The VC industry is hotter than ever as digital transformation is accelerating at a pace it was unimaginable 6 months ago.
All VCs are looking for the future Unicorns and Decacorns. These are the kind of stories we read all the time in TechCrunch, Forbes and other mainstream publishers.
Founders with a promising solution/product and initial revenue traction are being pitched all the time. Venture Capital firms are becoming the sellers and startup Founders the buyers.
There is also a story that is not as cool though.
I’ve been speaking with several VCs in mainland Europe lately and quite a few share the same pains or concerns:
- Not enough exits. Too many VC-backed B2B SaaS companies get stuck between 1 and 4 million € in ARR and the issue is not (or not only) the tech.
- The challenge to raise additional Funds. If well connected, the VC can manage to raise a second Fund. However without decent exits the third one can become a “mirage” because the LPs may lose confidence.
VCs choose potential “Cinderellas” but they often realise in 12-36 months they may have invested in her “Stepsister” instead.
How to detect that the risk is high:
- The startup keeps on burning cash.
- It generates low revenue compared to the ambitions and plans of 1-2 years ago.
- The type of reasons listened during the Boards: generic with tendency to buy time without showing outcome/fact-based plans, blaming the sales leader, talking a lot about the next feature that will generate the tipping point, and a few others.
VC exits do not have yet a base of revenue and process engineering. They are still too much linked to probability calculation and randomness.
Betting is ok when it’s a pre-revenue startup developing the “Beta” or looking for product-market fit.
Is it still ok when you invest in series A, post initial traction, and therefore you expect the startup to accelerate revenue in 1-2 years as a classic scaleup would do?
If you go for winning the Champions League and soon realize that you need to fight to avoid the relegation, this is painful for all involved parties (Investors, Founders, Employees). Isn’t it so?
As a VC are you willing to accept the idea of a write-off? Or even worst, that the company will survive but you won’t get any exit?
What should be the plan?
1. Consciousness – Reinvention – Restart
Many of these companies (and most of this money) can be recuperated if you bear in mind that there are no shortcuts in B2B SaaS.
Firstly, a serious exercise of self-consciousness at Board level is a must.
At least when you are in the “locker room” it doesn’t help if you keep on behaving like if the team was the Chicago Bulls of Michael Jordan, when the reality is that you need to fight to avoid relegation.
Secondly, as soon as the Board is conscious about the reality then the whole focus in the following quarter should be to reinvent and restart the engine based on this kind of roadmap/therapy:
- Refocus the company on efficiency before growth. Cash will be king in the next 1-2 years even more than ever.
- Align the Board on clear and measurable milestones towards the build up of revenue predictability.
- Understand which “postures” and “fundamentals” of the go-to-market strategy need to be refocused and how?
- Is it segmentation?
- Is it value proposition and pricing/packaging?
- Is it the go-to-market playbook?
- It it the people?
- Define a new set of targets and milestones and have that discussion with the Founders about the vision for a possible exit with a 2 to 4-year time frame.
- Plan and execute in real time. A control room needs to be built on purpose.
The sooner the better.
How much value is every shareholder leaving on the table each day of delay?
Often Founders and Boards succumb to the temptation to hire a pedigreed Sales VP instead of following a more sensible approach, in a desperate attempt to regenerate revenue quickly. Going all in just for the seasoned champion doesn’t work 99% of the times. It means to burn the residual cash that could have been used to reinvent and restart the business in line with what mentioned above.
2. Should you aim to the next VC round or an M&A ?
Let’s assume the Board and the Founders have put the feet on the ground on time and the business has started to execute in line with a sensible “reinvention” plan.
What should be the foreseeable exit strategy for the VC who invested in a series A: a series B through other VCs or an M&A?
It’s not possible to answer such a question before 9-12 months. It depends on how the business will react to the “therapy”, assuming that the portfolio company still has got a role to play in its sector and the product is still competitive.
The necessary condition in both cases is that the company should not run out of cash in the meanwhile. The pursuit of break-even or in any case a good level of financial stability will make the difference between life and death.
Generally speaking regenerating the business up to the point of a “re-birth of Cinderella” is possible but unlikely.
I’ve personally lived a revenue leadership experience in similar circumstances. A challenging journey of a post-series A scaleup that needed to reinvent itself by ramping a SaaS business up and moving upmarket to Global Enterprises internationally. It took 12-15 months just to fix, adjust and rebuild from scratch, but after then SaaS revenue blossomed. After 5 years the business ended up getting a Series B round and the future looks even brighter following the new reality driven by COVID-19.
The “re-birth of Cinderella” is an exception though. The most likely and reasonable approach is to go for an M&A plan:
- All the parties involved should first of all accept that the scaleup will not become a Unicorn and then …
- A control room will set the appropriate go-to-market “postures” and make the team execute them efficiently with a focus on stabilizing the business from a financial perspective: stable & predictable cash production and positive EBITDA.
- At the right time, the business will look for the right M&A operation, ideally no later than 3-4 years since that sense of self-consciousness started.
For a B2B SaaS company the M&A scenarios could be of 3 different types:
A) An high growth VC-backed scaleup running the unicorn/decacorn game could be interested in buying your company’s MRR, additional market presence and/or cross selling opportunities. From a valuation perspective this is probably the best possible scenario.
B) A big Corporation may have a gap in its offering and a good and specialized SaaS solution like yours can represent an appealing integration to the current product portfolio of the corporation.
C) Any business shopping around for good opportunities in a growing industry like SaaS could be a potential buyer. A possible downside of such an option is that the valuation may be even lower than the initial VC investment and based on EBITDA multiples instead of MRR ones. Although assuming the VC had accepted the reality of the Cinderella’s stepsister analogy, the M&A outcome will be considered as a gain on its own, given that the most likely alternative would have been a write-off or a business surviving without any exit.
3. Prince Charming or Mr Wolf
When unfortunately a portfolio company finds itself in the “Stepsister” position described in this post, everything gets so difficult including Board relations, internal team morale and Founders’ sleepless nights.
The best people of the team will look for other “Cinderellas” if they joined the business just because of its cool side. Right?
The people with less capabilities will be phased out and it’s always painful to let people go.
When the game becomes so serious, Boards should choose wisely what type of people they need on the court for the new reality.
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