Why is Cost of Capital Important?

The Route You Go Will Impact How You Grow

learn why cost of capital is importantWhen you’re weighing your growth capital options, it might be difficult to decide which avenue to take. Debt financing and equity funding both have their pros and cons, and those must be weighed alongside what you’re looking to achieve. While there are many functional differences between debt and equity, it’s also important to understand why the cost of capital is important with these two avenues. Just like every business improvement, you have to make an upfront investment to enjoy the benefits later.

If you’ve reached a certain monthly recurring revenue (MRR) and are ready to scale up to the next level, debt financing might be the way to go. This is because debt financing typically closes faster and allows you to accelerate sales and marketing efforts. Additionally, debt financing is helpful when you find yourself between equity funding rounds and need to extend your runway or offset your burn rate.

Equity financing, on the other hand, is useful for operational purposes, infrastructure or platform development, and other strategic needs — primarily for more established companies. Because an outside partner is taking a stake in your company, you can leverage their knowledge, experience, and contacts to achieve your goals. Capital received from equity funding can also be used for growth purposes.

Here, we’ll explore the cost of capital and why it’s important for SaaS companies that are weighing their options.

Why the Cost of Capital is Important with Debt and Equity

The Cost of Equity

The cost of equity capital is important for two key reasons. First, it’s significantly higher than the cost of debt financing. You will need to invest in a legal partner to assist you in reviewing documentation, performance agreements, financial requirements, stock agreements, and many other types of materials before the deal closes and you receive your equity capital. Legal fees are not inexpensive, and because equity capital can take time, you’ll be looking at a high cost for going this route in legal fees alone.

The second reason is closely related to the first: time. Reviewing all of this documentation and navigating the process will simply take many months. While there may be equity sources that close much more quickly, the average equity deal can take anywhere from several months to a year to close. This will cost you on two fronts:

  • Administrative Costs — In addition to legal fees, you’ll be paying your leadership team to participate in the process. Their time and involvement carry a cost that you’ll have to shoulder over the next few to several months as they work toward closing.
  • Lost Opportunity Costs — The more time and resources your team spends on the equity deal is less time spent on growing the business. Not having this capital in place for many months means you’ll have to pay for improvements and other efforts out of your existing revenue until the deal closes and you receive the capital.

That said, if you as a SaaS leader are comfortable and financially prepared to invest the time and resources needed to secure this type of funding, then there is nothing to stop you. Equity is a great opportunity for businesses to achieve specific goals and gain the insights and support of a proven partner for the long-term.

The Cost of Debt

The cost of capital is important on the debt side for a few reasons. First, the upfront investment is much less than equity. This has key benefits for smaller SaaS companies looking to leverage their momentum because you’re spending fewer resources upfront to secure an investment. In some cases, that upfront cost has been only a few to several thousand dollars as opposed to the five-figure costs of equity deals.

Time is also a cost benefit here. Because debt financing deals typically require less legal reviews and paperwork, you’ll be able to close and put that capital to work sooner. Depending on your goals and the creditworthiness of your business, debt financing can close in a matter of weeks up to a few months.

Another reason why the cost of capital is important with debt comes with the long-term. With equity, you’ll be paying dividends and will eventually need to recoup the equity that your partner holds, either when you decide it’s time or they decide to exit. Depending on your success, that could be a sizable check you’re writing to that partner.

Go deeper: See a side-by-side comparison of equity and debt here.

With debt financing, you’ll simply make monthly payments (either principal and interest or interest-only if you went that route) over time, typically anywhere from 36 to 48 months, though longer arrangements are possible based on your lender. There are no dividends to pay because there is no equity involved, and while you are paying interest on a loan, the end result can often be more favorable for SaaS owners down the road. With debt, those interest payments may be less over time than if you were to work with an equity partner, to whom you might be paying dividends for years.

Whatever Route You Choose, We’re Here to Help

Whether you’re just starting to research your options, or you’re coming down to a decision on which route to take, know that you can work with one proven partner for equity or debt (or both). River SaaS Capital provides both funding options and will help you understand why the cost of capital is important based on your goals.

Our debt financing solution is one of the most flexible in the industry, providing a variety of debt types, structuring options, and more. Our equity solution typically follows our debt, and we currently enjoy many long-term partners for both ends.

But above all, we remain a committed partner to you from the start — providing you with insights, guidance, and support from day one to ensure that your goals are a success while allowing you the freedom to grow your own way.

Connect with our team to learn more about the benefits of either option and why we’re the growth capital partner you need to achieve your goals.