The word “debt” often takes on a negative connotation in our minds. We think of personal experiences with large credit card bills, unpaid mortgages, and other stressful financial liabilities.
For your company and from your investor’s point of view, debt can mean the possibility of default, and with it, a loss of IP and assets. Not to mention, debt repayments can be extractive to your business.
But, contrary to popular belief, when it comes to tech financing, taking on debt can actually be a good thing! It can give you the capital you need to accelerate the growth of your SaaS venture post revenue.
The traditional way to fund tech companies
When you hear the phrase fundraising, I bet your mind immediately jumps to venture capital. You wouldn’t be alone.
We operate in a world where the bigger the round, the more high-profile the investors, and the more attention you get. It’s intoxicating at times.
However, amidst all the excitement, it can be easy to ignore some of the long-term impacts for Founders when it comes to taking on VC funding at the wrong time. Namely, the percent of ownership and the value of equity exchanged away.
The ownership stake for Founders at exit usually ranges between 15-20%, inclusive of Co-Founders. Through rounds of investment, generally a Founder can expect about 50-60% of the company to be exchanged to investors (the delta is usually spread across different tiered employee stock options).
With valuations continuing to flatline or even sink since their peak in 2021, that ownership stake has the potential to dwindle even further and at a greater speed, as Founders may be forced to take on more rounds of funding to get the money required to scale their company.
What’s a Founder to do?
Thankfully, taking on debt can offer a viable alternative for companies seeking to get funding and grow, while still holding on to their precious equity.
This is because most debt – excluding venture debt – is generally non-dilutive. (In certain high-risk investments, lenders may require covenants or even warrants, but those vary by provider.)
Debt also comes with a host of other SaaS-friendly benefits:
- It’s fast. Debt can be accessed in a matter of days or weeks, whereas a typical venture raise will take anywhere from 6-9 months, eating up time that could be spent running and growing your business.
- Its impact is felt sooner. Because of the shorter timeline for acquiring debt, it also means it can be deployed sooner, impacting revenue growth earlier on and potentially speeding up the path to profitability.
- It comes with a higher likelihood of approval. Most non-dilutive offerings are based on business performance, cash balances, and (sometimes) assets – so they don’t come with the normal hurdles of hockey stick growth you see with VCs.
- It’s cheaper than equity. Maybe not today, but down the line those additional points of equity could add up to potentially hundreds of thousands of dollars or more.
It’s important to understand, however, that there are a lot of different types of debt – bank loans, online lenders, alternative capital – and they all have different qualifications for funding and varying requirements after funding is received.
At Novel, we believe that your IP is one of your key assets, and therefore we never put our customers’ ownership of their idea at risk in instances of default.
But not all lenders share that view, so when taking on business debt, it’s important to know not only the terms, but also fully understand the impact of different cost structures.
So, how do I know if debt is right for me?
This is where capital strategy comes in. It’s important to define a plan, including what types of funding you’ll seek, how much capital you need, and what is the appropriate timing that allows you to maximize your valuations and capital access at each milestone in your journey.
Here’s a quick example:
Founder A starts off by owning 100% of their company. Over 10 years (the median SaaS exit timeline), they build a $100M revenue company that’s valued at $500M or a 5x multiple.
Because this Founder has chosen to do multiple equity rounds and bridges, they’re at 5% ownership, meaning they would walk away with $25M at exit.
Founder B chooses to take a different path. Over that same 10 years, Founder B hasn’t seen the explosive growth that Founder A saw. Rather, they built a $20M revenue company, leveraging strategic and short-term non-dilutive options along the way.
Though their company is smaller, Founder B still owns 75% of the equity. Using that same 5x multiple, their exit value would be $100M, and their ownership would equal $75M.
These are two different paths, with two very different outcomes for the Founders. However, that’s not to say that these are the only paths to take.
Many entrepreneurs employ a mix of funding based on what makes sense for their company – the right infusion of non-dilutive capital at the right time can actually help with equity rounds, since revenue growth will equate to better valuations.
And given the declining state of valuations the last couple of years, Founders need all the help they can get.
In short, it’s important to remember that this is your company, and the way you fund it should be based on a deliberate strategy that’s tailored to your needs. Just because other Founders are financing their company a certain way, doesn’t mean it’ll necessarily be the best approach for you.
Take your time, find the right balance of non-dilutive and equity-based options, and make the decision that feels right for your business in the long-term.