As a SaaS company, you have different funding options to grow your business. There are, of course, advantages and disadvantages to each route. In this post, we’ll look at the pros and cons of two common avenues for accessing new capital: Series A financing and Revenue-Based Financing.
Series A, Explained
Series A funding is an equity investment into a growing startup company. Investors—typically venture capital firms—provide Financing in exchange for shares in the existing company. A Series A round comes after ‘seed’ or ‘angel’ rounds. In the latter two, friends and family of the founders often invest in a business to get it off the ground. Series A funding shows that the company has grown sufficiently and shown enough promise to interest outside investors.
Revenue-Based Financing, Explained
Revenue-Based Financing is debt funding but doesn’t operate like a traditional loan. A traditional loan has a fixed term and a set interest rate. The cost of the loan is then amortized over the term. But with Revenue-Based Financing, the borrower pays (as the name suggests) a percentage of their sales each month to the lender. Interest is payable but in the form of an agreed-upon multiple. For example, a SaaS company may take $1 million in Revenue-Based Financing at a 1.5x multiple, agreeing to pay 10% of their monthly sales to the lender. Whenever the loan is fully paid back, the lender will have received a total of $1.5 million.
Advantages of Series A
The big advantage of Series A is that your company isn’t taking any new debt on its balance sheet and therefore does not have to make monthly or even quarterly payments. Instead, it only gets paid back through a sale of the shares purchased. This frees up more cash flow to be invested in monthly business growth. But another, perhaps more subtle, upside is that a Series A round can pique the interest of the broader venture capital community and ultimately set the company on the road for larger investments if needed and to an eventual IPO (hopefully at a great valuation, too).
Disadvantages of Series A
The biggest downside with Series A? In a word, dilution. Equity raises involve each existing shareholder owning less of the company once the round has been completed. That’s not the only disadvantage, though. In addition to simply owning less of the business, founders may lose control effectively if they take on venture capital investors. This can come about in two ways. First, the investors may require board seats or a veto over certain key decisions as a condition of the equity investment. Second, venture capital firms often take what is known as preference shares, which guarantee them a certain return before other shareholders are paid a dime. Depending on what the company is sold for, preference shares can render the common shares of the founders worthless.
Advantages of Revenue-Based Financing
Revenue-based Financing is attractive because of its flexibility. For example, if your company has a month or two of declining sales, you will pay less to the lender. Meanwhile, payments only increase when sales increase. Contrast this with traditional loans, where your payments are typically fixed no matter the state of your revenue. Another upside to this form of Financing is that the term can be extended if necessary to give you more time to pay off the loan.
Disadvantages of Revenue-Based Financing
One notable downside with Revenue-Based Financing is that it’s difficult at the outset to accurately estimate your cost of capital: That’s because, unless you have a crystal ball, you won’t know what trajectory your sales will take, and thus what the ultimate term of the loan can be. A related issue is that if sales explode, you may end up paying back the whole loan quickly, resulting in a very high cost of capital.
Whether a Series A round or Revenue-Based Financing is the right approach will vary depending on the company or founders in question. But before signing on the dotted line for either, it helps to know how the two stack up.
In search of funding for your SaaS business? We’re Element Finance, and not only do we offer Revenue-Based Financing, we also provide easy-to-understand term loans (and we don’t require equity warrants!) for companies just like yours. So give us a shout anytime. We’d love to hear about your business and see if we’re a match.