net, when you raise Series A and later capital, it’s supposed to be for growth, yes. But maybe the ideal way to do it is by using the funds as a buffer. So that you can make those hires you need in advance, not arrears.  But not with a goal of … spending it all.
(note: an updated SaaStr Classic post)