Small but mighty: Micro SaaS and its future impact on the PE/VC industry

As the world shifts towards industry-targeted digital tools, micro-SaaS companies are becoming increasingly prevalent, and many investors are eager to capitalize on this growing trend. Our guest today has years of experience in acquiring and scaling micro-SaaS companies and has recently opened his startup acquisition firm. 

Throughout the course of this interview, we will overview the current situation in the market, dive into the challenges and opportunities that arise in the industry, predict the upcoming years for micro-SaaS companies, and share tips on startup acquisition. Stay tuned for the insights that will make you a startup acquisition pro!

Kjael's Bio

Kjael Skaalerud is a President of Skaling Ventures, where he and his team are acquiring and operating micro-SaaS companies. Kjael enjoys crafting go-to-market strategies that include acquiring, retaining, and expanding customer relationships to help SaaS businesses grow their revenue rapidly. 

Questions

Nat: You just closed a deal on acquiring another company last week. What was the company involved in, and what was the process itself? 

Kjael: For those that aren't familiar, conventional software buyouts usually start at 5 million to 10 million in recurring revenue. That's where the traditional lower/middle market firms play. And micro-SaaS is an even smaller order of magnitude. I'd say micro-SaaS companies generate from 500k to a million dollars in ARR. 

That's why micro-SaaS has its own flavor of buyouts. And I chose to take this path after I was formerly a PE-sponsored CRO at a private equity sponsor. After we grew and sold it to another sponsor, I had the opportunity to stay on that path and continue moving up the market. 

I've been following micro-SaaS for a long time. When I was about to have an exit and come into a small amount of liquidity, I started thinking about how I could actively grow this capital. And so I decided to take the path less traveled. There was a fork in the road, and I wanted to try a combination of micro-SaaS and a derivative of private equity. I also wanted to do it on my own terms and together with a team that I've grown to work with over the years of contractors and consultants.

That was six months ago. And I was fortunate enough as well to have a financial backer (like a search fund). It was a firm called Hellbar that was willing to cover the income. The financial backer put me in a position to go try and attempt different things that consequently made me very familiar with operating companies.

I've been a CRO, and a venture-backed VP of Sales, etc. I've always been on the 'sell' side of the transaction, but I've never been on the 'buy' side of it. So I needed to come up with processes, systems, what I am actually looking for in a company, what are the attributes that make a company attractive, and think about it with due diligence from the other side. Only then could I form a thesis from there. 

I'm very systems-oriented, and I always joke that "You don't rise to the level of your goals, you fall to the level of your system." So right out of the gate, I want to make sure that we at least have something that is highly documented that we can iterate on. 

Fast forward after the first quarter, I was wondering if I was ever gonna find a business. Am I ever gonna acquire something? Is it as hard as everybody makes it out? When doing business, you want to have that perfect kind of ratio: 60% of a total comfort zone, 20% of stretching, and the last 20% staring into the abyss and being terrified. I was probably running it at a different ratio, more terrified than I'm typically used to. But that's, of course, where the growth happens.

Lo and behold, last week, we closed our first acquisition. So we're building in public and documenting our thesis online, explaining how we're going to approach it and what kind of OKRs are more under the hood than people are typically used to seeing. I'm not going to name the firm we acquired, but I'll tell you that it's a business management platform for creatives – small businesses (one to five employees), a lot of solo practitioners, like photographers, event-based professionals, etc., which participate in creative domains. 

There's also a very textbook story about founders' DNA and where it fits into an acquisition scorecard. I have a story from my own experience where the founder was playing in the category of being also a software developer. He started building tools for himself, which is a very common kind of entrepreneurial trajectory and then was eating his own dog food, so to speak. It started to really catch on when he joined a peer group that was in the same category where he shared his tool with the others. 

All of a sudden, it started growing organically. Fast-forward a few years – he's the lead web developer and the head of customer support. He's trying to market the business when he can. So at this point, it starts getting to this plateau where over a number of years, folks start to think: "I'd like to take my chips off the table. This has been an incredible run, but I'd like to go explore other things." So exactly this situation happened to us. 

Another aspect of acquiring SaaS is a conversation around acquisition vs. retention vs. expansion revenue. The thing that really stood out to me in the SaaS business is this concentration on retention. If you have 100 customers at the beginning of month #1, how many customers of those 100 customers will stay with us in month #2? Ideally, you're looking for 98% retention or above if you're selling to small/midsize businesses. The retention rate really speaks to the utility and efficacy of the product, and the loyalty of the customers. And if this metric is on the high level, you can build growth on top of that. On the other hand, when your SaaS business is like a really leaky bucket, where you're churning 10-15-20% of customers month over month, it's very hard to sustain growth. 

Nat: You are fanatical about crafting go-to-market strategies for businesses. From your experience, which stage is the most troublesome for companies' founders? 

Kjael: The context of this question is highly critical. One way to simplify or generalize the context is to consider the stage of business you are in. The typical trajectory contains many options: pre-revenue or early revenue, seed, series A, and series B. But to be more general, there are only two business stages to consider – if your business generates revenue or if you're product-market-fitty?

Now you've got your first cohort of customers, you're starting to transition toward a repeatable customer acquisition model. And that's usually transitioning away from founder-led sales. The founder is running around just telling the truth about the business and why he built it. Now, how do we replicate that pitch in a certain way that's authentic and start to implement a sales team around it? 

That's when you get into: "We have X number of customers; how do we continue to grow? But also, how do we retain our customers? And how do we expand our relationship with them over time?" 

Revenue growth is very romanticized, especially in a lot of sales cultures. Being a salesperson, you want to be a hunter. You want to be responsible for new businesses rather than being a farmer. And the reality is, if you want to grow by 20 new customers a month and you want to keep the customers at the same time, this is counterintuitive. Because there are diminishing returns to customer growth, too. 

You can potentially find a honeypot of perfect-fit prospects and have a big month. But in the long run, it's hard to acquire the same consistent level of customers. Customer retention is usually calculated as a percentage of the whole. So, as your customer base grows, it's harder and harder to keep that 98% of retention. Okay, you have 100 customers and it's pretty hard to keep 98 of them. But when you have 1000 customers, it's even harder to keep 980. 

So the challenge of retention scales geometrically as your user base does over time. So to answer your question very simply: Retention is the name of the SaaS game. 

Nat: Do you have any criteria apart from screening the business that decides if you would like to work and cooperate with the founder, e.g., personal traits or beliefs?

Kjael: I wish that my answer wasn't the way that it is. Because you, of course, want to be like Ray Dalio with a scorecard and an algorithmic translation. You want to just look at a list of criteria, see the score, and if it's above a certain level, to pursue the deal, right? I was trying to get to that but that's where a little bit of my naivety, or this being my first rodeo, was exposed. 

Because actually, the seller or the founder and their vision are absolutely mission-critical. It's so important, you can almost kind of throw the scorecard out the window. Obviously, you have to achieve some base case score to be able to have the conversation about the acquisition. But once you're in there, a positive conversation with a founder can really change the dynamic of everything. And there are a few reasons for that. 

A conversation with the founder is where the process involves less science and more art, it's where the gut or instinct comes into. The problem is, how do you repeat gut or instinct? How do you train somebody on it? How scalable is it? So at the end of the day, I think that's what makes us unique, it's the secret sauce of your success. 

In the context of our most recent acquisition, there's been an interesting conversation around the notion of a founder market fit that makes sense, and it's pretty intuitive. I was considering factors like how intimate the founder is with the market that they're serving, if they were participants in the market if the founder has a really unique empathy for the category. Empathy meaning they understand the users, and their pain points so that the likelihood of them building something relevant goes up. 

That's the reason why I spend a lot more time now digging into the founder's background. And the logic is: you came from this market, therefore you understand it, and consequently, you've built something that's unique. That's the vantage point that you could exploit. Another one is when the founders are repeat entrepreneurs. It means that it is very likely that they're very good at seeing something in the market and executing their brains out to take advantage of it.

And once they get their business to a certain spot, they move on to the next thing. A type where they just see that stuff, and then they go for it. When you come across somebody like that, you can feel pretty assured that in front of you is a professional who moves quickly and confidently.

Apart from that, there is also a factor that I call reverse marriage. For a month, the founder and I have been married. For the next 2 months, we're engaged, and then after that, we're just dating. What I mean is that it happens backwards, where we gradually become less attached to each other. 

I like this comparison because when acquiring a new business, you have to trust the founder, the seller absolutely. It's not the case like buying a house – you get the keys and say goodbye. 

In this situation, the business is alive. There are customers, transactions, processes, concerns, and all these things that are constantly moving, living, and continuing to persist. You will need a guide to tell you about all the really weird stuff in that closet, where a lot of the bodies are buried, and what stove doesn't really work. 

So now I go into much more partnering with this person, at least for a quarter. And the success of that transition completely depends on my level of trust in that person. When you trust them, it comes down to a colleague type of conversation. It's not like you interview them, and screen them for competencies. It's more from the perspective of "Is this person going to be accountable to a binding agreement that says this is how the business is going to transition? Am I going to enjoy my time with them?" 

What's also very unique to business acquisitions is that I'm looking for a person whose skill sets are the exact opposite of mine. Those people are developers first, they are builders that create products. When it comes to the go-to-market strategy, they can get only one channel going. They don't buy any ads and don't send any emails. And if you ask them, "How are you growing this business?" They say: "People come to our website and buy the software." It's very rare and only scales to a certain point because you can't have only one channel going. That's where people like me come in and light up as many channels as we can. 

So there's an opportunity in micro-SaaS where those skill sets can converge. The person who got their business to this point can handle the reins but, at the same time, can stay on the cap table for some equity. This way, you make it more interesting where they can take another bite of the apple, so to speak, and continue to ride the ride for that next wave of growth. 

Why would someone want to completely walk away from something that they spent many years of their life, and tears, and blood, and sleepless nights and just hand it off? Especially when there's an opportunity for new energy and new thinking to come in and take it to a new place.

So now, for me, the person in the selling role of a to-be-acquired business is an absolute critical component to me. It usually boils down to believing they know this market better than anyone because they have participated in it. It comes down to thinking that they will be serial in their ability to do this. It comes down to wanting to partner with them for at least the next three months, taking ownership of this business and making sure that we don't lose anything, and then perhaps partnering with them in the longer run.

These are the DNA components that I take into consideration when deciding on business acquisition.

Nat: What are your predictions for the upcoming years when it comes to sales growth and capital movement? 

Kjael: There's a big correction in valuations, especially for SaaS companies where that was just a blip in the trendline that will never come back, and we can't rationalize it. If some company is trading at 20x forwards, we may think it's going to make this in the next 12 months trading at 20x. And it's typical to trade on the revenue you generated in the last 12 months. Even 10x is a really healthy margin. So obviously, valuations are rationalizing, especially in software, as the cost of capital is going up, and interest rates are going to go up. 

This has a big impact on the risk-free rate and the type of returns that people need to generate. The risk-free rate is around 5%, and that money is generally kind of liquid. If I'm gonna give you my money for up to three or four years and there's a risk you don't give me any money back, I need at least a 30% return, right? And all those things are all interwoven. 

Generally speaking, if you look at the value chain of a venture, it is power law, right. They're gonna put 100 bets out there, and 20 of them are going to generate the results that they need across the entire fund. It's their job to prop up new categories and capitalize by playing a bunch of speed seeds and just praying that some of them grow. Or sometimes it can be knowing that some of them will grow to be category leaders, and they'll push new categories forward. 

And that's where a lot of innovation happens. Then, private equity comes in the context of leveraging a bunch of debt and acquiring the company. It consolidates the company with its next two competitors. That's where the playbooks become more prescriptive and less experimental. 

Micro-SaaS is private equity. It's more akin to these buyout scenarios, but it's way down the value chain, where you would typically see kind of series A companies. When it comes to revenue, let's say they're doing 500k. We then decide to pile money in and try to grow it because we think it can attack a huge addressable market. We're going to acquire a business that's highly profitable. And we want to two or three exits and get it into that tier million in ARR, 5 million in ARR, whatever it is. We sell it to another financial sponsor, or we just hold the asset. It just kicks off cash, and we invest in keeping it relevant over time. 

When I think about capital allocation, I guess my purview is a little bit interesting. Because in my former role, I was selling software to fund managers. I didn't lack the context because I hadn't lived through economic cycles in that role. So it was just gangbusters, allocations to alternative investments were absolutely ripping. It was private equity, venture capital, real estate, and a couple of other derivatives there. So in a typical portfolio, they might have made up 2-5-10% of the whole. And if you look at huge pensions and sovereign wealth funds, alternative assets were now 30 to 50% of their allocations. So all this money was going into private equity, private assets, however you want to define it, whether it was adventure play, etc. I think that's going to pull back just a little bit because there was a buzz that generated a lot of first-time managers and emerging fund managers. So, we're going to struggle to generate an interesting return like the 2022-23 vintage. This could be a tough year for funds. 

But generally speaking about predictions, I think alternative assets are here to stay. If anything, it's becoming more democratized, which is a lot of what success is for me. Do you want to invest in scaling ventures? It's a two to three-year hold time. And we're going to generate 40 to 70% IRRs. And you can see under the hood at any time you're going to get monthly updates with actual financials, etc. 

If compared to a typical private equity fund, which is a 10-year whole time, a minimum check size of 500 grand, and you don't get visibility into anything. So this is not for the common human. And there are other concepts like Sweater Ventures out there. So really, I think alternatives are here to stay. It's going to become more democratized, derivatized, and people are going to have access to it in different ways. Just like everything, right? Everything gets democratized over time. I find that really exciting because micro-SaaS has a very interesting flavor that allows people like me to play in the space. It also allows investors to get access to the space. 

I would also be remiss if I didn't mention generative human language models and big ML frameworks. I mean, ChatGPT has totally changed my work on a daily basis. I just ask how big is the industry back to our landscaping, how many landscaping businesses are there in the United States, and at what rate is it growing? And it gives you the answer right away. Earlier, you'd have to buy an industry research paper on who are the top 10 software providers in this category and, how you would describe their value proposition, and how you would segment the market. 

So I believe that GPT is definitely a new layer of the platform that's getting added to the infrastructure of society, where if we had computers at first, then the internet, and then mobile. So now, generative AI is going to sit on top of that. And I don't see it as a threat. For me, the warriors that win the war have the best weapons. So if you look at it as just raw operating leverage, you'd like to incorporate it in your processes. 

At the same time, I'm not running at startup concepts that way or thinking about acquiring companies that are doing this because that's a very lemming setup. Right now, everybody has AI somewhere in their business. They know that's what investors want to see. So it's like, oh, this is a ChatGPT thing that does this thing. And there's going to be huge capital that just absolutely pours into that. Because they're like, hey, you know, this is basically a platform shift for the internet. We're gonna bet on 500 search companies, under the assumption that one will be Google. We know that there are going to be some trillion-dollar winners here. 

So ChatGPT is an offset of a lot of the cooling around software, evaluations, and layoffs, etc. That's going to happen eventually. So how do we leverage Ai in the micro-SaaS world? How do we plug this into our business models to make them more profitable? Because we're not into growth above everything. We want profitable, healthy businesses. 

For example, one of the applications wants to refresh the customer support function. Instead of writing all this content, why don't we take all the support content that's been written, train a model on it, and our entire support function will just be a chatbot that is powered by this huge model that is ChatGPT? Then we'll train it on all the content that's unique to our context. We don't need to write anything, we don't need to build anything. That's like a quantum leap for us! 

And that saved us 100 hours of work, maybe more. 

So, you should pull things like this into your world and take advantage of the investment that's happening from institutional players. And maybe think less about whether we want to acquire these companies or want to invest in these companies and think more about how this stuff gives me leverage today. And can I basically outsource any of my activities to this new emerging technology that is going to be a game changer?

Rapid-fire questions

Nat: Your biggest regret?

Kjael: I think one of my regrets was that I didn't come up with a calculus for happiness that was my own. I inherited society's, Western culture's, and American Culture's definition of success, which was money, and material possessions. 

I never kind of paused, I just lived in New York City, went to a top 10 business school there, became an investment banker, wore around dope suits, and drove around in fast cars. 

But when I actually need to think for myself and understand what makes me happy, I'd be going on one really great ski trip a year, having a family dinner, learning an instrument, reading books every morning, and having a cup of coffee. I'd like to go to a cafe every Friday and visit it with a different friend every week. 

Happiness is an equation that you have to come up with. And I regret that I didn't do that work earlier in life.

Nat: Denver or New York? 

Kjael: If my son asked me this one day, I would say New York. Rule #1 is to go where the action is. New York is one of the most exceptional training grounds in the world. One year in New York is worth three or four in another market because it just moves fast. Outside of that, I think I was there for ten years, and in the last five years, your sanity is just in structural decline. 

Looking back ten years ago, it was a completely different time. I remember on the subway, it was 2011, and iPhones had just landed so hard in New York. One of the first observations I've made is that every single person on this subway has an iPhone in their hand, and their head is down. So, fast-forward ten years, and you can make up for not having geographic proximity to New York now better than you could back then. 

So, if I'd blend that into the equation, I think I'd pick Denver over New York for sure. I love to ski, I love sunshine, and I love being outdoors, I like being close to my family. But I already did my duty, my ten years in New York, which turned me into a sixty-year-old man spiritually. Down in my head, Denver is definitely my preference, but it's hard to remove the bias and the context and everything that got me to this point. 

Nat: If your son wanted to become a president of a VC, what would you advise him? 

Kjael: On one hand, I'm a product of liberal arts undergrad program that taught me to be social, gave me a chance to travel Europe, create life-long friendships, and participate in one of the top business schools in New York City. And when you get to the end of it, it costs 160 grand.

On the other hand, my intention is to get my son level up, make his life easy and take away the struggle. I could give him five grand instead and see what he'll do with it. Is he going to buy an ATM and put it in this gas station on the street that has a ton of traffic and no ATMs? Is he going to start a lawn mowing business with his buddies? Is he going to be a lifeguard and put the five grand in some interesting stocks? 

When you're a kid, everyone is going to ask you, "What do you want to be when you grow up?" But that's a lie. You need to be able to iterate your way because life happens, and sometimes you have to reinvent yourself. 

So if my son wants to get into a private equity venture, to acquire companies and operate them, I think the first thing I'd ask him is to show how he's going to operate a business. How is he going to measure performance? How's his performance compared to his peer group? How is he performing against their kind of base rate? Is he seeing a rate of improvement over time? What evidence does he have that could make him elite in this domain? 

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