For founders, SaaS means opportunity. The SaaS market is exploding. Analysts project that the global SaaS enterprise application market will grow from a $22.6 billion market in 2013 to $50.8 billion in 2018.
For investors, SaaS means security. One of the most appealing features of SaaS startups is their sticky revenue streams, which make them less risky investments. SaaS companies often start generating revenue and profitability much earlier compared to startups in other tech categories. And thanks to their software focus, many are able to bootstrap for a long time to gain early traction.
However, bootstrapping will only get you so far. At some point, putting off fundraising means limiting your growth. So how can SaaS businesses take their companies to the next level? What funding options are out there?
Banks are notoriously averse to providing credit to SaaS startups. This is because bankers have much lower risk tolerance, and they can’t underwrite a loan based on the value of non-tangibles like pre-paid subscription-based revenue. Without any hard assets or personal guarantees as collateral, the chance of getting a traditional commercial line is slim.
Even though a traditional bank loan may be hard to obtain, there are other options for an early-stage SaaS startup. At Lighter Capital, we meet many SaaS entrepreneurs exploring alternative lending options. Here are the most common funding types our prospects are looking for.
Short and Long-Term Debt Funding Options for SaaS Startups
1. Debt funding through internal funding sources / convertible debt
Before gaining traction, many early-stage tech entrepreneurs look for loans from sources close to them: co-founders, board members, or friends and family. They often structure these loans as convertible debt.
Convertible debt is relatively low-interest and converts into equity at a specified date (generally after a round of equity financing). It’s flexible for investors and founders, but there are a few common traps to watch out for:
Subordination terms. If the terms are aggressive, they can inhibit your ability to get additional debt from other institutional lenders later on.
Maturity date. Some convertible loans mature at 24 months, but some are much shorter: 18 months or even 12. If you’re unable to raise a round of equity financing before the maturity date, you’re convertible notes won’t convert to equity, and you’ll owe a big payment.
2. Working capital loans from online lenders
Some entrepreneurs look to scale with funding from online lenders (like Kabbage or OnDeck) and merchant cash advances (MCAs). Both of these options can allow you to access a small amount of cash quickly (less than $100K), but at a very high cost—triple digit APRs aren’t uncommon.
Only use these lenders if you have an emergency cash crunch and triple-check the true cost of such loans with an effective APR calculator.
3. Non-dilutive revenue-based financing
If you’re generating $200K in ARR, Lighter Capital’s revenue-based financing can be a good option for you. We specialize in providing non-dilutive growth capital up to $4M to SaaS companies and our three- to five-year loans are structured with payments that ebb and flow with your revenues.
Early-stage SaaS companies often have lumpy or seasonal cash flows, and the revenue-based financing model is designed to accommodate that: smaller payments in tight months, bigger payments in flush ones.
4. Debt funding through A/R factoring
With a SaaS business, your payment schedule can vary. Some clients may pay you on a monthly basis, but some may pay net 60, or even 90. A/R factoring allows you to borrow money based on your accounts receivable. Know that your ability to get the loan approved depends heavily on the quality of your contracts. For example, if you have a Fortune 500 client, banks will feel much more comfortable lending to you than a company with contracts from companies that are just starting out.
5. An MRR line of credit
The MRR line of credit is a relatively new lending instrument. Many SaaS businesses have monthly recurring revenue and some lenders are willing to lend between 3–5X of your MRR to help you accelerate your growth. If you have $5M annualized revenue, a tech bank, like Silicon Valley Bank, will have products that are similar to MRR lines for you. Most lenders, however, will require a personal guarantee, so make sure you read the fine print.
Raising capital and weighing your options?
There are now more options than ever before for entrepreneurs stymied by traditional banks. Entrepreneurs are discovering new ways to get funding that actually help them grow their businesses more effectively.
In our 30-page Startup Funding Playbook we explore the changing landscape of tech startup financing, highlighting alternative financing options like revenue-based financing. It's one of our most popular founder resources.