There are lots of ways to fund a business. You can get a loan from a bank, but traditional banks are often wary about new, unproven business models, especially those of software or SaaS companies. Since banks don’t have a lot of experience funding this sort of company, it’s hard for them to evaluate risk in areas that are new and unfamiliar. You can go to a VC, but they look for rapid growth and fast returns, which may not be your immediate goals. The reality is it can be a daunting challenge to navigate the complicated landscape of fundraising to fuel growth initiatives.
Financing options relative to company life cycle
The SaaS sector is different from many others: given the recurring-revenue business model, companies can generate revenue, and attain profitability, earlier than other tech startups. This allows you to choose from a number of different models for financing, such as bootstrapping, raising equity, or non-dilutive debt financing.
What SaaS Founders Need to Know
Bootstrapping, or using your own funds, is common for SaaS startups; in many cases, it’s the easiest way to get early traction. But bootstrapping has limits. If you don’t start raising funds, this can prevent your company from growing at a key time in its evolution.
The choices you make early on have an important effect on the future of your business, and on your subsequent options. Many early-stage companies seek out angel and VC funding, but this isn’t the ideal solution for all new businesses. Lighter Capital’s non-dilutive debt financing can make more sense at certain times in your company’s life cycle.
Debt vs. equity financing
When investors trade cash for equity, this has a long-term effect on your company. They get seats on the board, which gives them a great deal of influence on your company’s choice of direction and how it will grow. They can limit your freedom in controlling the business that you founded. And they can even remove you from the business, if they don’t like what you’re doing. Giving up control by taking money from angels or VCs too early may not match your goals in the early stages of your business.
An increasingly popular way of fundraising in the early stage of growth is to forgo equity rounds and use non-dilutive debt financing. Lighter Capital has shown, in their first alternative financing industry report, that revenue-based financing has become the most popular form of debt financing for startups with at least $15K in recurring monthly revenue and with gross margins of 50% or more.
One reason for this is because our rapid, non-dilutive debt financing model allows you to attain your next growth milestone, expand personnel with new hires, and lead your company to better valuations, which make them more attractive to VCs.
How debt financing works
Choosing revenue-based financing, rather than fundraising from VCs, means that you retain all your equity, and don’t need to continue seeking out venture capital, with a loss of equity at each round of funding.
Lighter Capital’s alternative debt financing model is superior to other traditional debt rounds. With this approach, a company shares a percentage of future revenue – usually from 2% to 8% – in exchange for capital, which can be up to one third of your annualized revenue run rate. Loan payments are linked to monthly revenue, so they fluctuate as your revenue does: payments are higher in months with higher revenue, and lower in weaker months. Monthly payments eventually come to an end, usually when they have reached 1.2 to 1.8x the principal amount, or “cap.” After three to five years, the remainder of the cap is due.
Example of a revenue-based financing round from Lighter Capital:
- $500K loan funded on June 1, 2020
- 36-month term
- 1.4X cap ($700K in total payments, including $500 in principal and $200K in interest)
- Monthly payments equal 5% of net customer revenue
With this model of entrepreneur-friendly debt financing, you would retain full ownership of your company, and full control as well. You don’t have to up equity, board seats, personal guarantees, or stock warrants. The payment schedule is flexible, since borrowers pay a percentage of the actual income received from customers. If income is down one month, then so are payments. This allows you to grow your startup with non-dilutive financing.
When you have finished paying off the initial loan, you can raise more funding with an additional round of revenue-based financing, approach VCs, or get in touch with tech banks to help you achieve your next growth milestone. Lighter Capital has a partnership with Silicon Valley Bank which allows you to raise non-dilutive financing and get banking service in one convenient online hub.
How debt financing leaves future options open
When you bring in VCs for funding early in your company’s life cycle, this can limit your options as your company grows. Lighter Capital’s revenue-based financing allows you to have a great deal of flexibility going forward; there are no commitments once a loan is paid off. When your company has grown more, and you have a clearer path to the future, you can explore more traditional forms of financing, such as bank financing or angel/VC equity. Maintaining this optionality allows you to:
- Raise venture capital at a later time. Using revenue-based financing can push back the moment when your growing company needs to raise venture capital: and it can actually serve as a catalyst for VC rounds.
- Sell the company. With venture capital, it can be difficult or even impossible to exit a company, because VCs expect a high return on their investment, and they may be able to veto any potential sale. With revenue-based financing, there are no limits to what you can do. As long as the loan is repaid, you are free to exit the company whenever you want.
- Maintain a long-term strategy for the business. If you get funding from angels or VCs, they plan for an exit from the company, usually by selling it, because they own equity and they generally don’t want to stay with a company for the long term. With revenue-based financing, you don’t have to sell the company, because you repay the loan over time, maintaining all equity, and enabling you to keep the business as long as you want.
Revenue-based financing, along with Lighter Capital’s other non-dilutive forms of capital – term loans and lines of credit – are safe options for funding companies at different stages in their life cycles, whether they are in a period of moderate growth or hyper-growth. And your company doesn’t need to be profitable to qualify for this form of funding; most companies opting for revenue-based financing are in early growth stages when they burn cash. Lighter Capital’s debt funding model is ideal for companies regardless of what their future funding plans are: if they have already raised venture capital, plan to raise equity in the future, or will never go that route.
Non-dilutive debt is an excellent way to finance your company
If you’re looking for financing to help grow your startup cost effectively, consider the true cost of capital for each method of funding: debt is almost always cheaper than raising equity. If you want your business to be capital efficient and to grow along with your aspirations, and you want to borrow only the amount of money you need while retaining equity and control of your business, revenue-based financing is an alternative funding solution that may work for you. And with our fast funding model, you’ll spend less time dealing with the ins and outs of financing and have more time to grow your company.
Written by Joe Silver, Lighter Capital CFO
Joe Silver has over ten years of finance experience across corporate finance, commercial lending and investment management. Joe began his career at GE Capital and has since worked in microfinance, impact investing and financial technology firms. He received a BA from the University of Washington and an MBA from Columbia Business School.