Why Is SaaS the Best Business Model?

There are a couple of reasons why SaaS companies have the best business model in the world. Let’s dig deep into some of the most relevant.

Every business wishes it could charge a subscription for its services and get paid in advance before it renders those services.

There’s a reason every consumer product niche is now blanketed with subscription companies, whether they sell snacks, underwear, or Star Wars merch. The subscription razor startup Dollar Shave Club sold for a billion dollars.

John Warrilow wrote an entire book on how to do this with traditional, non-subscription businesses called The Automatic Customer: Creating a Subscription Business in Any Industry.

Recurring revenue protects you during recessions and builds on itself every month. Every business wants recurring revenue, but only some can pull it off.

With SaaS, it’s built into the business model. People expect to pay you every month (or year) for your product. There is no need for financial gymnastics; you get it free with SaaS.

During the 2008 financial crisis, I owned a small software product that sold for a $295 one-time fee. As the recession hit, my revenue dropped by 80% in one month. I was lucky I had other sources of income to support me, a few of which charged a subscription. This crisis was my wake-up call: recurring revenue handles economic downturns exceptionally well.

Even if revenue plateaus during a recession or other unexpected events (like the COVID-19 global economy shutdown), revenue tends to be insulated against a free fall thanks to its recurring nature.

My mental framework for success involves varying degrees of hard work, luck, and skill. The amount of each depends on a myriad of factors, with hard work and skill being the easiest to control.

Launching a B2B SaaS company is about building a real product for real customers who pay you real money. You’re solving a problem, and therefore your profitability is based on finding a problem that’s worth paying to resolve and solving it in a way that makes your users desperately want your solution. There’s not much luck in that formula.

Compare that to a crypto startup, a new social network, or a ride-sharing app. Each of these spaces has had dozens of companies focused on them for years, and their winner-takes-all dynamics require hard work, great execution, and a good bit of luck.

There were many social networks before Facebook and ride-sharing apps before Uber. Still, variables out of your control, like smartphone penetration, consumer behavior, or Internet speeds, can make or break your company. This tends to be different in SaaS.

Don’t bootstrap a SaaS product if you want to start a startup for the excitement or the press coverage. Instead, move to a startup hub, raise boatloads of money, and hope you’ve bought the winning startup lottery ticket. If you want to start a company with a higher chance of a “base hit” outcome (meaning millions or tens of millions in revenue or enterprise value), go with SaaS.

One of the most challenging problems to solve when building a startup is kickstarting a two-sided marketplace, where you need to bring both supply and demand to the table simultaneously (think eBay or Uber). It’s a bit like marketing two startups at once, and one of the most common pieces of advice I give to bootstrapped founders who want to start a two-sided marketplace is: Don’t.

It’s not that they can’t work, but they usually need a ton of funding to get off the ground, and building one requires much more luck than most people realize. With a two-sided marketplace, if you have 10 people on one side and 1,000 on the other, your business is a failure. With B2B SaaS, if you have one, 10, or 100 customers, you have a business.

There are certain startups, such as those that manufacture physical products, marketplaces that charge a transaction fee, or social networks that push off monetization for years, that burn capital in the early days much faster than they generate it from customers. These businesses require outside funding to pay for their burn until they hit scale.

For the most part, SaaS does not have this capital requirement. There are thousands, if not tens of thousands, of SaaS companies that are profitable, continue to grow, and have never raised a dime of outside funding. Companies like Zoom, Slack, and PagerDuty went public with an enormous percentage of their venture capital still in their bank accounts. Actually, Zoom had more cash in the bank than they had raised!

As I said in the introduction, I am not opposed to outside funding, and in many cases, it’s the best option to survive the early days and reach escape velocity. But one of the best aspects of SaaS is that you don’t need funding, but if you find it helpful at some point, your capital efficiency and incredible margins make it relatively easy to raise.

Because of the low cost of servicing additional customers, SaaS companies reach gross profit margins of 90% and net profit margins of 50% or more at scale. This capital efficiency is one of the reasons they are easier to bootstrap than most other types of startups and an abundance of cash flows into SaaS, both from venture capital and private equity.

The increasing volume of cash-seeking to invest in or acquire SaaS companies has driven their valuations higher and higher each year. Exact valuations depend on your annual recurring revenue (ARR), growth rate, platform risk, and other factors. Still, it’s not uncommon for a growing SaaS company doing $1 million or $2 million annually to sell for four to eight times top-line revenue.

Note I didn’t say four to eight times profit, a multiple many businesses would kill for.

Think about it this way: for every $1,000 of monthly recurring revenue (MRR) you generate, you generate $60,000 of value in your company (assuming you sell at five times annual revenue). That is an unreal multiplier on your effort.

You may build your company and run it forever, which is great. But if you decide to exit at some point, know that the value you’ve created in your company is enormous compared to the same size company in most other sectors.