The past 12 months I felt a bit uncomfortable with the early stage VC funding environment. And not only because of the sky high valuations that we saw last year. But I couldn’t articulate precisely why. This is why I decided to take the time this summer to do some introspection and to try to put some words/structure on the reasons why some stuff felt out of place for me.
In this first post I will try to articulate the macro changes that I believe lead to the transition from the “radical SaaS” era to the “incremental SaaS” era.
Fifteen/ten years ago: Investing in the age of the radical SaaS
Fifteen/ten years ago the overall startup/VC landscape was very different:
- Founding or working at a SaaS startup was not mainstream. Working in finance/consulting firms and in big tech companies for developers was a better career choice than starting or working at a SaaS startup. So you had fewer people starting SaaS companies back then.
- B2B software was at the beginning of the adoption cycle. Even large businesses in horizontal categories were not well equipped in terms of SaaS. Plenty of software categories were still blue ocean type of markets (the challenge back then was market education).
- There were fewer VCs financing startups. As an anecdote, back in 2008 when I launched my first SaaS startup, we had to pay someone to get a list of all the VCs in Paris. And you often needed to send a paper based version of your presentation and business plan to their office (it’s crazy to think that we had to pay to get access to a list of VCs at that time 😂).
- Bootstrapping a SaaS was not the norm, taking VC money was. The path for a SaaS startup at that time was to take VC money. There were very few successful bootstrapped SaaS at that time (the OGs will probably remember Balsamiq).
In this context starting a SaaS startup and financing it with VC money was a no brainer. There was kind of a symbiosis between SaaS founders and VCs where, as a B2B SaaS startup, you often had no huge incumbents to face, a large pool of underserved customers and not a ton of competition like today.
These SaaS products brought radical changes to businesses (hence the term “radical SaaS”). So there was almost organically a chance to become a category defining company (I’m not saying it was easy). And the VC model is based on investing in category defining startups that provide huge returns on investment.
This is why I label this era: Investing in category defining SaaS/radical SaaS.
Fast forward today: Investing in the age of the “Incremental SaaS”
Fast forward today the startup/VC environment has completely changed (btw this change was gradual, not abrupt):
- Founding or working at a SaaS startup has become mainstream. The market has matured on every front and now when you say that you have founded a startup or that you work at a startup, even your grandma wouldn’t look at you as if you were crazy. So you have an increasing number of SaaS startups launched.
- B2B software is at the end of the adoption cycle in most of the big software categories (laggard stage). Most businesses are now well equipped with SaaS software (there’s even a saturation of software in some cases). And most of the big software categories have SaaS native incumbents in place. And replacing incumbents is really, really hard.
- There are a ton of VCs, incubators and other solo GPs deploying capital. From a European perspective, the number of VC firms and solo GPs has exploded in the past ten years. Even US VC firms are opening offices in Europe.
- The bootstrapped SaaS model is becoming mainstream. We have now an increasing number of very successful bootstrapped SaaS on the market. And plenty of founders are promoting this model by sharing their experience and knowledge (which is an amazing thing).
These factors lead to the current environment:
More “incremental SaaS” and not enough “radical SaaS”. A first consequence is that the majority of the new SaaS products coming to the market only bring incremental improvements/values to businesses (hence why I label them incremental SaaS).
It’s less of a revolution for a business to go from “no CRM at all to adopting a Salesforce” than it is to replace Salesforce with a slightly better CRM software. And while I believe that many of these incremental SaaS can be amazing businesses with life changing outcomes for the founders, most are more bootstrapped-compatible than VC-compatible at early stage.
I think that most incremental SaaS shouldn’t raise a pre-seed and seed rounds with VCs but should rather bootstrap until they reach a couple of millions of ARR and eventually raise with VCs at that point.
At the same time, while we see an increasing number of incremental SaaS on the market, I don’t think that we see the same increase in the number of category defining SaaS/radical SaaS.
So you can see a first shift in the original symbiosis between the VC and B2B software models. You have more funds and more money available but proportionally less category defining SaaS. What has really increased drastically the past ten years is the number of incremental SaaS.
B2B SaaS is the new restaurant. 15 years ago we all had friends who were working in consulting firms and dreamt of changing their life by opening a restaurant or a food truck. Today the equivalent is to launch a SaaS startup. Since the bootstrap model is more and more popular, you have an increasing number of people that chase the “bootstrapped SaaS dream” and want to live the life of a digital nomad. And like opening a restaurant back then, many find out that bootstrapping a SaaS is harder than what they thought. This also increases the number of incremental SaaS on the market.
Most B2B SaaS founders are still chasing VC money, even if they are building an “incremental SaaS”. As I explained above, I believe that most incremental SaaS are not VC compatible. At least until they reach several millions of dollars of ARR. Then they become VC compatible because they are on the path of building assets, such as a brand, that can help them escape velocity. But it will be the topic of another blog post.
And many of these founders are super smart people (the level has really increased the past ten years). But most still want/think that they need to raise the traditional pre-seed round and then a seed round with VCs. It was the normal playbook the past fifteen years, so it’s normal that most founders think that way.
And at the other end of the spectrum you have the VCs that see all these great founders and want to invest in them because “This team is so great that they will disrupt SaaS category X or Y”. It was the normal playbook the past 15 years, so it’s normal that we think that way (I include myself in it).
Conclusion
I think it’s this shift from the radical SaaS era to the incremental SaaS era that was at the heart of my discomfort the past 12 months. The original symbiosis between VCs and SaaS startups (great founders + SaaS startup = potential “category defining” company) is no longer true. I believe that far less SaaS startups should take VC money at early stage compared to 10 years ago.
So for me it’s not only a question of financial conditions (crazy valuations, the shift from a 0% interest rate environment to a 5% one) but a deeper shift that has slowly happened. Maybe some of the playbooks and the approaches that VCs and founders used the past ten/fifteen years need to be adapted to this new era.