Working in the VC space, you naturally come to learn a lot about the unique qualities and shared patterns that see companies grow from promising startups into established businesses. At Notion, we get to support SaaS founders and their teams as these journeys unfold and share in the excitement of their growth. But we also witness founder after founder hitting their heads against the same stubborn barriers.
The least exciting hurdles to overcome tend to be back-office distractions. A classic example is payments infrastructure, which can quickly become messy and expensive to manage, especially when encompassing billing and subscriptions. It’s typically the third-largest cost of running a SaaS business, after headcount and server costs. But it’s not exactly the sexiest part of the entrepreneurial dream, which is why we meet a lot of founding teams who haven’t given it any strategic thought, and why growing teams are reluctant to untangle or rip and replace systems that are causing them headaches.
We are increasingly investing in companies with a product-led approach to growth (PLG), which adds additional complexity for a few reasons. PLG normally means that companies want to sell globally (or at least in multiple territories) from day 1. Doing that successfully means catering to a platter of payments requirements from the outset, like different currencies and payment methods. And they rely on a highly optimized set of journeys through free and paid plans, including the checkout and payment experience itself. Any friction here causes big conversion problems and unplanned costs. Global sales tax liability also raises its head faster than many early-stage companies expect when pursuing PLG.
“Building a simple onboarding process and delivering quick time to value is vital for PLG businesses," says Itxaso, Partner at Notion and investor in PLG businesses, “PLG businesses want to reduce friction for their customers to get on board. Having a simple checkout workflow and a well-functioning payment gateway is critical to achieving this goal."
To scale successfully, SaaS companies must meet the challenge of robust payments infrastructure head-on, one way or another. Dragging your feet simply creates a drag on your growth.
The reactive approach
Early-stage SaaS startups typically build their payments infrastructure piece by piece when a particular need arises. If you launch with a self-serve model (normal in PLG), where customers pay and access your product through your website, you normally integrate a payments gateway, like Stripe. If you go to market with a sales-led motion, you’ll likely be using Xero, Netsuite, or similar to manage how you’re getting paid. With either sales motion, build vs buy seems like the simplest solution in the early days, but every time you reach a revenue milestone or introduce a new product or growth model, you’ll likely need to add a new tool to the mix, and eventually dedicated headcount. As you succeed, you’ll be taking more payments in more locations in more ways. This puts immense pressure on your payments infrastructure.
As you seek to expand your market reach and increase conversions, you’ll need to implement, integrate, and maintain the infrastructure that underpins different billing models – e.g. one-off payments, subscriptions, invoicing – and lets you support multiple currencies and payment methods. Finance will need to process revenue data from online card payments and invoices distributed across different bank accounts to get an accurate view of revenue. Suddenly your revenue data looks highly fragmented – a pain for forecasting and revenue recognition.
“Unifying and automating the billing and payments collection process is essential for global businesses,” says Pavla Munzarová, CFO of Mews. “Dealing with multiple separate services and workflows can quickly become a nightmare for billing teams and bring significant costs.”
There’s also the question of sales tax compliance, a highly underestimated challenge for scaling SaaS businesses. If your customer base is global, you need to stay on top of different tax thresholds and rates across locations, which is where tax tools come in. If you’re selling into the US, you’ve got over 11,000 tax jurisdictions to navigate at varying transaction thresholds. In Europe and Asia, there is no concept of Nexus; you are liable from your first transaction (as a foreign company). And we are not talking an average of 8% tax, like in the US, but between 18% and 22% where VAT applies. You’ll need your Finance team to register, file, and remit taxes in each jurisdiction – which brings complexity in terms of language barriers and unique legislation. Or you rely on the support of an external tax accountant or consultancy to do it for you.
“Rarely does a software founder start out considering tax compliance,” says Will Southgate, Finance Director at Notion Capital. “Yet when you grow successfully and internationally, it quickly becomes a serious and complex issue. Startups soon end up tripping over the sales tax thresholds in various countries, forcing emergency hires and reactive investments, attracting fines from various jurisdictions. We’ve also seen how these issues mount up, and create serious dings on valuation at later stage funding rounds.”
This approach becomes a growing time sink. Integrating and maintaining a suite of disparate tools distracts your engineers from product development and quickly requires a dedicated headcount. We’ve looked at how this adds up for two SaaS companies at different growth stages ($2M and $35M annual revenue) who shall remain nameless. We found that even at $2M annual revenue using only Stripe and PayPal and billing only in USD, there’s still need for 1-2 full-time developers just to build and maintain payments infrastructure. Meanwhile, there’s also need for a full-time employee (FTE) in Finance to cope with the manual processing and reconciliation of data from across their payments infrastructure and another FTE to handle all tax-related work. Another resource requirement is customer billing support, which is manageable enough in the early days, but in the case of our second company, at ~$35M annual revenue , they’ve needed to bring in two more FTEs to handle the load.
“With a regular payment service provider, you need a bunch of other stuff on top,” says Menno Olsthoorn, Managing Director of Resume.io. “One thing we looked at was a sales tax calculation software like Avalara or TaxJar. But even then, you still have to make sure you’re collecting the right information and file the taxes yourself - it’s way too much work and overheads for us to manage in-house.”
Another consequence of building your payments infrastructure in this way comes in the form of slower time to market and costly delays between a strategic decision being made and it being implemented. In the meantime, you’re leaving revenue on the table. You’re also inevitably limited on how far you can optimize your payments infrastructure by yourself. There are only so many payment gateways, local bank accounts, payment methods and currencies that you’ll realistically be able to implement and support. Constraints to your payment routing results in higher transaction fees, but also on greater volumes of payment failure, which affects conversions and causes involuntary churn.
“To get the features we needed, we had to use 10-15 plug-ins,” says Matamo lead developer and Innocraft Co-Founder Thomas Steur. “This meant at least one or two updates every week as well as the extra time to go through and address any problems or bugs that came up. While it was good to have the control to be able to go in and fix things in the open-source modules, it meant spending 3 to 4 hours a week just to keep everything secure and running.”
Cost and scope predictability
Founders are busy fighting the fires of today – they have very little time for tomorrow’s problems. So they build up until they reach a crisis point that needs solving yesterday. There’s a lot of variability in the timelines of the growth scenarios that create the requirements outlined above, but we see them unfold time and time again when SaaS companies progress from start-up to scale up and beyond. A considered review of the costs associated with a reactive, self-constructed payments infrastructure makes the importance of forward-thinking decision-making on this front all the more apparent:
And that’s not taking into account potential fines and penalties for non-compliance where you might slip up. These challenges and costs are not static; they grow as you grow; You need to consider the predictability of these costs over time. Payments, subscriptions, invoicing, tax – they all carry service and processing fees, headcount costs, and potential consultant fees. One of our portfolio companies, Paddle.com, has done extensive research into these costs over time and seen that they stack up to an eye-watering 7-9% of company revenue.
And the implications don’t end there. Your revenue data is scrutinized heavily by potential investors and needs to be accurate and consistent if you’re to secure funding. Due diligence could surface investment blockers if you’ve made errors or overlooked responsibilities related to sales tax compliance or fraud. Being audited for any reason can be a nightmare, let alone when wrangling fragmented data.
There’s a lot to consider here, and it’s easy to put your strategic decision-making on this front off until you feel the pressure. But if you don’t take the time now to really look at those barriers, there’s nothing to stop you from crashing right into them as you grow. So, what’s the alternative to the build-your-own approach?
Offload your payments complexity
Owning and investing in your payments infrastructure is one approach. The alternative is offloading it to a partner. Just like we traded trips to Best Buy for servers and cables for the convenience of AWS, certain payments infrastructure providers offer a new way to take care of the technical, financial, and administrative workload that underpins how you get paid and stay compliant.
Providers operating with the merchant of record (MoR) model, like software experts Paddle and general MoRs like Cleverbridge and Fastspring, are growing in popularity among startups who are looking to permanently offload payments complexity. An MoR essentially functions as a reseller of your software. When a customer makes a purchase, they’re technically transacting with the MoR, who purchases the product from you and sells it to the end customer. Transactions are routed through the global payments infrastructure already built and maintained by the MoR, who also takes on liability for all of the payments and sales tax compliance associated with those transactions. Revenue is processed and passed on to you as cash in the bank and as a single stream of data that you can connect up with your accounting and business intelligence tools. With the infrastructure there and ready to use, you can launch new models and strategies at a fraction of the time it would take to build your own.
“We’ve seen the MoR model grow in popularity within SaaS over the last few years,” says Stephen Chandler, Managing Partner of Notion Capital. “The best founders understand the core competence of their business, usually rooted in deep customer and market insight, and they seek to use best-in-class third party solutions in areas outside of that competence. Using an MoR removes complexity and risk from your payments infrastructure, increases financial efficiency and transparency, and allows for greater focus on your areas of greatest leverage.”
There are a lot of benefits to outsourcing the heavy lifting on your payments infrastructure. That said, handing over payments complexity to an MoR can feel like a loss of control, as certain transactional touchpoints with customers, like receipts, come with their name on and not yours. You’re also dependent on the MoR’s payout schedules as to when revenue reaches you.
When you're first getting started, it can seem cheaper and easier to implement a payment processor like Stripe. But as you scale across markets and geographies, the complexity rises dramatically. This is when the total cost of ownership for payments infrastructure exceeds 8% of revenue.
It’s important to consider the difference in the first year and think about the predictability of these costs over the lifespan of your business. And layer in the opportunity costs on top of that. Wherever you currently are in your growth journey, it stands to reason that you will go faster and further if you focus your efforts and resources on how your business delivers value, rather than building and maintaining your own infrastructure, be that web services or payments infrastructure. You can stand on the shoulders of giants for that.