Debt Financing vs. Equity Financing: Understanding the Key Differences

One Growing Company, Two Growth Choices

debt financing vs equity financingGrowing a software as a service business is no easy task. Regardless of your industry or geography, acquiring new customers, growing existing relationships, attracting top-performing talent, and managing the numerous administrative requirements of a business takes a great deal of effort from business owners and leaders. But the one thing that drives all those critical functions: capital.

For those growing a SaaS company, capital is everything. It’s how you retain and add talent, expand your platform, and keep your business moving forward. But subscription-based models often require SaaS companies to incur expenses early on to make sales that lead to future revenue, which can lead to cash flow challenges. So, what are your options?

In general, debt financing and equity financing are two available solutions for getting working capital for your SaaS company. These are two broad categories that encompass a variety of loan types and investments. Here, we’ll explain debt financing vs. equity financing, the specific options available, and when one makes sense over the other.

The Benefits of Debt Financing

First, let’s recap what venture debt financing is. Debt financing is a way for SaaS companies to obtain working capital without giving up equity or a board seat. While debt financing can come in the form of secured and unsecured loans, most venture debt lenders require some form of collateral. For banks, collateral can be a variety of things such as real estate, equipment, and accounts receivable. But growing SaaS companies often don’t have much in the way of these types of assets — if any at all. Thus, it can be difficult for SaaS companies to obtain a bank loan.

The best venture debt lenders allow you to borrow with more flexible terms and requirements. For example, some allow you to use intellectual property as collateral rather than a hard asset like real estate or equipment. They may also request warrants, which rather than requiring equity up front, can be converted into equity for the lender should it be necessary. And, unlike venture capital or private equity, you don’t have to provide the lender with a board seat. This allows you to maintain control over the direction of your company and growth plan. While your lender will not have the final say in the day-to-day running of the business, venture debt lenders often bring a wealth of operational and strategic experience — and the right lending partner will be willing to share it.

Finally, venture debt is often the much faster option in the debt financing vs. equity financing dilemma since funds do not have to be raised. As opposed to the months and months that venture capital investment can take to be finalized, venture debt is often completed in a few weeks — potentially less depending on the amount needed, your responsiveness, and the lender’s process.

The Benefits of Equity Financing

Equity financing is just that — obtaining capital in exchange for equity in your company. Equity financing comes through a variety of channels: venture capital sponsorship, angel investors, and private equity firms. Depending on the route you take, you’ll have to hand over a percentage of your company depending on where your company stands and the level of investment.

And, you’ll likely have to provide the investor with a seat on your board so they can have a say in the direction of the company and to ensure they realize their investment. Whether this works for your SaaS business is based on your culture and willingness to relinquish some control in exchange for a potentially significant investment (though it can take time to complete funding) and access to the often valuable experience and contacts that accompany VCs and angels.

Another benefit is that equity financing does not require principal and interest payments. Once you apply equity financing funds to your business, your profits do not have to go toward repaying debt. In the event your business doesn’t succeed, equity financing typically does not have to be repaid.

So Which Is Right for You?

Ultimately, equity financing can provide greater funding, but with the caveat of less control over the day-to-day decision-making and overall ownership picture of your business. Debt financing provides faster, more flexible funding, but you may be required to put up collateral in some form. Both avenues will give you access to a partner that takes an active interest in your business.

But in the debt financing vs. equity financing question, a final question remains: Which is right for SaaS companies? For SaaS companies, venture debt financing is a strong choice as it provides both funding and strategic and operational partnership while leaving SaaS owners and leaders in complete control. And when you’ve envisioned and built a platform, you want to be the one to control how it grows. Debt financing gives you the capital you need to ensure it does just that.

Learn more about venture debt financing for SaaS companies and how River SaaS Capital can help you achieve your growth goals.

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