Why is a SaaS business a good match to Venture debt?
As discussed in our previous piece, Venture debt is useful for companies who are still in the cash burn phase (negative cash flows) or lack the collateral required to access traditional debt.
This is very relevant to the SaaS business model since development costs are usually high before the first minimum viable product is created. After that there are additional costs to acquire customers, and it generally takes a while before a company starts to generate revenue. So after putting in the effort at the start and just as things are starting to get good — there’s a shortfall of cash. This can be particularly painful because with a good product in the market, you know you should be focused on growth rather than worrying about capital.
The good news is that SaaS businesses at the revenue generation stage are very appealing to venture debt funds. If you think about it, a subscription model allows for good predictability of future cash flows. Additionally, the cost to maintain your product is typically low and also predictable. At the simplest level, the development is done and now you just have to keep the servers running. If you mix this with good growth projections, you effectively have a very nice package to lend against. Through the numbers, the investors in this space have a good insight as to how your business structure will allow you to repay the debt.
So when traditional options of funding aren’t available, SaaS companies use venture debt as a tool to help them realise their potential and mature through the tricky initial growth phase. For some SaaS companies, VC investment may be unappealing because of the dilution of ownership. When you’re on the ground and see your product is start to generate revenue, you have a much better idea of its worth. At this stage existing equity holders and founders may feel that dilution is too high a price to pay given the future potential valuation of the firm. Venture debt here can act as a bridge to those higher valuations, or as a tool to stop further dilution completely.
Given the synergies between the SaaS business model and venture debt, it is important for a SaaS business to understand what options are available in this space and how they can access them.