Is IPO the right route for your SaaS business?
Do you worry about going forward with an IPO on the back of your expected continued revenue growth as opposed to your positive net income?
And as a result, are you wondering whether an IPO is the right exit route for your SaaS company?
Let me guess. You’re a high growth SaaS business reaching maturity. You operate in a market with plenty of room to grow.
Your VC/PE is nearing the end of its investment and is pushing you to exit via an IPO.
Or perhaps you have employees keen to exercise the stock options you gave them in your early days, that made up the difference between what you paid them and the market rate.
But you can’t help but notice the growing list of companies that have abandoned IPO plans due to worries about:
- The sustainability of their business models
- The weakening global economy
- Discounted valuations
And if that’s not enough, you’ve seen how hotly anticipated listings such as Uber and Peloton struggled when having gone public; their share prices halved.
So when is it the right time to go public? And if you decide to IPO, does it matter if your company is still losing money but at the same time growing fast?
Here’s what you need to know.
What are your reasons for considering an IPO?
Deciding whether or not to IPO depends in part on what you expect to do with the cash you generate from your listing.
For a SaaS company considering an IPO, you want to be in the position where you can use funds generated to develop your company as opposed to sustaining it.
What are the advantages of an IPO?
If you can find a stock market with experience in trading SaaS stocks (i.e. a stock market formed of investors who’ve developed measures to support you, such as valuation standards), then IPO funds can help you to continue your strong upward trajectory.
Chiefly research & development, sales and marketing, investment into sales efficiency, infrastructure, and expansion plans, including acquisitions all benefit from IPO money.
After that, when you IPO, you create a liquidity event which makes it easier for investors and employees to cash out. Plus, for you to pay off existing debt.
Beyond that, an IPO can generate publicity and business opportunities for your company which in turn can help you to increase your market share.
What are the disadvantages of an IPO?
On the negative side, getting your company through an IPO means expensive underwriting and filing fees.
Not only that, the IPO process is time-consuming and can distract management time away from a business.
Of course, time and expense don’t end with a listing. Post-IPO, you’ll need to factor in the time and cost of reporting requirements.
By the same token, as a public company, you’ll need to adhere to disclosure requirements. SaaS companies for whom IP is critical to their business models can find such disclosure requirements difficult.
Beyond that, once you take your company public, it becomes answerable to its shareholders. For you, as a founder, this means loss of control. And the need to adhere to stringent regulations.
Finally, liquidity is often an issue on smaller stock markets because investors perceive smaller companies as higher-risk investments. Consequently, going public can mean a great deal of uncertainty.
Does my company need to be profitable to IPO?
Not necessarily. It is the potential for generating future cash flows that form the basis for SaaS company valuations.
If your SaaS company hasn’t turned the corner into profitability, to benefit from an IPO, you must not only demonstrate your company’s ability to continue its fast growth but also its ability to operate with high efficiency.
What metrics does my SaaS company need to take into account when considering an IPO?
To arrive at a valuation, investors use revenue multiples to determine a SaaS company’s sustainability and ability to scale.
In the case of smaller private companies that lack liquidity, investors discount private SaaS multiples from public SaaS multiples.
Whereas at the time of IPO, market conditions determine public multiples.
Important metrics to consider when valuing a SaaS company include:
Of course, top of the list and critical to a successful IPO is revenue growth. You aim to demonstrate you have a market opportunity, sales efficiency and ability to grow at scale.
In particular, you should take into account:
- Perpetual license revenue
- Replacement license revenue
- Upsell revenue
- New users
- New markets
- Churn rates
- Customer acquisition costs
After revenue growth, profitability metrics demonstrate your ability to attract investors and fuel growth.
Gross profit (revenue less cost of goods sold)
Your gross profit measures the percentage you earn on the sale of your SaaS services. Use it to measure price point, cost of goods sold, and operational efficiency.
Gross margin (percentage of revenue that exceeds your cost of goods sold)
Your gross margin is a vital valuation driver, as it demonstrates your cost efficiency and ability to fare in a competitive market.
What are my alternatives to IPO?
If you decide you’re not ready to make the leap and go public, know you have alternative options for raising funds to keep your company on its growth trajectory.
At first glance, an acquisition is a hard exit route. Because when your company is acquired, you give up control. Having said that, when you sell your company to a larger company, you can use the liquidity created to payoff founders and investors.
If a Private Equity firm sees your potential, it can give you funds, resources and invaluable advice to scale your business over a set period, usually between five to seven years.
For the most part, with a PE firm on board, you remain in control. But a member of a PE firm will sit on your board and play a role in making decisions.
Here, your company asks a large number of people for small amounts of money through smart fundraising initiatives.
To generate momentum, you can offer compelling rewards.
When you restructure and refinance your existing debt, you can release funds to enable existing shareholders to exit.
Non-dilutive debt is suitable for companies wherever they sit in their growth cycles, including preparing for an IPO. Better still, debt comes with clear and finite terms.
For SaaS businesses, specialist private debt funds can use intellectual property as collateral for a loan.
Bridging loans are ideal for covering costs and giving you immediate cash flow/capital, while you prepare for your IPO.
Lines of credit
With a line of credit, you can access funds for as long as you need them by way of open-ended revolving loans.
Recapitalising your business with private debt creates liquidity you can use to buy out departing shareholders or a VC.
SaaS companies have much to consider when deciding whether to IPO.
As can be seen, if a pre-profit SaaS company can demonstrate strong revenue growth, sales efficiency and market opportunity, it is possible for it to IPO.
But it must be remembered, SaaS companies do have alternative options to IPO. Non-dilutive, flexible private debt is just one way for a SaaS company to generate capital to keep it on its growth trajectory.
Whatever your decision, know that raising capital always takes longer than expected. Along the way, you do not want to run out of cash or find yourself in a weak negotiating position.
For this reason, early exit planning gives you strategic, practical and monetary advantages.
To get your exit plan off to a good start, it pays to get specialist advice from a financial expert.
I’m ready. Are you?