Why Founders of Agencies struggle to run SaaS Businesses
Why Founders of Agencies struggle to run SaaS Businesses
Having experienced this myself and witnessed it first-hand from other founders, I realised that agency founders have a blind spot.
I started my own digital design and build agency in 2004 with my two cofounders. Then we decided that our future was in product, so we closed the agency and started a very successful SaaS business, ScreenCloud.
In our agency, a common boast I made when pitching to clients was: “we’ve never had any investment, we’ve never even had an overdraft”. It was true. We’d grown entirely from the success of our previous work. As founders we’d taken a bit of a smaller salary in order to ensure we had what we liked to call our ‘war chest’. This war chest allowed us to sleep at nights and also invest in side projects if we had the bandwidth to do so.
But then we decided we wanted to be a SaaS company. And because SaaS takes a while to get going and even when it does start generating revenue it takes a while to build up that head of steam, and perhaps because we didn’t in actual fact want to blow our war chest on what seemed like a punt, we also decided that our SaaS company needed to be venture backed.
Launching a venture-backed SaaS business set off a journey where I eventually realised that I needed to completely rethink what rules drove good and bad decision-making. It needed a radical shift in mindset. I’m not going to lie: this was a struggle to begin with.
I’ve been working with a company that is a services company that has built a SaaS offering that it is looking to spin out and raise venture capital for. They showed me their draft investor deck and when I got to the finances slide, I was reminded of where my head was at back in 2016 when we did our first round. You see, the financials page looked like something you might send to a bank when you wanted to extend your overdraft, not what you would send to a VC. Why?
A few things really leapt out:
Their 3 year plan showed them making a small loss this year, but a decent profit next year (and an even bigger one the year after)
And yet, there was talk of a Series A in a year’s time
There was a whole section featuring EBITDA
There was a shopping list of all the things they would buy with their seed investment
What is wrong with this? In short, they were approaching this with what I term a ‘Margins Mindset’, when what they needed to do was switch to a ‘Growth Mindset’.
Margins Mindset vs Growth Mindset
In an agency, or consultancy or professional services business you are, quite rightly, looking to ensure that every job you do is profitable. For this you need to make sure your costs are less than your fees and that the gap between the two is large enough for you to create a bit of a cushion and make some bets about the future. In a venture backed business, you want to maximise growth as fast as possible without running out of money. There’s a difference.
To illustrate the shift, here are some key differences in the Margins Mindset and Growth Mindset founder:
Hiring
Margins Mindset: we will hire the best person we feel we can afford. If we find a bit of a promising junior person for a bargain that we can ‘train up’ over time, even better.
Growth Mindset: we will hire the best person available. Finding someone we can train up is not an option because we don’t have time to learn on the job. We need to get there fast and the best way to do that is to hire someone who has been there and done it before.
Business Model
MM: the amount we charge for the services we provide is approximately 20% more than the amount it costs us to provide them.
GM: the amount it costs us to acquire a customer is less than 33% of the Lifetime Value of that customer. Also, our gross margin (ie the revenue from each subscription minus the actual cost of delivering each unit of software such as hosting, payment processing fees etc, but not the cost of the business as a whole) is around 80%.
Pricing
MM: our pricing is based on day rates, marked up to deliver a healthy margin.
GM: our pricing is based on an understanding of the value we provide to our customers.
Growth
MM: Growth will come. It might come slowly but better to have slow growth than no growth. And better to have no growth than bankruptcy.
GM: We’ve raised money and given away part of our company in order to grow quickly. So we need to do all we can to maximise our chances of growth, otherwise what was the point?
Profitability
MM: If each month we make a profit, then that was a good month. Saving money where we can will pay dividends down the road.
GM: We need to manage our burn and runway. But becoming profitable shouldn’t be a driver for decision-making. If it is, then that chunk of our business that we just gave away (and the associated control that goes with it) was for nothing. What’s more, our investors don’t want to give us money just to pad out our bank balance. They could do that themselves without our help!
Risk
MM: We need to be pretty risk averse and where we do take risks, try to hedge them. If we hire an expensive creative director, we did so because we knew that we have a big creative job on the books. Hopefully, the quality of his or her work will allow us to win bigger and better work and if we don’t, well then we can get rid of them once the big creative job has finished if we really have to.
GM: The only way we get to grow fast is to try things out, even if we don’t know for sure whether they will work. Double-down on our paid media. Hire that brilliant, yet expensive engineer. Attend that event on the other side of the world. Send a whole team to pitch to that big enterprise prospect. Sign up to that workshop with the superstar consultant who charges more for that session than we earn in a year. Obviously we still need to jettison things if we discover they don’t work after trying them. But the point is, we won’t know if we never try.
Metrics
MM: EBITDA is the best measurement of success. Revenue is Vanity, Profit is Sanity. Whether we work on several small projects at a time or one big one, it’s all about that difference between the amount we charge and the amount it costs us to deliver.
GM: EBITDA is anathema to venture-backed fast growth companies. Of course we are going to be loss-making, otherwise why would we even be raising in the first place? Success will be measured by month-on-month (or quarter-on-quarter) revenue and customer growth. It will also be about churn and expansion, Average Contract Value and number of ‘logo’ subscribers.
Pipeline
MM: Pipeline is always good to have, but it needs to be managed very carefully. Like attempting a hill start in a manual-gear car. We want enough interest to give us new projects as we complete the old ones, but at the same time we don’t want so much work that we don’t have the capacity to service it.
GM: Pipeline has a direct correlation to growth targets. Understand the relationship between pipeline coverage and future revenue targets. But broadly speaking, the bigger the pipeline, the better because it will add to our overall growth trajectory (unless our SaaS requires a lot of professional services).
Defining the Offering
MM: Within reason, so long as it’s profitable for us (and we know how to do it), we will pretty much deliver whatever each client wants. We’ll do what they decide if they are paying us enough.
GM: The product is based on an evolving understanding of what our customers as a whole need, rather than any individual bespoke requirement. This becomes a product roadmap and we will decide its priority based on our own judgement of whether it is in the best longterm interest of the product and the business.
Financing the Future
MM: We will finance our future growth either out of the funds we have accumulated through years of profitable operation, or we may get a loan and maybe even investment. But, in order to do that, we need to be able to show profitability first.
GM: We will finance our future growth through investment or possibly venture debt. Neither of these will require us to be profitable. In fact, why would we even want to raise venture capital and dilute our own shareholding, if we plan to be profitable in the near future?
How to think about future financing
MM: We have a shopping list of things we want to buy and we don’t have enough money ourselves to buy them. These may include higher salaries, nicer offices, more people, better computers, some marketing, a more advanced set of technical tools we use to do our jobs.
GM: We are going to use this tranche of cash to get us to the next investment round. In that time we are going to prove x by achieving y and z.
Thinking around potential once we reach scale
MM: We think we can consolidate our position by continuing to deliver a good service with a solid margin.
GM: We could become profitable tomorrow, but we still see more potential and so we want to keep pushing as hard as we can for growth.
Changing your Mindset
None of this is rocket science. If you’ve grown up running a services business, you already have a lot of the skills needed to run a SaaS business. But the sooner you realize that you very likely have this one blind spot, learnt from years of difficult decisions that became second nature to you, and learn to switch your mindset from a Margins-first approach to a Growth-first approach, the better things will be.