4 Capital Allocation Mistakes Smart SaaS Founders Avoid

Founder500 Sept 2022 Kevin Houston Head of Finance, Founderpath 4 Capital Allocation Mistakes Smart SaaS Founders Avoid … lessons I’ve learned from deploying $250m to SaaS founders over the past 5 years

My Quick Background Run finance and underwriting at Founderpath, joined as 1st finance hire Underwritten $250 million of SaaS debt to 190 SaaS companies over last 5 years Raised over $150 million from credit funds and banks

Over the next 20 minutes I’m going to show you lessons I’ve learned underwriting $250m+ SaaS deals LESSONS 1-2 LESSON 3-4 Overuse multi-year contracts (and what’s better) Let Receivables Get Delinquent Ignore Net working capital (plus why it’s better than cash) Mismatching sources and uses of capital

Lesson 1: The Downside of the Multi-Year Contract

Story Time - Cash in Bank vs. Cash Flow Hardware + SaaS Company

Which Contract is Better? Both contracts have average ACV of $50K

Which Contract is Better? Both contracts have average ACV of $50K

Let’s compare these 2 contracts Comparison Contract 1 Contract 2 Average ACV $50,000 $50,000 Discount 10% N/A Year 1 CF $135,000 $40,000 Year 1 MRR $3,750 $3,333 Year 2 CF $0 $50,000 Year 2 MRR $3,750 $4,167 Year 3 CF $0 $60,000 Year 3 MRR $3,750 $5,000 Which contract is better for (✔): Contract 1 Contract 2 Cash flow day 1 Total cash collected MRR Growth Net Dollar Retention Gross Margins

Comparison Contract 1 Contract 2 Average ACV $50,000 $50,000 Discount 10% N/A Year 1 CF $135,000 $40,000 Year 1 MRR $3,750 $3,333 Year 2 CF $0 $50,000 Year 2 MRR $3,750 $4,167 Year 3 CF $0 $60,000 Year 3 MRR $3,750 $5,000 Which contract is better for (✔): Contract 1 Contract 2 Cash flow day 1 ✔ Total cash collected ✔ MRR Growth ✔ Net Dollar Retention ✔ Gross Margins ✔ Let’s compare these 2 contracts

Lesson 1 Key Takeaways Multi-year contracts may help in early days but transition away from them as soon as possible TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Building in automatic upselling through the contract itself is an Net Dollar Retention cheat code Cash flow is your most valuable asset, maximize it to generate true cash profits

Lesson 2: Bad Accounts Receivable and What to Do About It

Example Company Metrics Metric Value ARR $1,400,000 Y/Y Growth Rate 53% Cash Flow Margin 14% Rule of 40 67%

Can You Really Count Customer Revenue Committed But Not Paid For 90+ Days?

Which Happens to These Metrics: Starting Point (⇧ / ⇩) ARR $1.4M Growth Rate 53% Cash Flow Margin 14% Rule of 40 67% Can You Really Count Customer Revenue Committed But Not Paid For 90+ Days?

Answers Which Happens to These Metrics: Starting Point (⇧ / ⇩) ARR $1.4M ⇩ Growth Rate 53% ⇩ Cash Flow Margin 14% ⇩ Rule of 40 67% ⇩

Lesson 2 Key Takeaways Ensure customers ability to pay - stay on top of news for your largest customers TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Instill a Close and Collect culture on your sales team Be Proactive - don’t wait to reach out for payment

Lesson 3: Why Net Working Capital is Good for Your (Balance Sheet) Health

Remember Lehman’s Commercial Paper Problem? Commercial Paper Demise Total Commercial Paper Outstanding, USD Billions

What is Net Working Capital? Net Working Capital = Current Assets - Current Liabilities Current Assets Includes Current Liabilities Includes Cash Accounts Receivable (under 90 days) Inventory - I remove this unless it’s high margin Prepaid Expenses - I remove this as it doesn’t convert to cash Accounts Payables Accrued Expenses Credit Cards Short Term Debt Deferred Revenue - I remove this for high margin SaaS (65%+ Gross Margins)

NWC Runway = Net Working Capital / Last 3 month average Burn What Can We Do With Net Working Capital? Calculate your runway Why not just use cash?

Cash is not king. Net working capital is. Raising Debt With < 12 Month Maturity Raising Debt With > 12 Month Maturity Cash Working Capital Long Term Liabilities Current Liabilities Current Assets Current Assets Current Liabilities Long Term Liabilities (>12) Working Capital

Lesson 3 Key Takeaways Look at both cash and net working capital when thinking about your Runway TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Be careful with short term debts if you are planning to use the capital for growth Spend time with your balance sheet each month to see how accounts are trending

Lesson 4: Match Your Sources and Uses of Capital

Uses of Proceeds Good Use of Debt? Bad Use of Debt? Marketing Program with a Return On Ad Spend (ROAS) of 1.5x

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? X Short term debt is a great option Marketing Program with a Return On Ad Spend (ROAS) of 1.5x

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option Marketing Program with a Return On Ad Spend (ROAS) of 1.5x

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here Marketing Program with a Return On Ad Spend (ROAS) of 1.5x

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here X Long term debt would be better Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here X Long term debt would be better Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year An Engineer hire to work on a new complementary product

Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here X Long term debt would be better Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year An Engineer hire to work on a new complementary product X 48+ month debt, equity, or profits best for this X 48+ month debt, equity, or profits best for this

A Mental Model for Capital Raising Credit Cards (<1 month) Marketing Spend Short Term Debt (<12 months) Other Go-To-Market (sales hires, SEO, etc.) Long Term Debt (>12 months) Equity / Retained Earnings* Product & Engineering Capital Product Duration Use of Proceeds Duration (months) As a SaaS founder, you should use a combination of capital sources so that you can invest across your organization and manage the risk of the products used. It depends on your use of proceeds: *Retained Earnings are net cash flows produced from current operations. 60+ 0 1 12 24 36 48 Duration (months)

Lesson 4 Key Takeaways You can use multiple sources of capital to build your balance sheet TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Manage risk through your sources and uses of capital Create buffer in your plan to maximize optionality

Key Takeaways 4 MISTAKES AVOID Founders top job is to mitigate risk Bootstrapping requires patience Double down on small experiments to control risk Multi-year contracts Receivables (watch out!) Net working capital Matching capital sources and uses

Over the last 20 minutes I showed you lessons I’ve learned underwriting $250m+ SaaS deals LESSONS 1-2 LESSON 3-4 Downside of multi-year contracts (and what’s better) What to watch for with your receivables Net working capital (and why it’s better than cash) Matching sources and uses of capital

Sept 2022 Kevin Houston Head of Finance, Founderpath