The short answer is “as much as you need”. The more tactical answer is “as much as you can raise cheaply”. The latter is a pragmatic view. Raise more than you need when times are good. Just because you raise it does not mean you need to spend it – capital efficiency is always good!

In this post I look at what VC are saying SaaS ventures need to raise to get to scale and profitability. But I’ll also look at what VC are doing – what SaaS deals they are funding currently. I look at the capital efficiency drivers, what you can do to reduce your need for capital. And finally, I show you which VC are active in SaaS today.

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What Are VC Saying?

The answer according to Bruce Cleveland of Interwest is about $40m.

Take that seriously. Cleveland is a SaaS specialist with serious operational experience who has done his research on this subject. But as he points out, the details matter. There are two points of caution:

1. This is looking in the rear view mirror at ventures funded some time ago that did an IPO in 2007 or earlier. It is a different world today – less capital available and less need for capital.
2. VC are happy with models that require a lot of capital. Capital is what they have to offer and if you need a lot they are in the driving seat.

Lets look at the operational details, the capital efficiency drivers, in a minute. First, lets see what VC are actually funding today.

What Are VC Doing?

We looked at the Series A round for 17 SaaS ventures that closed after January 2007:

• Clarizen
• Maxplore
• Loopfuse
• Jive Software
• SlideRocket
• Elastra
• Syncplicity
• SocialCast
• AriaSystems
• Lavante
• Lithium Technologies
• Maxplore
• PivotLink
• SmartTurn
• Zuberance
• InsideView
• Bill.com

These 17 ventures raised $90.25 million total, an average of $5.3 million. That sounds like the “old normal” $5 million Series A. You can see how you would get to $40 million for a venture that is getting traction and can do a series of larger rounds at higher valuations. Lets say, a) $5 million; b) $10 million; c) $25 million; and total: $40m.

If the C round is pre IPO, everybody does well. But that is the old normal. The new normal is different. First, those 17 deals had two outliers: Jive raised $15 million and Bill.com raised $17 million.

Now let’s start with a later date. If we filter by Series A deals that were done after the market meltdown in Q4 2008, the average more than halves to $2.55 million. Those five deals are:

• Maxplore
• Loopfuse
• Syncplicity
• Zuberance
• SocialCast

Capital Efficiency Drivers

There are two numbers to obsess over.

1. How much does it cost to acquire customers? Cleveland defines this as CAC/ACV, or Customer Acquisition Cost divided by Annual Contract Value. If this is less than one you are in good shape. You can take this further. If you can get your customers to pre-pay for the year and your CAC/ACV is less than one, you can self-finance growth at least on the marketing side. Charging annually rather than monthly will slow down growth but that would be a small price to pay for controlling your own destiny. In some markets, customers will pre-pay in return for a discount and that is certainly the cheapest capital you will ever get.

2. How much do you need to spend per customer on infrastructure? The SaaS pioneers made a big play out of having their own data centers. When SaaS/Cloud was new, this was essential. Today you will be courted by lots of big, deep-pocketed, credible cloud vendors selling PaaS, IaaS and HaaS on a pay-as-you-go basis. The pay-as-you-go basis means you don’t spend precious capex on infrastrucure.

But more important is the total ICC or Infrastructure Cost per Customer. If this is low enough you can afford to be more creative with your freemium strategies – which will reduce your CAC/ACV if done right. In other words, your R&D guys had better pay attention to performance engineering from the get go. The days of throwing sloppy code out there and covering your mistakes with huge dollops of cash later are probably over.

Who You Gonna Call? SaaS Funders!

You need capital to build a SaaS venture. You can self-finance using the cash flow from another business. (Typically a professional services business as this requires no capital.) This is what both 37 Signals and Zoho/Advent did. But that is still capital, it is just your own capital!

If you have a small niche, you might need very little capital as it is easy to reach your market. Which is a good thing as no VC will fund a small niche. If you are have a venture that is in that rare magic quadrant that is both viral and monetizable… well you are one lucky dude!

For SaaS ventures that are going after a big market and have normal marketing characteristics, VC (probably preceded by Angel) is the conventional route. If you do decide to raise VC for your SaaS venture, it is better to go to a SaaS specialist.

We know this is not an exhaustive list. It is not meant to be. We have seen many VCs do one or two SaaS deals. We want to highlight the VCs that have done more than that, and that have an active focus on SaaS (a section on their site, a partner focused on SaaS, some interesting research, etc.). These are the ones that made that cut:

• Bay Partners
• Benchmark
• Bessemer
• Emergence
• HummerWinblad
• Interwest
• Northbridge
• TrueVentures
• Venrock

What you really need to know is, who is funding SaaS ventures right now. Here is the much shorter list of VC that have done two or more SaaS A Series deals since the start of 2007:

• Emergence
• TrueVentures
• HummerWinblad
• Venrock

OK, let’s make a really fine filter. Who has done SaaS A Series deals since the market meltdown in Q4 2008? That list is down to two firms:

• Emergence
• TrueVentures

In raising money, relationships matter – a lot. So if you know a VC that is not yet active in SaaS, call them. If your venture puts them on the SaaS map, they will love you. For most VC that like Internet or software like SaaS, the business model attractions are screamingly obvious.

Photo credit: Mokra
Discuss

Yesterday we wrote about Enterprise 2.0 from the point of view of the Enterprise, the buyer. The conclusion was that the impact of social media on the Enterprise was very big, addressing the very “nature of the firm”. This post looks at Enterprise 2.0 from the point of view of the vendor, specifically startups. This is a 30,000 foot view, but we aim to get past the hype to insights you can use in your startup. Further posts in our recently launched Enterprise Chanel will drill into specific market segments, companies and technologies.

1. Subscriptions are the best revenue you can get. Subscription revenue is more recession proof than advertising and more predictable than traditional enterprise software licensing. As long as you don’t mess up, you will have a low churn rate. Then your new subscriptions drive your revenue growth
2. It is much easier to get subscriptions from a business than from consumers. Sure we all love the idea of consumer subscriptions, the potential is enormous. But do this reality check. How many subscriptions do you pay for? How many current subscription costs would you love to eliminate or drastically reduce? What would your really (no, really) agree to pay for every month? We are in a serious consumer recession in the developed markets that may last a while. What was always hard, just got an awful lot harder. Selling to business is much easier, if you focus hard on the next rule.
3. The other 80/20 rule. 80% of enterprise IT budgets just “keep the lights on”. Only 20% goes to new stuff. I learned this in the technology nuclear winter in 2002, when a 20% cut in IT budgets meant that no (zero, nada) new projects were approved. If you can show how to reduce that 80%, you get a better shot at the 20%. That 80% market is a replacement market. You need to know what cost you are replacing. The incumbents are looking at the 20% budget as well and they have the inside track. You have to attack the 80% to make it big.
4. “Parallel replacement” is new. The old enterprise replacement market was based on capital expenditure write offs. If the client bought a $1m license fee over 5 years ago, you had a shot at selling another license fee for something “better, faster, cheaper”. In the new enterprise world of SAAS and open source, upfront license fees are the exception rather than the rule. Buyers prefer to hold onto the old stuff a bit longer until they can see either an open source or SAAS alternative. Replacement is always very risky, leaving incumbents in control and startups banging outside the door in frustration. So you need to show that you can run in parallel with the existing solution for a period until you are established enough to be a viable, safe replacement. Step 1 is run in parallel, step 2 is replace. This is what Google Apps and Zoho are doing to Microsoft office (I use both Google Apps and MS Office. Even though I use Office less frequently I own a license, so why delete it? When I get a new laptop I will decide whether I need to buy Office). To play this new parallel replacement game you need to a) offer a free entry point (the Freemium strategy) so you get traction with a low cost of sale and b) you need to show one very clear new value proposition that will tap into that 20% budget for new stuff.
5. Have one simple new “blue ocean” value proposition that any business user can understand. You need this to access the 20% of budget going to new stuff. Being “cloudy” is not a value proposition, it is simple]y a way to deliver your value proposition. The incumbent can always launch their SAAS equivalent. Your free entry level just gets you through the door so that you get a chance to upsell to your subscription; free is not a value proposition. You have to show how you will do something really basic such as either a) increase revenue with a low cost of sale or, b) reduce cost on an existing process or c) create strategic sustainable advantage in measurable ways. Most likely you will do this by enabling better collaboration/communication, both within the enterprise but also, more critically, outside the firewall to the “extended enterprise”. For a startup, this has to be “blue ocean”, a market that has not yet been defined by the incumbents. By its very nature, this means the market size will be very hard to define and there will almost certainly not be recognized external authority that has defined the market size. Smart VC understand that Blue Ocean strategy and precise market size estimates seldom go together.
6. SaaS ++ means that Open Source is no longer a problem. Open Source has been great for buyers but it has also taken the entry level market away in most segments and that trend shows no sign of letting up. That is bad news for a startup looking to sell traditional software with a “better, faster, cheaper plus we try harder” replacement pitch. You cannot undersell Open Source. That has forced many ventures with great software and strong teams into the dead-pool. With a “SAAS ++” offering, you can use Open Source as the base, add a bit of new code and bundle it all up with hardware and service in a monthly fee. Unless buyers really want to do all that in-house, using their dwindling internal IT staff, you have a shot at it. SAAS alone however is not a barrier to entry. Anybody can replicate it. Which means (smart) VC will/should pass. You need the “++” bit as well. That is likely to be something to do with viral, communications and network effects that create a growing user base and proprietary data coming from that base. That is the “magic sauce”.
7. You need to become a very good financial and data modeler. You will need some old-fashioned face to face relationship selling to get large enterprises to understand your solution, so that the "powers that be" encourage adoption and do not seek to block it. But the business will grow one subscriber at a time and users convert to subscribers one click at a time. Modeling becomes a core competency. Modeling the costs of all the SaaS components (R&D, hardware, infrastructure software, software maintenance, system and data maintenance). Modeling the cost of subscriber acquisition using SEO, SEM, social networking, conversion from free to paid and inside telephone sales in a highly efficient funnel process that delivers the right $ per subscriber. Modeling the revenue growth with multiple what if variable assumptions. Modeling the ROI for your clients at various levels of adoption.
8. Most external market size projections do not help your business plan. Forrester Research reports that Enterprise 2.0 will be a $4.6 billion market by 2013. That is not nearly granular enough for a real business plan. You are not really in the Enterprise 2.0 market. Saying “we will get 1% of the $4.6 billion Enterprise 2.0″ market is totally meaningless and will simply get you shown the door in the VC office. You are in the market of solving a specific business problem, for a specific type of customer, competing against specific incumbents and startups. That is how you need to build a market size, from the bottom up. This is particularly true for “blue ocean” strategies where the market has not been defined by an incumbent. Building the real world, bottom up market size takes real hard work and detailed market knowledge. Look for a small enough market where you can get 20% and take that to 50% share and then leverage that market to get 10% in another market. Rinse and repeat. It is an old formula, but it works.
9. You need VC, they need you but there is a disconnect. Since 2000, most VC have sent any business plan with the word “enterprise” straight to the trash. With good reason. During the nuclear winter, the enterprise IT market was dead as a dodo. Then the big incumbents got into the consolidation game and it looked like you would count enterprise IT vendors on the fingers of one hand. The cost of entry was high, needing expensive sales teams upfront and the revenue was lumpy and unpredictable. Yech. Better to back a few inexpensive developers building a free service that some big vendor would buy and figure out how to monetize. That was a great game for a while. Most VC now view it as in its final innings at best. There is a shortage of buyers, no IPO market, we are in a cyclical downturn for advertising and in a major funk figuring out how social media can be funded by advertising. So VC need Enterprise 2.0. But they have missed the early winners. Very few of the current Enterprise 2.0 startups are venture backed. This is a disconnect. The early players always find it easier to bootstrap than later vendors. Today you need capital to fund the ramp-up and to build distance from competitors as the Enterprise 2.0 market moves from “below the radar” to “early hype” phase, thus dragging more entrants into every category.
10. Vertical is not the same as Horizontal. Classic Web 2.0 services such as Delicious, YouTube and Skype are geared at mass markets. Anything that is more niche has tended to be called “vertical”. That is confusing. Vertical means a specific industry such as banking, healthcare or manufacturing and sub-sets of those industries. Horizontal (applying to any industry) should mean a set of common and linked features used by a specific type of person in the company (e.g. accounts payable by Finance, CRM by Sales and so on). The general rule of thumb has been for vertical ventures to be bootstrapped and eventually rolled up into larger entities. VC tend to view vertical as too limited. Horizontal on the other hand is big enough.
11. Know how to deal with secrecy, structure and control needs. Social Media is about being open, loose, unstructured, informal and fun; no ties allowed. Enterprises are about secrecy, structure and control. Ties show that you are serious and fun is for after work. The ties and fun bit is just style. But secrecy, structure and control is real. If you threaten those, many forces within the enterprise will shut you out. It will be like the red blood cells attacking the foreign virus. On the other hand, if you go along with all the secrecy, structure and control rules of the enterprise you will lose the social media benefits of extended enterprise collaboration and innovation. Many people within enterprises understand this and some of them are in a policy-making position of authority. In general, the trend is towards loose, unstructured, “emergent business networks”. So “make the trend your friend”, but beware of the very strong forces of opposition and deal positively with their legitimate needs.

Conclusion

What is your position in the Enterprise 2.0 market. Do you work in IT in a large Enterprise? Do you work for a large incumbent Enterprise IT vendor? Do you work for a startup that is going to change the Enterprise world? Are you writing about this rapidly emerging market? Do you have unique insights or research to share? We would love to hear from you in the comments and maybe as a Guest Author. Email us if you’re interested in writing for ReadWriteWeb’s Enterprise Channel.

You can subscribe now to our special RSS feed for the Enterprise channel.

ReadWriteWeb’s Alex Iskold recently described modern Biz Dev 2.0 techniques that do not involve knocking on doors and talking to people. The Internet is great at automating routine transactions and more software is being sold as a service on a simple “click here” to subscribe basis. But occasionally some contact sport is still required, and you have to resort to what we can now call Biz Dev 1.0 — what we used to call selling. You will need these skills to raise money and to sell your business, even if you never have to sell to anybody else. Fred Wilson reminded us of the most basic requirement, to ask for the order. Here are 10 other tips:

1. Close on every call. Whether your call is by email, phone or face-to-face, have one single objective that you can close. It might be “please sign here,” it might be “will you have lunch with me next Tuesday?”
2. Expect mutual effort. A sure sign of spinning your wheels is when you make all the effort and the buyer/investor does nothing. Ask them to do something to indicate some level of interest. If you don’t see this, move onto the next prospect.
3. Wait until you hear the screams. If you have a fire engine, you are not needed until the house is on fire. The best sales people wait until they see a real need before applying a lot of effort. One way to judge this, of course, is via #2.
4. Two ears, one mouth. If you only learn one lesson, this is it. This is particularly hard for technically oriented entrepreneurs with a deep passion for their product. People don’t buy products, they buy solutions to problems. Find the problem and show a solution based on your product. Ask lots of open-ended questions. People are much, much better at talking themselves into buying than you will ever be at talking them into buying.
5. Talk about the weather. This a lesson that I learned the hard way. Just as the buyer was about to sign, I said something that prompted a question that was critical and for which I did not have a good answer. The next day something happened, totally outside my control, that put the deal on indefinite hold. When somebody is about to sign, be quiet and if silence is uncomfortable find something banal to talk about.
6. Imagine the press conference. This is a good way to focus on the one thing that really matters to your buyer. What would the buyer tell the world about your deal? Assuming the usual attention deficit, this will be one simple point. Focus relentlessly on that one thing.
7. Recognize the emotional tipping point. Selling is a contact sport. You cannot do it by email or phone alone. Even in a long, complex sales cycle with multiple people in a decision team, there is one person who really matters and one moment when that person says to themselves, “I am going to do this.” Everything before that moment is preparation and everything after is clearing due diligence.
8. Stomach knots, table banging, and other good signs. These agita moments show both parties that the negotiating is nearing the end. It reassures them that they are not leaving money on the table. Of course, good negotiators can fake it, and watching that can be pretty amusing. (Is that what we are witnessing in the on-again off-again Microsoft/Yahoo! negotiations?)
9. Don’t take it personally. Look at every rejection as a learning experience. Really. Even if you think the guy was a jerk/idiot. If he is a jerk/idiot, how do you recognize jerks/idiots earlier so that you waste less time? More likely you did not do #2, #3, or #4 properly. In other words, it was not a good fit and he was not a jerk/idiot.
10. Measure face-to-face time. Biz Dev 1.0 is a contact sport. Email and phone is great for details and follow-up, but selling happens face-to-face. Always has, always will. So measure face time. But also remember #1, close on every call. Just socializing can be good to build some warmth in the relationship but my rule is that respect is essential, liking is optional.
11. Ask for the order. Fred Wilson articulated this well (and the comments are worth reading).

Even if you hire sales people to sell your product/services and M&A advisers to sell your company, some of these Biz Dev tips are likely to come in handy at some stage. Do you have any other tips? Post them in the comments.

One of the most difficult parts of starting a startup for any entrepreneur is finding that small bit of seed capital to get things going. As evidenced by small seed funds like Y Combinator, a little can go a long way for startup entrepreneurs, but raising that chunk of change to get started can be tricky. Luckily, there are a number of different roads you can take to get from concept to Series A. Below is a list of 13 seed funding options for startup entrepreneurs.

This list is a mix of old, borrowed, new, and blue:

1. Bootstrap from revenues. You will exit for an EBITDA multiple. Forget about crazy high multiples unless you have that magic formula that really can create high growth + low costs on almost zero capital — but if you really have that you won’t need/want to exit. Don’t worry about what anybody thinks other than users and customers. No, this does not have to mean enterprise products; consumer ad-supported works fine as well — just ask the founder of Plenty Of Fish.
2. Self-fund on credit cards and a second mortgage. You are brave, maybe brilliant, and maybe stupid. Just don’t expect any VC to give you more than words to recognize your courage. And also remember: it will take more capital than you think. Self-funding is not bootstrapping, it is just using your money and not somebody else’s money.
3. Do consulting on the side to self-fund. This is less risky than using credit cards. One partner works for a Big Old Dinosaur on contract for $20k per month and splits it 50/50 with the other partner, who builds the company which is shared 50/50 between the two. It gets a little more complex with more than two people.
4. Rase funds from friends and family. This can augment any of the above options. Richard Branson (a man who knows a thing or two about starting companies) can help with formalizing the relationship to avoid emotional damage.
5. Already a successful entrepreneur? Self-fund from cash via your last exit. VCs will be beating down your door to co-invest. Your choice…
6. Go from concept directly to $3m Series A. Wait, you did say your name was Marc Andreessen, right? No? Oh, sorry.
7. Use angels as a bridge to Series A. This is the perceived traditional route. If the angels know the VCs that is fine, but if not, then the VCs may cram down the angels, and that’s tough on you and those early investors that you’ve built a great relationship with. This works best if VCs tell you early, “We like the space/concept/you, develop it a bit and we’ll be interested. MyFavoriteAngel can help you get there.”
8. Use angels to augment bootstrapping. You have a to show a really clear path to profitability that is not dependent on VC funding.
9. Use angels as a bridge to a flip. Angels who know the target acquirers can make this a sweet deal for all.
10. Spray and pray models. A fund or incubator that puts tiny sums into lots and lots of ventures in hope of finding one star in the bag (see this post). Sounds a tad random to me.
11. Seek out founder-only evergreen seed funds. These are slightly more formalized versions of angel networks that aren’t managing other people’s money (i.e. LP=GP). Exits get re-invested into the fund, so there is no fixed time horizon for exit. There should be more of these.
12. Get a convertible loan from a VC to develop your concept to a level where Series A is appropriate. Charles River Ventures led the way with their CRV Quick Start program. More of these would be great.
13. Check out one of the paid links when you search for “seed funding” on Google. Not.

The good news: I planned my usual 11-point list and had to go to 13 (well 12, if you leave out that last one — which you shouldn’t). The bad news: none of these options are easy. But then, you already knew that, right?

For decades financiers of one type or another have been the “Masters of the Universe”. People who, as Bob Dylan once sang, “make the rules, for the wise men and the fools”.

In the 1970’s, with stagflation and oil crises, it was the commodities traders who ruled the roost. As the 1980s kicked in, the forex traders had their day; when Tom Wolfe published Bonfire of the Vanities in 1987, the leading character was a bond trader. From 1995 to 2000, the VCs in Silicon Valley had inherited the formula for turning base metal into gold.

Today the crown is shared by Private Equity (PE) and Hedge Funds. When you see the PE big shots selling shares to the public, you know the PE party is nearing its riotous end. And the Hedge Fund party is getting crowded, with too many lesser talented investors dragging average returns down – to levels similar to buying an index fund (but with massively bigger fees).

So who will be the next 'Masters of the Universe'? For the first time ever, maybe it won’t be another financial asset class. All those assets classes remain and their practitioners will always be wealthy and influential; it's a great time to be in commodities again for example. However, we are at a unique moment in history when power is shifting to creative entrepreneurs.

What are Creative Entrepreneurs?

I was going to just say “entrepreneurs”, but it is broader than that. Creative people – whether they are developers, musicians, actors, scientists, writers or (insert creative type that I have annoyed by omitting) – are the next Masters of the Universe. Entrepreneurs who tap the rise of the creative class will do well, but the trend is a deeper one that makes creative people into entrepreneurs.

This has huge disruptive and destructive implications for big companies which today act as the toll booths, through which creativity has to pass. Hedge Funds that like selling short can take note.

It is of course the Internet that changes everything. Here are the “straws in the wind” that indicate a pretty profound change:

* Radiohead opt to sell all their music online, by-passing the 4 major firms that dominate music sales and even by-passing the “new” toll booths called iTunes and Amazon. They are not the first and won’t be the last music artist to do this.

* Software developers who build an intuitive user interface on a SaaS model don’t need to sell to CIOs to get traction within companies.

* People seeking attention (for themselves, their products and services) no longer need to hire PR firms to get journalists to look at them; as long as they have something worth saying of course.

* In Hollywood, clout has shifted from the studios to actors and directors. Outside Hollywood, the path from YouTube to Sundance (and alternatives) to a growing network of independent cinemas is increasingly well trodden.

* For authors, yet another publisher rejection letter is less depressing when you can self-publish using Lulu.

* For entrepreneurs the VC round is no longer mandatory; with much lower start-up costs, lots of ‘pay as you go’ infrastructure, increasingly active angels and, yes, Hedgies willing to jump in with creative financing when you need to scale. See Fred Wilson’s recent post and Alex Iskold’s follow-up for more on this trend.

Conclusion: Power Shifting to Creative People

I don’t mean to underplay the very real barriers that still remain and the power still wielded by incumbents. This is a big transformation and one that won’t happen quickly.

A big reason that power is shifting to creative people is the reduction in inter-company friction. You can outsource pretty much everything, other than creativity. More importantly, you can use multiple smaller, specialist vendors on something close to a level playing field relationship – rather than being dependent on one big company that does everything to get you to market. When you add in millions of new knowledge workers from what we used to call the emerging markets, you have a formula that keeps the prices down and terms for these services quite reasonable.

Photo by Thomas Hawk