Debt Financing: What Startups Need to Know… and Why Many Are Using It

Let’s talk about debt financing. First things first, I’m not neutral. I’m in the business of helping SaaS companies use debt to reach their goals. So this is not an ‘on-the-one-hand-on-the other’ post. Consider everything I say from this point on from that perspective.

There are two ways to fund your company; one is equity and the other is debt. The other ‘options’ you might be thinking of are essentially just variations on those categories or a hybrid of both.

In startups, people usually begin by investing savings then getting investment from friends and family. They start building a business, win customers, grow that customer base and start to hire people. Then there’s an office — well, not right now but… — and everything that comes with that. Overheads stack up.

You need funding to scale. It’s unwise to sell equity too early because you also end up giving away the upside too early as well. Debt is an option for companies who have revenue and are trying to grow that revenue. So…

What are your options?

You have many routes to choose from, but what you really need is a lender who understands your business, the pressures on entrepreneurs and are able to be a true growth partner. So what are your options for debt providers:

  • Main street banks offer very limited options if any and usually require personal guarantees, are slow to engage and do not understand your business.
  • Lenders who provide small lines of credit such as receivables financing – all good but limited in the amount and time to repay. These are not the right choice if you are looking to fund growth further than a couple of months.
  • A growing market of alternative providers. These lenders are becoming a real possibility for SaaS companies, the variations in the market include:
    • Revenue based finance: This is just debt financing where you repay the loan by sharing a percentage of your monthly revenue with the lender. These usually are priced with a multiple pay off amount or fee instead of an interest rate.
    • Term loans: A loan like any other where you agree to a monthly repayment each month, maybe some interest only period and a fixed or variable interest rate.
    • Flexible finance: A variation of the above, but it will let you grow the amount available to you by tying it to your monthly revenue. This is great for growing companies who need multiple financings along the way. These are becoming more intuitive and clever as to how they use technology to gauge how much to lend to your company.

Make sure you find a debt finance provider who doesn’t require warrants, personal guarantees, restrictive covenants, penalties if growth is not met or the funding is paid off early.

But what about COVID? I hear you say.

The pandemic has thrown up a lot of questions. Valuations have been hit and those needing additional capital in the last 6 months may not get the valuation they could have before the pandemic. In the meantime, companies have relied on PPP and debt to bolster their balance sheets. Airbnb is an example and I’ve gone into more detail here.

Debt is more available at the moment. Private capital has realised that debt funding for SaaS companies which have passed a certain stage makes a lot of sense. These investors know that the recurring nature of the income is such a strong revenue stream that it has underlying value. Banks should realise that but they’re taking their time to come around. The sooner they do, the better for SaaS companies.

You shouldn’t need to raise crazy amounts of VC money to get to $m’s in ARR, you can do it differently. If you’re a founder, you know that.

SaaS lenders want you to succeed. Lenders operate a business that needs high rates of success for companies and founders, unlike VC, who rely on big wins to make up for the bets which did not pay off.

VCs like to portray debt financing as predatory because it’s in their interest to do that. It’s more than a little bit hypocritical for VCs to accuse other parts of the industry of being sharks.

So SaaS lenders provide capital in a sustainable way to companies who can manage the debt. For the most, lenders will offer advice on how they look at lending to companies and it is a very honest process. I do these calls everyday and give straight, honest, fair advice to companies, no bullshit.

And now you want to know what I’m selling. Here it is —

How Element is different:

Element provides flexible growth finance to SaaS Companies, we want to be your growth partner and help you along your journey. We don’t require you to give us warrants, board seats or restrictive covenants, but we give you flexible solutions to help you grow.

Conclusion

If you choose the equity route, make sure it’s not just a cheque. Ensure they open doors to new customers or have experience which is going to benefit you in the future, e.g. if you want to IPO in 3 years, is the board rep they are sending your way experienced and likely to be helpful in this process?

Of course I’m going to be pro-debt financing. It’s my business. But I’d seriously encourage you to think about it carefully. It is a great option, and in the current climate, it could be the most efficient way for you to scale your company.

Talk to us about how we can help you. There’ll be no hard sell, just a good conversation.

Elements of Finance

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