Understanding Venture Debt and How SaaS Companies Can Benefit
What is Venture Debt?
Venture debt is a form of financing specifically designed to help startups and pre-profit, high-growth tech companies. It can be assimilated to complement equity financing or used as a stand-alone product. It’s commonly known as ‘risk capital,’ and companies that make use of it do so because they lack tangible assets to use as collateral.
This funding method gives organizations greater flexibility when growing their business and, if appropriately structured, is less costly than equity. The debt is usually structured over three to four years and requires annual or quarterly payments.
Venture debt is meant more for companies that are already making steady revenue and have some history with funding. It allows founders to move the company into the next phase without impeding the capital.
Benefits of Venture Debt for SaaS Companies
You can use the funding to boost and accelerate your company’s growth. The following are just a few examples of how venture debt can help your business expand:
● Extending your organizations cash runway
● Having access to working capital
● Opening new sites
● Hiring more employees
● Expanding sales and marketing
● Developing new products
● Bridging to the next round of capital
Limitations of Venture Debt
The biggest downside of choosing this debt variation is the possibility of dangerous financial obligations. If, for instance, you don’t grow as quickly as you’d hoped, then you might not meet the required metrics as per the loan document.
This situation could lead you to default on the contract. When that happens, your loan is due for payment immediately, along with any accrued interest. Many startups don’t recover from such financial hits.
Banks also require a large amount of reporting. You’ll need to prepare monthly income statements, balance sheets, collateral audits, and much more.
Criteria for Raising Funding
Everybody, who’s even a bit familiar with the industry, will tell you that SaaS finance is a little bit tricky to nail. Most companies are volatile. They have shorter-term cash-flow models, so they sometimes fail to gain the potential investor’s trust. There are a few strict requirements a company should meet to qualify for venture debt.
Established Funding History
Before you can seek a venture debt solution for your SaaS business, you need to have already received funding from other institutions. Banks will want to see proof of reliable reserves from institutional interests. Unfortunately, angel investors don’t count. So if you’ve managed to raise $1 million from friends and family, your company won’t be a strong candidate.
Financial Sustainability
As you’re considering the loan option, you need to know that the potential investors will want to see some financial data. We live in a competitive world, and you’ll need to put numbers on your company’s performance. Prepare revenue and cash flow statistics and other relevant evidence the bank might want to see.
As part of the application, your company’s team and product will also be evaluated.
Availability of Relevant Metrics
Any SaaS entrepreneur knows that data is essential for running and growing their company. Investors and banks agree. They will most certainly request specific SaaS metrics during the company evaluation phase. Some of the more common ones are
● Customer acquisition costs (CAC)
● Monthly (MRR) or annual recurring revenue (ARR)
● Growth in recurring revenue
● The customer lifetime value (LTV)
There are several metrics that SaaS companies track, but not all are relevant to the process of raising money. However, the bank might request other information to justify your predictions, so it’s best to have as much data on hand as possible.
Venture Debt for SaaS Companies
The majority of SaaS companies have uncertain streams of cash flow. Many of them have negative revenue or are only breaking even. The majority anticipate negative income for a very long time before any positive returns will be seen. There’s a chance that the company will eventually have enough income to offset the lack of profit.
While current income streams are an essential way to gauge value, the company’s potential to produce higher future profit is a better indication of its worth. Venture debt can help boost the company’s progress, moving it forward towards the positive quadrant faster.
Take your time to track such important metrics as MRR or ARR. You’ll establish a more favorable arrangement for the investors to see the potential in your business. Moreover, if these metrics show steady growth, your chances of getting an excellent deal from the investors will grow exponentially.
SaaS metrics and business intelligence tools will also quantify the company’s standing, which will help you decide whether venture debt is a wise option for you.
In Summary
Starting a SaaS company isn’t easy, even with funding. Sometimes a business can see success on the horizon but get stifled by a lack of resources. Venture debt is a more affordable option than getting a traditional loan and can help place the startup on the right track.
Choosing to go with it isn’t an easy task. The company should be able to prove its future worth to potential investors. If your company happens to fall short on the promises of growth, it might default on the loan, which is an expensive road to hell for a startup.
It’s prudent for the business owners to seriously consider their metrics and make careful decisions before committing to this type of funding.
