Understanding Warrants and Their Benefits — and Risks
As you focus on building your SaaS business, you’ll likely consider a variety of sources for growth capital. From venture debt financing and equity-based funding to bank loans and other funding avenues, there are ample opportunities for your business to get the capital it needs to achieve its growth goals. For venture debt companies in particular, you’ll come across a common financial mechanism — warrants — that are both advantageous and risky to SaaS companies.
We’ve explored warrants in-depth before, but interest in them is growing along with increasing demand for SaaS solutions — despite the pandemic, Gartner put revenue for the SaaS industry at $20 billion more than last year.
For SaaS company leaders that might be exploring venture debt financing to accelerate marketing and sales efforts, it’s important to understand the key terms of warrants (which are also called equity kickers). This will help you decide whether you want to consider them as part of your bargaining strategy with your selected investor. (Remember: River SaaS Capital doesn’t ask for or accept warrants as part of our debt financing — more on that later.)
Want to speak with a member of our investment team about warrants? We’re here to help. Get in touch now.
Four Warrant Terms to Know When Exploring Venture Debt
Venture debt warrant coverage is the number of shares the lender or investor receives through the warrant. It’s important to understand that this is expressed as a percent of the loan amount the lender is providing as opposed to the value of the company. If you applied for a $2 million loan, and you negotiated a warrant with five percent coverage, then the coverage would be $100,000. This figure is then used to determine how many shares that equates to and the price at which the lender can purchase them should they choose to exercise the warrant.
The security is the class of stock your warrant gives the lender the right to purchase. Examples include common stock, preferred stock, and so on. There are no restrictions on the class of stock provided in the warrant. The terms of the class of stock offered will also be the same if the lender were to exercise the warrant. But unlike other forms of stock, warrants don’t have liquidation preferences. So lenders assume some risk in taking them — if your company failed, and the lender hadn’t exercised the warrant, they’d likely receive nothing even if they were to exercise.
In a venture debt warrant, the strike price is the price per share. This is negotiable with the lender. The strike price can be set above your current value, at current value, below current value, or — and this is common — for as little as one cent per share. Strategically, lenders try to set strike prices lower because this enables them to purchase valuable stock for less when they exercise the warrant, providing them with a greater payout. Even if the company is being liquidated and the stock value is low, it’s likely that they’d get more back from a lower strike price. This could be viewed as an insurance policy against possible failure.
Venture debt warrants feature an expiration date of anywhere from five to 10 years. This feature of the warrant is negotiable, and when the date comes around, your lender will have to make a decision on whether they want to exercise the warrant or let it expire. If your SaaS company is struggling or there are other complications, the lender may choose to exercise to recoup a portion of their investment (and send you a message in doing so). If you’re growing, they may want to exercise the warrant to take an ownership position in the business.
Why We Don’t Take Venture Debt Warrants
While warrants give lenders an incentive to invest in your company, the ideal outcome is for the lender not to exercise the warrant. Most lenders won’t exercise the warrant unless the company is being liquidated, but they may still choose to exercise at the expiration date — particularly if your company is performing well and the stock has been growing in value. This would enable them to obtain a portion of ownership in your company at a certain price and potentially sell it for a profit. That said, they might not exercise. It’s up to the lender, your relationship with them, and your progress.
At River SaaS Capital, we don’t take warrants because of what they represent. Our venture debt financing is non-dilutive, and while a warrant doesn’t provide ownership until it’s been exercised, we believe in allowing you to guide your organization as you see fit. Whereas equity investors take a portion of equity in your company and occupy a board seat (and we do offer an equity solution for those interested in its benefits), we want you to have the freedom and flexibility to make decisions without outside influence.
Our investment team believes in true partnership. We’re here to guide you on your growth journey and support you, but it’s up to you to call the shots. Our team will always be available to answer questions and provide advice and input, but when you’re free to make decisions on where your company is headed, the results are amazing. That’s because you built the business and the platform — no one knows it better than you. When you’re free to achieve what you set out to achieve, we both win.
If you’re ready to work with a company that values your leadership and drive for your SaaS business, we’re here to help. We’ve helped a number of SaaS companies achieve their growth goals, and we’d enjoy the opportunity to learn more about you and your objectives.