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Which Funding Avenue is Right for You?
We’ve explored the differences between debt and equity financing a few times here, but we wanted to take the approach of showing how both options impact founders, their ownership, the repayment process, and their eventual exit results. Be sure to review our other articles on the topic if you’re still exploring your options so you have the best understanding possible before making a decision.
Let’s Set the Stage
After several years of bootstrapping and focusing on pure organic growth, a SaaS company has achieved a pre-investment equity value of $10 million. Currently, the business has 100,000 authorized and issued shares, all of which are held by the founder, putting the price per share at $100.
To reach the next level of growth, the founder decides to obtain $1 million in working capital. As the funds will be used to accelerate growth, most of those resources will be invested in sales and marketing efforts such as expanding the sales team, hiring a sales leader, building out more advanced marketing solutions, investing in lead acquisition and nurturing marketing initiatives, and more. Some funds may be used for operational purposes, but a dominant portion of the capital will be focused on sales and marketing.
Preferring to work with an established organization instead of an individual investor, and wanting to avoid bank loans due to the organization being heavily remote and lacking significant assets, the founder decides to explore debt and equity financing options.
Shares & Ownership
- Equity Financing — In order to secure the investment amount of $1 million, part of the deal includes providing 10,000 shares to the equity investor. The founder creates an additional 10,000 shares, bringing the total to 110,000. Those 10,000 are provided to the equity investor. As a result, the founder has diluted his or her ownership by 9%.
- Debt Financing — With debt financing, the capital-issuing lender does not require any shares. (While some lenders may require warrants as part of the loan terms, not all lenders do.) By not having to issue shares to the lender, the founder retains total ownership over the company — avoiding outside influences on decision-making, finances, hiring, strategy, and more while also preserving their board seats.
- Equity Financing — To obtain working capital via equity financing, the founder navigates a long process of meetings, paperwork, due diligence, presentations, and legal reviews. Unfortunately, the journey takes several months (for other founders, the process can take up to a year or more) — prolonging the time until the founder can put the growth plan into motion. The upfront costs for this process were much higher than expected considering the number of legal reviews and time involved.
- Debt Financing — The founder identifies a SaaS debt funding company and applies for debt capital. After some initial conversations, the lender begins the due diligence review process. A term sheet is issued, and the lender and founder discuss the offer. The legal costs for debt financing are a matter of thousands, not tens of thousands, and the process is successfully concluded in a manner of weeks.
- Equity Financing — With equity financing, there is no formal repayment — although the founder must pay periodic dividends to the investor. As the founder uses the working capital, the company begins to grow. This results in the value of the shares increasing, which leads to higher and higher dividend payments (that can fluctuate depending on value, meaning they’re unpredictable). Depending on the founder’s long-term goals, the investment will be repaid when the founder exits (such as via a sale) or the investor decides to exit. However, the investor does not need to exit by a specific time. They can continue to hold interest in the company, meaning the founder must continue to pay dividends.
- Debt Financing — With the loan term set at 48 months, payments will be predictable. The founder uses the funds to invest in and accelerate growth, enabling the company to increase its share value. Over those four years, the founder pays principal and interest monthly. At the end of the four years, and based on the $1 million loan amount, the founder will have paid $972,707 in interest — making the total repayment $1,972,707. That might sound shocking, but hang in there — the end result will make things clearer.
Compare side-by-side: Explore the costs of debt and equity financing.
Exit & Founder Takeaway
For the sake of example, the company has achieved a $50 million valuation after four years. The founder decides to exit.
- Equity Financing — Because new shares were created in order to secure equity financing, the value per share has been reduced and stands at $454 (50,000,000 / 110,000). The founder’s 100,000 shares are thus worth a total of $45,455,000. While there was no debt repayment, the founder will also have paid a great deal in dividends throughout those four years as well.
- Debt Financing — With debt financing, the founder did not have to dilute his or her ownership. Principal and interest payments were made over the four years, satisfying the loan requirements. When the founder decides to exit, the 100,000 shares are worth $500 each — bringing the founder’s takeaway to $50,000,000. Factoring in the $1,972,707 that was repaid, the founder’s total takeaway was $48,027,293.
The total takeaway for debt financing is $2,572,293 higher than the equity financing takeaway.
And along the way, the founder was able to maintain the company’s growth momentum without outside involvement in decision-making or having to make unpredictable dividend payments (which, depending on the company’s success, could have seen the founder paying out even more over time). Clearly, venture debt financing is the way to go for high-growth SaaS companies wondering whether debt or equity financing is right for them.
At River SaaS Capital, we offer both debt and equity financing. Our SaaS debt funding is most often the first growth avenue chosen with our portfolio companies, and many have seen outstanding success as a result of using our debt capital. Whenever companies are ready to take their growth to the next level or achieve some other strategic financial objective, our equity financing offering is available. In both avenues, our highly experienced investment team works closely with founders and their leadership teams to provide advice, guidance, and support as requested.
And because we don’t take warrants with our debt financing, there’s no backdoor mechanism for us to obtain shares in your company. (Learn more about warrants and their impact here.) We believe in founders charting the course to their own success because they know their companies better than anyone else and have the vision to make that success a reality. Our team is here to support that vision and direction — not influence it.