We love SaaS. If you want to learn more about how Magma thinks about Latin American Saas, check out our article. In this article, we’ll cover some opportunities and headwinds that Latin American SaaS founders have to deal with.
Opportunities: High margin, recurring, predictable revenue
“What makes the software market so fascinating from an economic perspective is that the marginal cost of software is $0 (...) it doesn’t matter how much effort was needed to create said software; that’s a sunk cost. All that matters is how much it costs to make one more copy – $0.” Ben Thompson in his Business Models for 2014 paper.
- High margins: Great SaaS companies can have 80%+ gross margins by having a lean COGS (Cost of Goods Sold) structure and being able to leverage their core tech infrastructure to upsell and cross-sell. A16z’s podcast episode on When Gross Margins Matter has some good hints of what should or shouldn’t be included as a “cost” depending on the company’s stage and whether they are leveraging new technologies.
- Low marginal cost: Once you’ve built the product and infrastructure, serving additional customers or providing upgraded features is highly scalable and cost-effective.
- Recurring and predictable revenue, rather than one-time purchases. A company can estimate how much money it’ll earn at the start of each month and make accurate projections going forward.
- Expansion by upselling/cross-selling is more organic, a single client can buy additional features by paying more, increasing revenue.
- Lower barriers for customers to try the product through free trials, short-term discounts, and freemium options. Clients can buy online and start using the product immediately.
- Longer-term revenue: Companies can have better long-term revenue growth by charging customers a recurring fee instead of a one-time upfront fee. (E.g. Microsoft Office used to cost around $500, but by shifting to a monthly fee, they are now making it cheaper in the short-term but more expensive in the long-run).
The headwinds against Latin America SaaS startups
After reading the last section, SaaS looks like an amazing business model. But there are some drawbacks, no matter where in the world you start your business:
Growth challenges
Depending on who you ask, SaaS startups need to reach a bare minimum of $10M of ARR to be attractive to VCs. Other VCs will say $50M or even $100M. These companies should be able to keep growing for years after that.
Global established competitors and bundling
Many SaaS products are global. There’s no need for a local Latin American alternative. Latin American companies will just use the global standard.
- Most companies don’t need a Latin American CRM. They use Salesforce.
- Most don’t need a Latin American version of Microsoft Word, Slack, Basecamp, Box or Gmail.
- Nobody got fired for buying IBM
- Enterprise customers generally prefer global brands rather than smaller, local companies unless the local company is 10x better than the global brand.
- Bundling and copying: Global brands (Google, Microsoft, Salesforce, etc) don’t need to have a better product than a startup for it to win: If they see that a startup’s new product is working, big companies would be able to copy it and then offer it for free or for a lower price as part of a bundle. Read more: Why Slack lost to Teams - Bundling and distribution by Snir David.
Transitioning to a fully automated SaaS
from an agency or consulting model is really hard! Every agency owner dreams of disconnecting their hours worked from the revenue they can make. But consulting isn’t scalable, and shifting your mindset is really hard. Many consulting or agency businesses aren’t 100% tech businesses and struggle to build out a tech company infrastructure. This transition can be amazing when it works.
Latin American Specific Headwinds: Lower prices, longer sales cycles make scaling more difficult
These challenges make it tougher for SaaS startups to reach the scale they need to in order to drive VC returns. Some of the reasons why scaling SaaS companies in Latin America is tougher compared to the US include:
Revenue growth
Most Latin American SaaS startups struggle to reach $5M in annual recurring revenue (ARR). Progressing to $10M gets much harder, and only a few achieve $25M or $50M. There can be amazing businesses that reach $3M-8M ARR, but in order to return capital at the rate that LPs in VC funds demand, VCs need to invest at a low enough valuation to drive a 10-15x return on exit.
- A startup that gets stuck at $5M ARR and is growing slowly might only be worth $5M-$10M in Latin America on exit.
- Founders who took little to no VC might be happy, but if you’ve raised significant VC to get to $5M ARR, it’s likely most of the exit will go to your VC’s liquidation preference and you might get very little.
- We’d love to see more models like Indie.vc in Latin America that can be win-win for founders who are trying to build VC scale SaaS, but might not become big enough for the VC model, but still succeed.
Lower prices
Compared to the US market. Latin American companies pay less money for the same SaaS than US companies are willing and able to pay.
- Most of the largest Latin American companies are only willing to pay what a mid-market company in the US might pay, so it's hard to scale.
Longer sales cycles in B2B
B2B sales cycles are naturally longer than B2C, but selling to businesses in Latin America involves longer sales cycles due to bureaucratic processes and additional local requirements like invoices, regulatory compliance and other formalities from each Latin American country. On the plus side, once you are in, it’s harder for a Latin American company to churn.
Lower multiples
Acquirers have generally been less willing to pay high multiples for SaaS businesses in Latin America compared to the US market or global SaaS.
- Founders often compare their LatAm-based SaaS businesses with those in the US or those with global reach, and try to aim for comparable multiples. In our experience, Latin America’s reality is very different from those in public benchmarks like Bessemers’ Index.
If you want to learn more about how Magma thinks about SaaS, check out our article which goes into detail about what we’re looking to invest in.
If you are a SaaS founder in Latin America or considering starting a new SaaS venture, whether you fit our funding model or not, we're interested in talking with you. We are always looking to connect with amazing founders in Latin America.
Feel free to create a Magma Memo to get feedback.
