When Capital Prohibits Growth, What Are Your Options?
For a growing subscription-based SaaS company, expenses can come close to or even exceed monthly recurring revenue (MRR) — creating cash flow challenges. Or, the business may simply need another infusion of capital beyond (or between) venture investments to propel growth. In either case, additional working capital is needed for a business leader to focus on growing a SaaS company.
So, how can business owners and leaders go about obtaining the working capital they need? Bank loans, angel investors, and additional VC investment are all viable solutions for growing a SaaS company. But each comes with a catch that might not be best for the long-term goals or leadership culture of the business.
This is where venture debt financing comes in. While it’s still a loan in the conventional sense, the flexibility of venture debt financing is what makes it beneficial for growth-stage SaaS companies with subscription-based revenue. We’ll touch on this shortly.
Venture debt isn’t a new concept, either. In fact, it’s been around since the 1970s. It took shape in the 80s and 90s, peaking during the dot-com era. When the Internet bubble burst, many lenders abandoned the market or became more conservative. While the early-2000s market stabilized, the credit crisis of 2008–2009 created more limitations for venture debt providers. A new breed of debt financing providers eventually emerged, offerings expanded and more flexible financing solutions appeared.
What’s the Difference Between Equity Financing and Venture Debt Financing?
Equity financing is a model that provides growing SaaS companies funds in exchange for an ownership position in the business. Angel investors and venture capital investors are examples of equity financing providers. Each provides different amounts of capital, but both will likely require a portion of the equity in your business as well as a board seat.
While equity financing brings certain benefits like a large amount of capital and investors’ experience and an extensive list of contacts, it can take a long time to secure funding, distract you from management responsibility, create legal restrictions, and of course, relinquish some ownership.
Debt financing stands in stark contrast to the equity financing model because it allows growing SaaS companies to borrow against recurring revenue instead of borrowing in exchange for an equity stake in the company. It’s non-dilutive, meaning you retain full ownership of your SaaS company and do not sacrifice any shares, which with continued success will increase in value. The debt may even be tax-deductible.
While some venture debt financing providers require SaaS companies to have previous venture capital sponsorship, others do not. Some allow you to repay the debt based on monthly performance. If your revenue is up one month, more will be paid toward the debt. If you’re down the next month, less will be paid.
So, when you’re considering debt financing versus equity financing, why is venture debt a good model for growing a SaaS company as opposed to equity-based financing? If you need capital, you’ll find it difficult to get funding through a bank because your company doesn’t have the assets they need to feel comfortable with the risk they are taking. VC funding will deprive you of a portion of ownership as well as a say in your company’s direction — both of which are valuable to your company’s future.
What Can You Do with Venture Debt Financing?
For business leaders focused on growing a SaaS company, a significant time sink can be fundraising. Meetings with potential investors, preparing and delivering presentations, participating in due diligence, and other activities can quickly consume business leaders’ time — not to mention the legal fees — taking them away from critical responsibilities like expanding their customer base, hiring talent, and enhancing their SaaS product. Debt financing helps you focus on actually growing rather than how that growth will be paid for.
But what if you already have equity-based financing through venture sponsorship? The good news is that venture debt can complement that financing to extend your cash runway between funding rounds. This allows growing SaaS companies to achieve business milestones and ultimately demand a higher valuation. When the time comes for another funding round, the debt financing capital used to accelerate growth can help minimize equity dilution.
What to Look for in a Venture Debt Financing Partner
Working with the right debt financing provider is critical to achieving your goals. Not all venture debt financing lenders offer the same loan amounts and repayment options, nor do they all serve SaaS companies of all sizes.
- What’s your recurring revenue? Some lenders may not be able or willing to work with you if you’re not at a certain monthly recurring revenue figure or won’t be for some time. Others may partner with you and provide insights to help you get where you need to be to take advantage of venture debt financing.
- What is your leadership culture? Are you comfortable with an angel or VC having an ownership position and say in the management and direction of your company? Or do you prefer to retain full ownership without any third party involvement?
- What are your long-term goals? Are you trying to raise capital for operations? Are you looking to build out your team and subsequently your customer base? Are you looking to invest more in your SaaS platform? Do you want to simplify your current debt situation, if any? Are you trying to extend your runway between VC rounds?
Answering these questions will help you know where you stand and match your company with the right debt financing partner. Once you have a company in mind, consider the following points to determine if their offering is right for you:
- What are their MRR or ARR requirements?
- Do they require you to be profitable when applying?
- What is their application process like (and how fast is it)?
- What is their maximum loan amount?
- Do they offer tranches for minimal interest payment?
- What are their loan repayment terms?
- Can repayment scale with your company’s growth?
- Can you re-borrow principal that you have already paid?
- What is their due diligence process like?
- Do they require venture sponsorship?
- Do they take warrants?
- Do they require an acquisition strategy?
- Do they lend and leave it there, or do they advise you?
- What is the experience level of their leadership team?
- How can they continue to support you in the future?
- Is there follow-on capital available?
Applying for Venture Debt: How to Do It and What to Expect
Once you’ve done your research, you might be wondering how to apply for venture debt financing. Depending on the company you’ve chosen, your initial application shouldn’t be too extensive — contact information, your MRR or ARR, and an explanation of what you’re looking to do.
Be prepared for a comprehensive due diligence process after applying. Questions typically focus on your SaaS metrics (CAC, LTV, churn, etc.), product offering, management team, and business plan. This information will be reviewed along with your financial statements, projects for the next couple years, current contracts to determine subscription revenue and customer makeup, and your sales process.
Once this information is complete, you’ll receive a term sheet for review and negotiation. Your lender should maintain a high-touch level of service and communication with you during this process to answer any questions and keep you informed of their decision.
When your loan is approved, you should receive your funds quickly. Of course, the speed of funding depends on the lender you choose, their process, and your participation. Try to partner with a lender that can help you get funding in an efficient time frame.
Once you’ve received your funds, you’ll be set to hone in on the most important thing you should be focusing on: growing your SaaS company. Lean on your debt financing partner for advice and strategy — they’ve worked with many companies before and understand the position you’re in. With the right partner behind you, you’ll be in a stronger position to achieve your goals.
Leverage your momentum faster than ever. Apply with River SaaS Capital now.