Understanding the Financial Benefits of Debt
A while back, we explored reasons why a growing SaaS company might consider going into debt as opposed to taking out a bank loan, working with an angel investor, or giving up equity in exchange for funding from a venture capital firm. Beyond knowing why debt might be an ideal solution for a SaaS business, it’s also important to understand how debt is good for a company. Often, debt provides upfront and long-term benefits that aren’t available with other solutions.
Due to the nature of their industry, SaaS companies often face difficulties early on that make other avenues unviable. These include higher churn rates as SaaS companies seek to establish and refine their business, platform, and processes. Early-stage SaaS companies often lack physical assets like equipment and offices that might be needed for traditional funding solutions such as bank loans. And should a SaaS company decide to part with a portion of its equity in exchange for capital during those pivotal early years, profitability decreases (more on this shortly).
While equity-based funding has its time and place, it places limitations on SaaS companies looking to leverage their momentum, accelerate sales and marketing efforts, and reach the next level of growth — all while maintaining control over their operations and decision-making. SaaS debt funding is the stronger alternative, especially when it comes to financial benefits. Let’s explore how debt is good for a company in the SaaS industry.
Four Ways Debt Can Be Good for a Growing SaaS Company
1. The Cost is Lower
One of the most immediate reasons for how debt is good for a company is that its cost — versus the cost of other funding avenues — is much less expensive. This applies to both upfront expense and long-term expense. With debt, the borrower is legally required to repay it over a specified period (say, four to five years). While there may be some flexibility built into that, the debt will eventually be repaid. With equity, SaaS companies will be paying out a percentage of profits to the shareholder for as long as they hold that stake. It may be possible to purchase it back eventually, but that’s not a guarantee.
Additionally, depending on the lender, the debt capital arrangement might have little to no upfront fees associated with the loan. And when comparing the legal and due diligence costs of debt (shorter timeframe, less paperwork) with equity financing (several months or longer and significant legal reviews), the total cost of debt will be far more appealing.
2. The Profit Stays In-House
Another reason how debt is good for a company is that the profit made stays within the company and benefits no one but the founder, its leaders, and its employees. With equity, shareholders will be expecting a dividend payment. The more profit made, the higher those dividend payments will be — and the less profit remaining for the business. With debt financing, the only obligation is paying principal and interest. If profits are exceptionally strong one quarter, the borrower won’t be on the hook to pay more toward the debt (unless desired), meaning all of that glorious profit stays in-house.
Depending on the lender, interest-only financing may be available. Instead of making P&I payments, the debt portion of the loan is used to enable the company to meet its interest payment obligations and keep the profits entirely.
3. Interest is Tax Deductible
With the new administration, the corporate tax rate is expected to increase to 28% from 21%, meaning that opportunities for tax savings are more welcome than ever. With SaaS debt funding, companies can use interest payments as expense deductions against revenues to lower their overall taxable income and thus the overall cost of debt capital. With equity, dividend payments have to be issued from after-tax income and are not deductible. Companies with interest-only arrangements make debt financing even more appealing, as the payments made are deductible while also allowing profit retention.
4. The Long-Term Payout is Better
While the above reasons for how debt is good for a company to apply upfront and over the following years, one long-term reason to consider debt in a growth strategy is the financial benefit to founders upon sale or exit. We explored this topic in-depth, but the bottom line is that when all is said and done, SaaS debt funding provides founders with the most financially advantageous result after achieving their end goal.
In the comparison example we explored, we compared two companies — one that chose debt capital and one that chose equity capital — both of which were valued at $10 million and sought a $2 million investment. After four years, the companies sold for $100 million. Once the obligations and dividends were all settled, the debt-side founder took home $13.6 million more than the equity-side borrower. Read the complete comparison here.
Work with a Lender That Offers the Flexible Solution You Need
When you’re focused on growth, the last thing you need is to be using growth capital solutions that restrict your decision-making ability and limit the amount of profit and financial freedom you have during those crucial growth stages. At River SaaS Capital, we designed our SaaS debt financing to be flexible, scale with you as you grow, and ultimately help you leverage your momentum for more rapid success.
Offering loan amounts from $500K to $1.5 million (with flexibility up to $5 million) and various loan structures to support your strategy, our team will help you accelerate your growth while taking a partnership approach from the very beginning. At all times, you’ll be in complete control over your direction — choosing who and when to hire, what tools and solutions to use, where to take your platform, and more.
Connect with our team below to learn more about our SaaS debt funding capabilities, or apply online quickly and easily here. If you’d like to explore the benefits of debt capital in greater detail, download our ebook How Going Into Debt Can Grow Your SaaS Company.