Capital Sponsor Appetite for SaaS Companies Still Burning Cash?

January 23, 2020

by a searcher from University of California, Los Angeles in San Francisco, CA, USA

I'm curious what the general appetite from search fund LPs is for software companies still in the cash-burning stage. More specifically, growing SaaS companies generating between $3-10 million of recurring revenue typically do not have enough top-line to cover their larger expense base, mainly due to the nature of the subscription business model where R&D and S&M costs are high in the early years. As customer lifetime matures, however, they become highly profitable if retention and gross margins are high.

With this in mind, are there search fund LPs open to funding cash burning SaaS businesses that have strong unit economics, modest growth, and a clear path to profitability? I usually see LPs mandating profitability as an investment criteria, but it just doesn't seem to make sense for cloud-based software companies that generally don't become profitable organically until $15 million+ of recurring revenue.

Would be great to hear if anyone has more insight here, or has experience searching for SaaS companies in general.

Reply by a searcher
from Georgia Institute of Technology in 9 Medford St, Somerville, MA 02143, USA

I think the degree of cash burn is significant here; investors will probably not buy into a true VC-like profile where cash burn continues (or even expands) to fuel "hypergrowth" and dependence on future rounds is high. On the other hand, if the company is relatively close to break-even, I think you can show a model where the biggest difference in deal structure is leverage: in lieu of financial leverage (which will be hard to support and risky given the lack of cash flows), structure an all-equity deal where the inherent operating leverage of SaaS businesses drives the return. I think at least some subset of more sophisticated / creative search fund investors to be open to that pitch.

Reply by an intermediary
from University of Pennsylvania in Durham, NC, USA

Depending on the magnitude of the cash burn rate, debt financing is often available for SaaS companies with a clear path to profitability. From the owner's perspective, it's a better alternative to raising equity. However, debt is usually capped at 3x to 6x of monthly recurring revenue (MRR).

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