Wait, Isn’t Debt a Bad Thing?
You’re borrowing money that has to be repaid. You also have to pay interest on that debt, resulting in having to pay back more than what was borrowed in the first place. This can’t be a good thing! So why would companies take on debt when those funds could be applied toward other things like investing in the SaaS product, adding more people to the team, investing in sales and marketing, and so on? What could the benefits of debt possibly be?
Because when it comes to growing SaaS companies, the funds needed for those things often aren’t available. The SaaS model relies on sticky subscribers for a consistent revenue stream. During those first years, SaaS churn can be higher than normal as companies flesh out their model, define and implement customer service/success processes, and continually enhance the product for greater performance and usefulness.
So, when the need for additional funding arises, SaaS companies have few choices. Bank loans require collateral like equipment, property, etc., which SaaS companies often don’t have — or have enough of. Equity financing means giving up a board seat and a percentage of ownership of the company (as well as a chunk of any future sale proceeds).
Debt financing, however, provides funding as a flexible loan — without requiring physical collateral or an ownership position in the company. Of the options available, debt is often the most advantageous for this business type. Let’s explore these and other reasons why companies should take on debt as part of their financial strategy.
1. Debt Financing Keeps You in Control
We already touched on this, but the value of maintaining 100 percent ownership of your SaaS business can’t be overstated. Whether you’re the sole owner or share ownership with a business partner, your company has a mission and vision — a roadmap for what success looks like and what the vehicle will be to get you there. Keeping yourself (and your business partner or partners) in the driver’s seat ensures that you control the journey toward that destination.
With equity financing, you’ll likely have to give the investor a seat on your board. That means they’ll have a say in the goings-on in your company. Hiring decisions, strategy adjustments, major purchases or expenses, and more will all be on the table.
2. Debt Can Be Used to Regain Control
If you’ve already secured equity financing support, or if some of your early employees were given company stock as part of their compensation package, debt gives you an opportunity to buy them out. This puts you back in the driver seat so you can steer the company in the direction you want.
While having employees with stock doesn’t necessarily mean that they’ll have a say in the direction of the company, it can be a good idea for business owners to have complete control. This is especially true for SaaS businesses that are moving from the growth stage to the scaling stage. You might want to provide an early return to those employees for sticking with you during those first few years. Or it may be worth reducing the reporting requirements involved with additional stock owners as the business moves into the future.
3. Debt Can Be Your Bridge Between Raise Rounds
If you already have venture sponsorship, you’re likely well aware of the requirements and process for obtaining it. It takes time — usually a long time. Months and months. Sometimes SaaS companies don’t have that much time available. Debt provides an opportunity to extend your cash runway between raise rounds.
If your burn rate leaves you without enough time and funds until more capital can be raised, debt is a worthwhile consideration. Working to increase sales and reduce expenses is also worthwhile, but results are not guaranteed. That’s why companies take on debt — to ensure they’re able to get from peak to peak without getting stuck in the valley between them.
4. Debt Makes Sense When Cash Flow is Strong
Why would companies take on debt if they already have sticky subscribers bringing in revenue? Because that doesn’t mean cash flow is strong enough to help those companies move to the next level. It might only be enough to sustain operations, payroll, etc. Or, the current profit rate might not allow them to move forward fast enough to achieve their goals.
In these instances, debt can be used to help the business focus on growth-oriented tasks. Examples include ramping up a SaaS marketing strategy to attract new subscribers and recruiting new sales talent. This is one of the most advantageous uses of debt financing in that it helps move a company forward faster.