With SaaS companies offering apps that continue to provide efficient solutions to an array of modern business and consumer needs, the success of this platform format was assured. Nonetheless, as the volume of VC’s driving astronomic valuations increases and becomes more competitive, methods of driving growth and valuing companies are going through a much-needed evolution.
Having a clear understanding of cash burn and cash runway enables a company to accurately forecast the growth of their teams and investment in technology. For the investor, this additional transparency provides certainty. But how can this be achieved?
In this article, I will explore the SaaS phenomenon and how R&D tax incentives continue to play a vital role in driving company growth through non-dilutive R&D funding.
SaaS and Unicorns
Without the need for expensive installation and maintenance of site-based software, SaaS sits on the provider’s servers, is accessed over the internet and usually via a web browser. Low cost and low effort remain an obvious draw, but it was the ability to access SaaS solutions via mobile devices and scale usage quickly that resulted in widespread adoption. This saw the meteoric rise of SaaS fintech companies led to some becoming members of a select group of privately held companies known as ‘unicorns’.
The term has been widely used in the VC community for some time and refers to a privately held company with a valuation of over $1billion. Although first seen in the 1990’s, the term was officially coined in a 2013 article written by VC, Aileen Lee titled “Welcome to the Unicorn Club, Learning from Billion Dollar Start-ups”. Her analogy to the mythical beast hinged on her estimation that only 0.07% of start-ups during the 2000’s achieved this goal. In other words, rare.
Fast forward nearly a decade from Aileen Lee’s article and sightings have become more common. As of March 2022, there are now over 1,000 unicorns worldwide with a collective value of $3.5 trillion and typically occupying the technology, mobile technology and IT sectors (or a combination of the three).
As the basis for such high valuations is often supported by the fundamental finances and driven by an ever-growing appetite for late-stage private capital investment, this phenomenon has now been replicated so many times that it could be argued that the term ‘unicorn’ is somewhat redundant.
While money makes the world go round, it is necessary to acknowledge that state of the art innovation is at the beating heart of many of these companies, manifesting as incredible advances in technology and often providing answers to some of the toughest questions being asked of sectors including energy, agriculture, aviation, manufacturing, food, distribution, etc. Nonetheless, researching and developing new technology, hiring the right skill-sets and entering new markets is fiercely expensive and generates an insatiable thirst for cash.
Luckily, the prospect of missing out on the next ‘unicorn’ company has seen many late-stage investors waving goodbye to the risk analysis normally applicable to this scale of investment when compared, for example with an IPO.
The evolution of non-dilutive funding
Earlier stage (Seed to Series B) investors have, however, demonstrated a willingness to learn and adopt strategies that can drive short term company growth and increase investment ROI. As R&D costs represent the largest capital expenditure for many high growth companies, using non-dilutive R&D funding methods has become a higher priority.
Context is required to answer this and we need to go back 22 years to when R&D tax incentives were being launched by the stronger economies in Europe, (taking their cue from the success of the scheme in Canada introduced in 1944). Designed to drive continued investment in technology and create technological hubs that would drive employment, prevent the previously seen ‘brain drain’ of eminent scientific leaders and boost foreign investment in UK plc, the scheme took a little while to gain momentum. Initially, companies were unwilling to engage so readily with tax authorities but the generous incentives in the UK steadily gained traction. Bit by bit, the yearly R&D tax claims became an accepted part of the innovative company’s funding structure.
Notably, changes to schemes such as the reduction of benefit in Spain in 2010 which resulted in reduced levels of investment that returned to previous levels once the incentives were increased again, showed a direct correlation between localised government tax incentives and appetite for private capital investment. In other words, the incentives were fulfilling their purpose, so it comes as little surprise that we have seen the number of SaaS unicorns, particularly fintech, rising exponentially with the total figure in 2021 standing at 520.
Nevertheless, the end-of-year claim process that can bring back up to 33% of qualifying R&D expenditure to loss making companies in the UK have remained largely retrospective, ‘just-in-time’ processes. The downside here for a potentially high growth company is that this traditional approach only offers a small window of opportunity in which to leverage R&D data for strategic or commercial benefit. At a time when the very solutions offered by SaaS companies are delivering process improvements, it could be argued that this outdated approach to claiming R&D tax is no longer fit for purpose.
For companies whose activities and therefore expenditure are close to R&D, it is imperative to better understand the ‘true’ cost of people and projects. Implementing the accurate recording of project data through time-sheeting / ERP provides the means to improve cost analysis and gives better visibility of future R&D tax benefit.
Having this information sooner rather than later can influence a capital investment strategy for recruitment or investing in technology within a financial year. It can also open channels of non-dilutive funding to company owners and investors alike. For example, based on the Quarterly Reporting methodology we use, up to 80% of forecasted R&D benefit can be realised as short-term debt funding that allows companies to invest in resources more quickly. It also means that when they do come to raise further PE or exit, they can do so at higher values.
As part of a high-growth strategy, this data rich approach brings additional value to companies in improved accuracy and compliance with new legislation and guidelines at a time when HMRC are beginning to tighten the reigns. On this note, it could be argued that the incentive scheme in the UK has been a victim of it’s own success with over 62,000 claims (up 17% from previous year) totalling £5.1bn (up 15% on previous year) made since Sept 2020.
With greater competition for funding, particularly prevalent with SaaS fintech displaying the greatest number of new ‘unicorn’ companies in 2021 and the greatest end-user demand with 57% of US and European companies increasing SaaS spending in this period, some, like author John Mullins who wrote, “The Customer Funded Business” argue that the market is looking frothy. Others believe technologically driven productivity should be viewed in the same terms as the birth of the printing press or the industrial era that could lead to not just unicorns, but decacorns and so on.