The non-equity sources of financing for SaaS startups in Europe
During our portfolio day last year, I ran a workshop on alternative sources of financing for post-Series A SaaS startups which was very well received by our founders. It was quite surprising to me that many of them hadn’t even thought or heard about other options before, mostly because they simply had been too busy with their daily business or their “normal” equity fundraising activities. However, I believe that in certain situations it may be smart to not (only) raise money from VCs but also consider other options. Hopefully, my thoughts on this topic will also be helpful for other SaaS entrepreneurs out there that are not yet familiar with those alternative financing sources.
In case you have any questions/comments or want to share your thoughts on the topic, please feel free to reach out at andreas(at)senovo(dot)vc!
Which alternative sources of financing are there, who are the active providers in Europe and what are their typical investment criteria and sizes?
- Venture Debt:
This is probably the most prominent alternative to growth equity with a number of established providers in Europe, e.g. Kreos Capital, Columbia Lake Partners, Harbert, BOOST&Co (UK) and Silicon Valley Bank (recently expanding in Europe). In 2015, Barclays was the first of the big four banks to also offer debt funding for early stage companies in the UK. Providers of venture debt typically look for companies with significant assets or cash flows (ARR>$1m) and/or attractive growth rates and unit economics and/or institutional equity investors on board. Their investment size ranges from $1M up to $10M and is mostly tied to the amount of capital raised in the last equity financing round (rule of thumb: 25%–50%). - Acceleration Capital:
In late 2016, The Riverside Company announced a new growth lending fund, Riverside Acceleration Capital (RAC), which has an exclusive focus on enterprise software companies. At first glance, their offer looks very similar to those of other venture debt providers but they’re actually quite different in some aspects which will become more clear later on. RAC initially lends capital in the amount of $500k-$4M to companies with a history of efficient growth and a proven business model (ARR>$1.5M). - Working Capital Loans:
A much less known option which is particularly suitable for SaaS businesses is working capital loans which are mainly provided by banks and trade finance providers, e.g. Deutsche Handelsbank in Germany. The prerequisites for receiving working capital loans are quite similar to those for venture debt, i.e. significant working capital/cash flows (ARR>$1m for SaaS businesses) and/or institutional equity investors on board. Loan sizes start at $100k and are typically tied to the receivables/MRR of a company.
What are the typical deal terms and return mechanisms?
- Venture Debt:
The maturity (date on which the loan ends) is typically somewhere between 2–4 years with grace periods (periods without repayment) of up to 1 year. Some venture debt providers allow balloon repayments, meaning that you mainly make interest payments during the contract term and only repay the outstanding loan amount at maturity. Current interest rates range between 10% and 15%, but the total return expectation of venture debt providers typically lies somewhere between 12% and 25%. Therefore, venture debt providers often combine their loans with warrants or rights to purchase equity. Those warrants allow them to convert a share of their loan (rule of thumb: 5%-20%) into equity at the share price of the last equity financing round. These options are usually exercised before an acquisition or an IPO. - Acceleration Capital:
RAC’s model looks quite a bit different as they give money as a 5-year note and expect you to pay back a fixed amount between 1.5x and 1.8x their investment within that timeframe. Repayments start immediately and are coupled to the monthly revenue of your company. That also means that their return in terms of annual interest pretty much depends on how quickly you grow your revenues. Similarly to venture debt providers, they might combine their note with warrants or rights to purchase equity. Furthermore, RAC emphasizes on its ability and willingness to provide follow-on equity capital from their multi-billion PE fund. - Working Capital Loans:
Working capital loans are typically provided as revolving line of credit or as current account. Current interest rates range between 8% and 12% and the investment is secured on your receivables. Loan agreements do typically not include any warrants or equity kickers making it a “true” debt instrument.
Which source of financing fits best in your situation?
What you should be aware of is that all of the above mentioned providers of capital — in contrast to equity capital providers — actually expect you to repay their loan/investment in cash, no matter if you had a liquidity event in the meanwhile (i.e. trade sale, IPO) or not. Therefore, you should only borrow from those sources if you have a clear path to profitability, are planning to secure further financing or are going to exit your company within the contract term.
- Venture Debt:
In my opinion, venture debt is best suited for prolonging your runway to a next equity round or an exit. This is especially the case if you feel that you can significantly increase your valuation by creating more traction or reaching a major milestone until then. Also, it can be a very useful instrument to fund acquisitions as cash flows from the acquired targets may be used to repay the debt. Venture debt is also sometimes used to prevent the need for a bridge/down round to get through a tough period, but my take on this is, that it’s mostly not a good idea and puts you under extra pressure if things don’t work out well. - Acceleration Capital:
As the name says, RAC is best suited for accelerating your pace of growth as add-on to a (recent) equity round. This facility may help you to expand faster and reach your next milestones in shorter time. In my view, it is quite similar to an upfront payment from a very large customer contract which you have to pay back in smaller monthly rates (reducing your future cash flows). Considering that investment sizes only go up to $4M and the immediate start of repayment it is less suited for acquisition financing unless you have a target that creates positive cash flows right from the start. - Working Capital Loans:
Working capital loans are typically the cheapest source of financing for a SaaS startup and perfectly suited to cover your short-term cash needs. They, in particular, may help you overcome liquidity shortages due to some customers’ low payment moral. Being rather limited in size and contract term, they are not well suited to fund long-term projects or acquisitions.
What else should you consider when choosing a provider of financing?
First of all, you should always check in with your existing investors (if you have any) and see whether they are open to alternative sources of financing. Venture debt and other instruments are still much less known and spread in Continental Europe than in other regions, so your existing VCs might not be familiar with them or even be barred from co-investing with such financing providers by their internal investment guidelines.
Second, I’d recommend you to really understand and carefully compare all deal terms and not only nominal interest rates. The “real” cost of capital may differ significantly depending on grace periods, contract terms, equity kickers, etc. So please be sure to choose the package that best reflects your current and future needs.
Third, you should always consider what an alternative provider of financing can bring to the table besides the money. Are they supportive and collaborative? Can they assist you in shaping your future capital structure or do they even have domain-specific knowledge and can possibly bring value-add to other parts of your business?
Last but not least, — as with venture capitalists — I’d advise you to do research and reference calls on how a financing provider has behaved in the past. Have they been open to help other entrepreneurs restructure a loan when things did not go well? You definitely do not want the opposite if things are going south for you.
