Debt vs. Equity: Why Not Both?

In previous posts we’ve covered some of the reasons lenders love SaaS companies, explained why SaaS companies should be considering debt-based capital options in lieu of traditional equity-based investments and even offered tips on how to find the right lender for you.

What we haven’t discussed is how well debt-based options can work alongside equity investments to help SaaS businesses gain the momentum they need to achieve significant upside. Here’s just a few of the ways debt-based capital solutions can complement traditional venture capital rounds.

Managing Dilution:

When you’re growing a business with outside financing, how much equity to part with is a significant consideration. Your company may not be worth millions at first, but ownership is still the most valuable thing you have.

Smart entrepreneurs don’t obsess about eliminating dilution of their ownership altogether—after all, it’s nearly impossible to build a startup without outside financing. Instead, they do their best to control when and how they give up ownership to preserve as much of their stake as possible.

This is where debt-based options  can play a role. Venture debt and the term loans provided by River SaaS Capital can help address short-term cash flow issues without requiring an equity fundraising round. This keeps dilution to a minimum, while also extending the businesses’ runway.

The uniquely favorable economics of SaaS companies (fixed revenue and low costs) makes them a particularly good fit for these debt-based options. They gain the working capital needed to scale, but if cash flow gets constrained, they can scale back on sales and marketing, and use revenue to pay the debt while maintaining ownership in the process.

Obtaining Higher Valuations

Another area where debt can help companies reach their potential while preserving ownership pertains to valuation and achieving the maximum value at the next equity raise. The goal of every business is to maximize shareholder wealth, and having the financial leverage to scale sales and marketing and grow quickly will be reflected in investor interest at an increased valuation from the previous financing.

Done well, a company can combine debt and equity financing to obtain maximum cash for minimum dilution while staying on course for extremely favorable valuations. Since valuations are often set while conducting growth equity fundraising rounds, the key is to make significant progress between rounds, so as to receive a higher valuation.

It’s a delicate balance, but debt-based capital can be very helpful as a bridge when companies need funding but still need more time to meet major milestones before their next equity raise.

Overcoming Capital Shortages

Anyone doing business in the Midwest today will tell you that there simply isn’t enough capital to go around. The landscape has improved significantly, but there still isn’t nearly enough venture capital available to fill the needs of every growing startup away from the coasts.

In this climate, debt-based capital can be combined with venture capital to fill the capital gap. RSC, SaaS Capital, and Riverside’s recently announced debt fund are all additional tools in the overall toolbox of funding options for young software startups. Combining these options with burgeoning angel networks and seed funds can help startups away from the coast complete fundraising rounds and extend their runway.

To learn more about debt-based funding options, the kinds of companies we fund at RSC and whether our lending options are the right fit for your SaaS business, read our FAQ. Then fill out our short online application to get the conversation started.