Software as a Service (SaaS) is a growth market that shows signs of unlimited potential. TripleTree Investment Banking Services describes it as "the biggest transformation and growth driver since the Internet." Yet, despite such glowing forecasts, some venture capital firms (VCs) and other potential investors remain a bit leery because SaaS is unlike any business model they've analyzed. Their apprehension and sometimes dismissive attitude stem from the one constant in the development of a SaaS model: the requirement for considerably more growth capital upfront than a traditional perpetual license software business, sometimes more than double the amount.

This is a daunting challenge vendors need to address if their models are to succeed. What is required is a heavy dose of realism that includes a viable business plan covering long- and short-term cash needs, a growth blueprint designed to appeal to investors despite the initial capital requirements, accurate revenue projections and an exit strategy for selling the company. Equally important is the ability to successfully present the model to those investors who can impact the company's future.

SaaS is still considered an unproven business model, which means that anything less than a frank and honest presentation to targeted investors will likely result in rejection. Vendors have the best chance to alleviate the discomfort by:

• Demonstrating their knowledge of the amount of capital required from the first through fourth year
• Creating a pricing model that parallels sales and invoices during those years
• Providing an honest appraisal of yearly contract renewable rates, which factors in possible cancellations.

VCs, Angels and Other Investors
Investor groups are diverse with varied interests and responsibilities. Each has different criteria governing investment decisions, so perhaps it is best to start at the opposite pole and cite the source that is least likely to give serious consideration to a SaaS investment - a national or regional bank. We have concluded from our experience that these banks are not about to provide funds until the model gets to profitability, especially one that requires intensive capital at its inception. SaaS by its very nature must be considered a long-range investment, perhaps too long for the banks. Far better to spend time considering one of the following sources:

1. Business development authorities. These are the entities whose mission is to fund businesses with debt that will translate into job creation, particularly in the tech sector. Some may offer grants, but most prefer five-year term loans from $250,000 to $2 million. Business development authorities, as a rule, tend to subordinate debt to a credit line or to other senior term debt lenders. SaaS firms have found them to be an understanding source of capital and quite receptive. These sources can be located on state and regional websites.

2. Specialty banks. Unlike their national and regional counterparts, these banks have extensive experience in the tech sector and are not averse to offering credit lines to SaaS models. Some examples are Silicon Valley Bank, Square One Bank and Bridge Bank, all of which offer either invoice financing or credit lines secured by a firm's accounts receivable assets. Similar sources such as SaaS Capital and Vencore can provide programs we have found to be quite innovative in advancing funds that are based on the selling point of SaaS - the long-term value of recurring contracts.

3. Venture Capitalists. Venture capitalists maintain strict high financial standards for companies to qualify for their investments. If a firm cannot conclusively project $20 million to $30 million in sales revenue in five years, it is unlikely to get thumbs up from a VC. What must be presented is a realistic plan for a high level of growth accompanied by a scale that demonstrates a profitable exit through sale of the company. The presentation portion discussing the sale should include an explanation of who would be most likely to buy the company, why anyone would buy it and the anticipated multiples. Obviously, not every company has these figures and projections available within house, so consider the use of research sources; e.g. Capital IQ and The 451 Group that can provide market data. Other resources accustomed to providing research and banking advice for SaaS companies are Software Equity Group and the previously mentioned TripleTree Investment Banking Services.

4. Other Equity Investors. Outside of VCs, angel groups that are usually funded by entrepreneurs are an often sought investment source, especially since their standards tend to be less rigid than VCs. Many can be found online. These are the people who can help open the doors, assist with the presentation and perhaps eventually become board members of the company. It is best to seek an equity investor with previous experience in funding the software industry.

5. Customers. It is surprising how many companies overlook the possibility of customers playing a role in start-up capital. Agreements with initial customers can be priced to include product development fees, certainly a fundamental for future growth.

6. Partners. There are three sound business reasons for partnerships. They can extend a sales force, help co-fund and extend company marketing and provide strategic investments especially if the partner is a much larger firm. The latter is the most likely of the three to consider purchasing the business - a consideration that will not be lost on other investors.

Some companies may be less confident with investor presentations, comparing them to walking on egg shells. If so, they should consider retaining an investment advisory firm with substantial investor contacts for setting up meetings and sorting through options. It also helps to assign a key company contact to manage projections, presentations and contact database.

Time for the Presentation
The foundation for all investor presentations and, for that matter, the SaaS model is a viable business plan that clearly and accurately depicts a high level of growth and subsequent results. To that end, build projections that model the pyramid growth of sales and invoicing. Clearly show the pricing and contract policies that will support this type of business model and, of course, highlight recurring revenue potential.

Understand that there has to be an exit discussion. Investors want to see what niche the model is in and what size it must reach to be sold at a decent profit. A projection that offers less than $20 million to $40 million in sales revenue will not generate interest among VCs, but may spark interest elsewhere.

Generally speaking, most of investor groups want to see a business that is grown and sold within seven years.

Avoid Lethal Mistakes
Despite the necessity for frank, incisive and forthright presentations, some firms have attempted to base their projections on certain elements that will not stand up against the harsh light of investor scrutiny. One is highlighting custom deals transacted during start-ups that distort pro-forma financial statements. A custom contract will lead to inaccurate revenue projections since it does not represent a firm's standard business model. This is an obvious red flag for financial experts.

Another is basing revenue on one price model. Most SaaS businesses require several, each with different margins to be calculated against profits. Then there are unrealistic sales projections that cannot be supported by the proposed use of funds.

Looking for some real deal-killers? Try presenting less than credible financial statements or an insufficient sales and market strategy for acquiring recurring customers. Then there is the management team. It should have a track record of previous business growth. Anything less than sufficient leadership will be viewed as an unnecessary risk.

Other potential lethal mistakes can occur from lack of forethought. Some examples include a failure to consider investor policies for follow-up funds that may be needed as the business grows and an inadequate determination of the exact extent of investor involvement in the company's decision-making process. An agreement, preferably crafted by a law firm, should enable the management team to run the business and not severely limit its ability to raise additional funds.

Converting the Cautious
SaaS vendors can overcome an inherent bias against large capital expenses for long-range profitability through effective and honest explanations of their business model. Financial experts on the receiving end of these pitches certainly appreciate long term growth, business value, increased margins and multiples. Such information hits the marks when presented with properly calculated and clarified evaluations of recurring revenue potential, future levels of invoicing backlog and capital to cover those crucial first years.

It is the best approach for converting financial skeptics of Software as a Service into supporters.


Steve Chunias is chief financial officer of LogicBay Corp., a leading developer and provider of channel training, management and development solutions. For more information, please call (888) 301-0751, email Steve at schunias@hotmail.com or visit www.logicbay.com.