Anyone who owns a small SaaS business knows securing growth funding is not easy. Competition for equity from angels or venture capitalists is intense and traditional lenders like banks struggle with aligning the SaaS business model with their lending practice and requirements. Business owners can spend a lot of time and energy seeking new capital – time that could be better spent on nurturing and growing their businesses. It can be surprising to entrepreneurs that their commercial bankers – whom they have done business with for years – won’t come to the party when they need substantial growth capital. The closed network of angels and venture capitalists can also be challenging for entrepreneurs to break into if they are new to capital raising or not in located in “funding hub”.
Fortunately, there’s an alternative funding source for SaaS entrepreneurs that is particularly well-suited to SaaS businesses and is designed specifically to help fuel their growth. It’s called Revenue-Based Financing and there are a handful of reasons why more and more SaaS-preneurs are turning to this financing model:
1.) Revenue-Based Financing truly aligns the goals of the investor and the business owner towards mutual success.
Most debt providers’ repayments are fixed and must be made whether or not the borrower’s business is growing. In the case of Revenue-Based Financing, entrepreneurs are provided with unrestricted growth capital in return for a small percentage of future months’ revenues. As a result, monthly repayment amounts ebb and flow in direct proportion with the business’s revenue. This means the business is never stretched to meet a fixed repayment amount when revenues are down. On the upside it’s also possible for the loan to be repaid faster – should the company grow faster than forecast. The total repayment amount is capped at a pre-determined specific amount which assumes a certain revenue growth rate over a set longer term period. So, if the business grows faster than forecast the loan is pad back in a shorter period.
SaaS businesses are typically well suited to this kind of financing and repayment model because of their high margins the long term nature of their contracts and subscriptions and their ability to scale through cash flow and smaller capital injections.
2.) No personal guarantees or covenants required.
Unlike a bank, SaaS-preneurs can fund their businesses without risking their home, collateral, or their personal credit. Banks will also often require a business to maintain certain financial covenants as part of their loan obligations. There are no personal guarantees or need for hard assets to secure Revenue-Based Financing. While Revenue-Based Financing lenders do typically hold security interests and liens on the assets of the business – the entrepreneur is not personally on the hook for anything and there are no financial covenants.
3.) Ownership and control stay with the entrepreneur.
Most SaaS-preneurs appreciate that this debt financing model is “non-dilutive” – meaning the SaaS business owner does not trade ownership in the company in exchange for cash. Unlike equity, Revenue-Based investors don’t own shares and don’t take board seats, so all control and ownership are left entirely in the entrepreneur’s hands. Also Revenue-Based Financing’s cost of capital typically ranges in the 1.5 to 2 times the funded amount – far less expensive than the 5 to 10 times return equity investors are seeking.
4.) A potential path to a better valuation.
Speaking of preserving equity, it’s also a great way to increase your company’s valuation if you do decide you need to raise venture capital. But how are equity and valuation connected? The valuation of your SaaS business is what investors think your company is worth, which has a huge impact on your company when you raise future rounds. The higher your valuation, the less equity you have to give up for a particular dollar-amount of investment.
Using a debt option such as Revenue-Based Financing to access a smaller amount of capital to drive growth over the coming year or two may mean you will have a bigger market share, more customers and more market credibility – making you a more attractive investment for an equity investor.
5.) It’s fast.
Revenue-Based lenders recognize that fund raising consumes way too much of a SaaS-preneurs time, so they are using technology to make the application process more efficient. Lighter Capital, for example, has automated its application process and can provide businesses the capital they need in as little as a month. And by using technology to monitor revenue and customer data over time, it’s possible for SaaS-preneurs to secure extra rounds of capital in as little as two weeks.
While giant venture capital deals continue to dominate the headlines, Revenue-Based Financing is quietly gaining a lot of momentum and has already helped many SaaS businesses around the United States – like Cloudbilt in Charlotte, NC and CellarStone, Inc. in San Mateo, CA – to grow their businesses and better position themselves for a brighter future. If you’re a SaaS-preneur with a growing business, take a closer look at Revenue-Based Financing before you surrender your equity to an investor. You’ll be happy you did.
by BJ Lackland @bjlackland
BJ Lackland is the CEO of Lighter Capital in Seattle. He has spent his career working with emerging technology companies as an operating executive and investor. He has been a venture capitalist, the CFO of a public technology company, a consultant to early stage companies, an angel investor, and a senior finance and marketing leader at startups.