Episode 579 | The SaaS Fundraising Landscape (+The TinySeed Syndicate)

Rob: Welcome back to Startups For the Rest of Us. I’m your host, Rob Walling. Every week on the show since 2010, we’ve covered topics related to building and growing startups using an ambitious yet a sustainable approach. We’re not willing to sacrifice our health, relationships to grow our company. We want to build real businesses with real customers who pay us real money. Actually, it’s kind of surprising that most of the world doesn’t think of startups that way.

Today, I have my co-founder of TinySeed, Einar Vollset, joining me on the show. We’re going to talk through not only the announcement of the TinySeed Investment Syndicate—if you don’t know what that is, we’ll define that in a bit—but we’re also going to talk a bit about the investment landscape for B2B SaaS, because frankly, it’s kind of opaque to most bootstrap founders.

We think that whether you’re raising money or not, if you ever plan to sell your company, or even sell a minority stake in your company, or there’s a chance that longer term you might want to raise a small amount of money (or might want to raise a large amount of money), knowing some of these details, is just good hygiene. I think it’s good hygiene as a founder to understand the dynamics of a market. What do you think, Einar?

Einar: I think that makes total sense and thanks for having me on.

Rob: Absolutely. Thanks for joining me. Before we define what a syndicate is and talk about the TinySeed syndicate—why we’re launching it, what it looks like, how it applies if you’re an investor and you want to invest in companies, if you are a founder and you potentially might want to get funding—let’s dive into this investment landscape for B2B SaaS.

Einar: Sure. Before we even get into the bootstrapped, what I think most of the audience here is doing, I’m just being very specific about the fact that here I’m excluding the VC track. This is a whole different Series—Series A, B, C, D, E, whatever IPO. This is the kind of thing where you need to have certain metrics like if you’re sub–$10 million in ARR, you probably need to be doing 200%–300% year over year growth.

Actually, there are a bunch of metrics. An interesting report that came out from Bessemer actually, it’s called scaling to $100 million like this and it basically has benchmarks for where you need to be growth-wise to be on the venture track. It means 110% net retention, 3X every year, and keep going in order to get there. This is more like what it is for bootstrapped or mostly bootstrapped B2B SaaS founders.

This is part of the reason why we started TinySeed. There was a hole in the market at the earlier stages. For TinySeed, what we do is typically invest in companies that are super early. They’re doing $3000–$15,000 typically MRR, although the range is much wider than that.

Rob: We’ve invested as low as $500–$1000 and upwards of $100,000 MRR. Obviously, we don’t exclude people, but I think you’re right. I think the cluster is in that $3000–$20,000 is kind of what I would ballpark.

Einar: Pretty much. We started TinySeed because there was definitely a hole in the market there. It’s a very specific niche that we operate in. We do a 12-month accelerator, we’d run them in batches, we invest in $1–$3 million pre-valuation. However, there’s obviously in the space of bootstrap SaaS or mostly bootstrap SaaS, or other sized companies that look for different kinds of funding.

I think it’s worth mentioning and this is partly because I think if you’ve run a B2B SaaS business, even quite a small one for more than six months, and certainly once you start listing on Capterra, you get nonstop email from people who want to get to know you. They’re from XYZ Capital or so-and-so investors.

I think it’s worth understanding who these are (the people who are reaching out to you) and what kind of funding options are available at the stage. Just to be clear, I think most of the time, what we’re talking about here revenue-wise, once you’re at least $500,000 ARR, but more likely north of a million ARR.

Just to summarize real quick about what kinds of funding options are out there, there are basically two different kinds. The first one is the traditional primary investments, and these are typically what a VC investment is. This would be money that goes into the company for future growth, or hiring, or whatever. They usually issue new stock, it dilutes everybody, and the founder who raises $10 million doesn’t get to put $10 million in his back pocket, probably unfortunately.

That being said, once you get into this north of a million ARR, there is this other concept and this does happen a little bit more now in traditional VC, but it’s this notion of secondary. What secondary is it’s basically a way for a founder who’s gotten to a certain state to de-risk their personal finances, so take some money off the table.

This would be, okay, I’m a founder, I got a business that’s doing a million or $2 million. I’m going to sell some of my own stock to another investor and that money then does go into the founder’s pocket.

Traditionally, that’s almost been the difference between VC funding and more like private equity kind of funding. VCs historically have been very negative to secondary. They feel like you’re not all in unless you need to get to become a unicorn. Why would you take any money off the table? This will be worth 10X in five months versus private equity has often been a little bit more flexible in that regard.

Rob: And it derisks it for the founder. I am pro secondary and if you’re super, super early, it doesn’t make sense. You’re raising $10,000 ARR or something. You haven’t built enough of a business, but if you’re doing seven figures of ARR and your business is literally worth $5 million, $10 million, $20 million and you have zero diversification as a founder, that was a huge concern of mine when we were running Drip. It’s just like I’m a multimillionaire, but I can’t sell any of this. I didn’t know that secondary existed or it would be available to me back in the 2015 timeframe.

Einar: I don’t think times have changed a little bit, too. I think it’s more common now than it used to be and is less stigmatized, but it’s definitely a thing. The way to think about it for me is, secondary is not a bad thing for an investor because I think a lot of the time a founder will come along and they’ll be worried. They might even sell a little bit too soon or go for a smaller subscale exit if they have all their eggs in that one particular basket.

If they can take some money off the table, $500,000, something like that, then they’re much more able to say, okay, screw it. Let’s just go for a $50 million or $100 million exit, or $20 million, or whatever. I think it’s a good thing. It’s actually now more common to see sort of a combination of it. If you’re raising this sort of type from these kinds of people, then typically, there are some primary and some secondary.

The other piece of it is, typically, who are the people reaching out to you on email? I’m sure a lot of you know what I’m talking about. You’re getting an email from Slocum Capital, from so and so, who says he’s an associate or an investor. It’s like hey, we’ve done a little bit of research on you, fascinating space, would love to connect to give you our view of the market or see whether we can help blah-blah-blah.

The one thing to realize is these are typically not venture capitalists. They are typically software-focused private equity funds. There are a number of different kinds of these. Some of these people are looking for companies to buy, either sort of standalone investments or tuck-ins to their portfolio, but the ones that we’re talking about mostly now in terms of people wanting to do investments are what you would call growth investors. These are private equity, people who are out there looking to buy a minority or a majority of your company once you get to a certain size.

Typically, these kinds of investors, these kinds of funds are a bit quite large. Some of the software-focused private equity funds have billions of dollars under management, but they’re also several hundred funds that have tens and hundreds of millions of dollars to spend. Usually, they’re looking to write checks of $2–$3 million up to over $100 million per investment. The thing to be aware of—and this is why I’m saying it’s not VC, it’s a different model—typically the way these guys think about things is like they’re looking to 3X–5X their investment in 3–5 years.

If you take investments—definitely majority—then these kinds of investors often in some cases are very hands-off, but quite often are pretty hands-on in terms of they have a playbook, in some cases they have a certain set of expertise they bring to the table. That can be good or bad.

In some cases, I talked to founders and they’re actually looking for that. They’re looking for either a CEO type to take it to the next level, or somebody who has a fund, that has expertise in scaling sales or any kind of go-to market–type strategy.

Those are the kinds of investors that we’re often dealing with when we’re looking at B2B SaaS investments north of a million ARR.

Rob: That’s what the founders like you said, if you’ve built a SaaS company to even half a million in ARR, you’ve been running it for more than a year, and you aren’t on any list of any kind, you’re going to start getting emails from these types of folks. Some of them will be junior partners or not even partners, just junior associates at venture firms. Some of them will be private equity. There’s a difference between those two, as you’ve already defined. The venture is investing in the company for growth and they invest at higher valuations typically, whereas private equity will want to buy some of the company but are also more open to secondary.

Einar: I think also there are funds that do both. They have a venture arm, they have a […] arm. It’s not that clear cut, but that’s a useful rule of thumb.

Rob: Right. That’s kind of the SaaS funding landscape. Then TinySeed, we launched it because there was really no option for people who kind of didn’t want to go down one of those routes. We’ve run four batches. We’re in the middle of our fourth batch. We’ve raised two funds and are raising our third, funded 59 founders. We are perhaps in-between or the third option between truly bootstrapping and going after venture, or selling a piece to private equity.

I think that begs the question. We’re launching a syndicate. What is that? Why should it be interesting if someone is an accredited investor listening to this, or if they’re founder where maybe the accelerator model that TinySeed offers isn’t a fit?

Einar: Basically, the goal with the TinySeed Syndicate, and we promise, we’ll get to the point where we explain what a syndicate is if you don’t know, because we’re TinySeed, we’re knee-deep into B2B SaaS every day. We do see a lot of founders who reach out and say, we want the kind of investors TinySeed likes, and we definitely hear from investors who are into that’s the kind of investments we want to be making. Typically, they’re angel investors. They’re not looking to write $50 million checks into a single company. They’re looking to write smaller checks and get more exposure later on.

Rob: If you’re listening to this, you may or may not have heard of what a syndicate is because it’s definitely a more well-known term in the venture space. You go to AngelList, type in AngelList Syndicate, it’s a vehicle that allows accredited investors—unfortunately, I would love it if it allowed non accredited investors—to essentially invest as a group.

The syndicate is led by someone. Usually, you have a syndicate lead who is essentially getting deals selecting deals. A company would approach us, we would select, vet that deal, and then offer it to this list of pre-vetted, pre-verified accredited investors. It’s an email list of investors, in essence. Then they are allowed to invest all in a single entity.

I don’t wanna get too technical, but it’s a Special Purpose Vehicle or an SPV. It’s a single little one-time use fund (almost) that puts the investors in the syndicate who want to opt-in, put their money into it. It is a one line item on the founders cap table. If you have 50 investors in a syndicate, each putting in $5000, that’s $250,000. You don’t have 50 line items on your cap table because that becomes a mess. That’s the idea.

Syndicates are like just-in-time funds, is almost how I think about them. They spring up, the accredited investors in the syndicate are notified about a deal, and they can opt-in or opt-out. There’s no money upfront and then they can say, I want to put a couple of thousand dollars into this one or I want to put $20,000, depending on how much is available. This SPV, the syndicate springs up, money goes in, money goes to the company, a single item on the cap table and that allows you to have these lower minimums.

Typical Angel raises are $25,000 minimum. Typical venture fund raises are $100,000–$250,000 and up. They go way up because of this stupid 99 investor rule we’ve talked about on this show before.

Einar: That’s true. The only question that remains is why are we doing this syndicate if you already have funds? Really the answer is that our TinySeed funds are only for a certain kind of investment. That’s what it does. It just does very early-stage B2B SaaS and we keep hearing from people that they want exposure to this kind of deal flow. We keep hearing from founders that yeah, I’m doing $500,000, I’m doing a million, I want to get access to this. This is effectively our vehicle to make that happen.

Rob: To clarify, the TinySeed accelerator and the funds that we are raising for that, we’re going to continue to do those and we’re full steam ahead on those. But the syndicate is an additional arm of TinySeed, in essence, and it’s an additional way that we can bring some deals to investors who may not currently be TinySeed LPs, TinySeed investors in our funds. It’s also a way for (like you said) some founders, some companies who may not exactly fit the accelerator model to come through the syndicate and be able to get TinySeed to ask funding from a group of MicroConf-friendly, Startups For the Rest of Us–friendly, TinySeed-friendly investors.

In addition to that, a non-trivial number of TinySeed accelerator companies, portfolio companies who have been funded by us—we funded almost 60 by now—about 20%-ish have gone on to raise additional funding rounds. Usually it’s an angel round or preseed round, and that’s been up to them. That’s totally their choice of whether to do it, but we support and assist them in that process if they want to. Usually they have a bit of their own network bring in some funding, and then we communicate their raise to our investors (our LPS as I keep saying, the limited partners), and they can decide to invest in the round or not.

This syndicate is now another layer. It’s another group of investors that could potentially write small checks into TinySeed accelerator companies who want to go on to raise a subsequent round or two. It’s a nice bonus if you think about an extra option for any company that goes through the TinySeed accelerator.

Obviously, just like a venture fund, there are two sides to a syndicate. There are the investors who essentially opt-in to hear about it and opt-in to hear about deals as they come, and then there are the founders. Let’s start with how this might work for an accredited investor who’s listening to this who might want to apply to be a part of the TinySeed syndicate?

Einar: It’s reasonably straightforward. Basically, you just apply to be part of the syndicate and we’ll run it through AngelList. There’ll be a bunch of accredited investor things, KYC, AML-type things. Once you’re approved, you basically get on the list. Whenever there’s a deal that we’ve selected, vetted, and done our diligence on that we think is a deal that fits in sort of the TinySeed mold, then you will get an email that says, here’s the deal, here are the terms, this is the valuation and how much is available, and the minimum.

Like you said, the nice thing about being able to do a syndicate is that you can have a lowish minimum, like $1000–$5000, I don’t think is unreasonable. Then if you decide to invest and if there are enough people and enough interest, we put together what’s called the SPV. We invest through that and we charge pretty minimal fees. There’s a one time $10,000 fee, which is shared pro rata among the investors. TinySeed itself takes a carry, which actually existing TinySeed investors get a pretty hefty discount.

Rob: And that carry is how TinySeed will make money from the syndicate. Basically if a company were to exit, the money first goes to pay the investors back. It’s called a 1X Hurdle and it (in essence) pays the investors back their initial investment. Any profits over that, TinySeed gets 20% of them; that’s called the carry. And as you said, existing TinySeed investors receive a big discount on that carry, as well as getting an early look at deals.  LPs in our funds, those are the folks that kind of get the best deal.

I’d imagine over time, there will be folks who participate in the syndicate who decide that due to the quality of the deals and just the interactions that they will want to become TinySeed LPs. That’s kind of the gist. Anything else to say to folks?

Einar: I think it is worth mentioning. If this is interesting to you either as a founder or as an investor, then just get in touch. If you’re an investor, you should go to tinyseed.com/invest. If you’re a founder and you’re interested in exploring this—I think you’d probably need to be like $500,000 or at least a million in ARR. I think the sweet spot for this kind of funding is anywhere really from about $1–$10 million ARR—then go to tinyseed.com/apply. You can fill in forms there and I probably will be the one who reaches out to sort of clarify. Actually, if you have any questions or you’re uncertain this is a good fit, what does this look like, feel free to just email me at einar@tinyseed.com.

Rob: As we wrap up, here’s what I love about this idea of a syndicate, also just the ability to launch TinySeed in this day and age is that up until now, up until a couple of years ago, there were just so few options. It was bootstrapping, it was venture, and there just weren’t these in-between vehicles. When we launched TinySeed, remember it was a crappy landing page that we threw together in a few weeks. It was a tweet and an email and right away we knew investors are interested, and this is an asset class, but founders are also really interested in.

What I didn’t know was our bootstrapped founders were interested in taking a small amount of money with (I would say) a lot fewer expectations and fewer strings attached is a strong phrase, but just fewer complexities than trying to get on the venture path. I had a hunch. I would have done it and I had a hunch. I could see Jordan Gall doing it. I could see Customer.io did it, Churn Buster did it because I invested in them. I knew there were founders out there, but I didn’t know across the broader landscape of the tens of thousands of those types of founders, how many would be interested. Turns out a lot. We’ve had thousands of applicants at TinySeed.

Einar: Yeah, I think so. I think, actually, there might be more investor interest, too, because there’s a reason why all these software private equity companies and growth investors are hiring all these fresh MBAs to cold email everyone with a heartbeat and the SaaS app. It’s because it’s a very nice investment. Being able to bridge that between investors that aren’t necessarily joined private equity funds and between founders who have built something amazing but maybe want a little bit more for growth and take a little bit off the table, I think that’ll be interesting to see.

Rob: Yeah. I want to be clear, Startups For the Rest of Us and MicroConf have been about building ambitious software companies since the start. And there wasn’t even SaaS. I mean, they existed, but it was not the focus in 2010. I think a bootstrap SaaS, there were a handful of people doing it.

We have evolved with the time, but what we’ve not done is just turned our back on anything. I think SaaS is an amazing business model. I think bootstrapping is an amazing approach. And this podcast and MicroConf will continue to support those folks who are doing that, because 80% plus of the MicroConf community probably won’t raise funding. When we talk about this kind of stuff on the podcast, I don’t want our listener to think oh, my gosh, Startups For the Rest of Us is now all about raising funding, because it’s not. It’s just another option. Startups For the Rest of Us is about giving you the options and the tools to make the best decisions. We’ve done that for 11 years, in 500 and almost 80 episodes. That’s my pledge to you as a listener.

Einar, thanks for joining me. Obviously, if folks want to keep up with you you’re @einarvollset on Twitter and einar@tinyseed.com if they want to email you directly.

Einar: Thank you for having me.

Rob: Absolutely. And thank you so much for joining me again this week. As we said earlier, tinyseed.com/apply or tinyseed.com/invest if you’re interested in learning more about what we’re up to. We’ll be back with another regularly-scheduled program again next Tuesday morning.