For founders, SaaS means opportunity. The SaaS market is exploding — the market’s estimated worth is approximately $197 billion in 2023 and expected to reach $232 billion next year.
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 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.
At some point, though, not fundraising means limiting growth. When opportunity strikes, how do you extend your runway to reach that next level? What SaaS funding options are out there?
Banks are notoriously averse to lending 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 for collateral, the chance of getting a traditional commercial loan is slim.
Equity funding has its downsides, too — for many founders, it’s not worth diluting equity and ceding control of the business for a few million dollars. What’s more, rising interest rates and economic uncertainty have made venture capital much harder to come by recently. Halfway through 2023, VC deal values are down significantly, as are the number of global VC deals, which hit their lowest volume in more than 6 years according to Pitchbook data.
Source: VC finds its footing as headwinds weaken (Pitchbook, July 6, 2023)
There are still good debt funding options for an early-stage SaaS startup, though. In fact, global private debt funds recently surpassed venture capital fund volume — they are expected to raise more than $200 billion in new capital for the fourth year in a row.
At Lighter Capital, we work with many SaaS entrepreneurs exploring debt financing. Here are the most SaaS-friendly funding options to help your startup extend its runway and invest in future growth.
5 Financing Solutions for SaaS Startups
1. 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, your convertible notes won’t convert to equity, and you’ll owe a big payment.
2. Revenue term loans
This familiar term loan structure offers upfront cash that’s paid back in fixed monthly payments over a predetermined amount of time. These loans are straightforward and predictable, compared to less conventional debt instruments.
Unlike a traditional term loan from a bank that’s hard to get and will likely require collateral to secure the loan, as well as debt covenants that restrict your business operations, a revenue-based term loan is far more SaaS-friendly. The application process is quick and easy, and you don’t have to bet your house to fund your runway! Secured against your recurring revenue streams, you won’t get the ultra-low interest rate you would from a bank, but it’s far more affordable than selling equity for capital to grow your business.
3. Revenue-based financing
If you’re generating $200,000 in ARR or more, Lighter Capital’s revenue-based financing can be a good option for you. We specialize in providing non-dilutive growth capital up to $4 million to SaaS companies and our three- to five-year cash flow loans are structured with payments that ebb and flow with your monthly revenue.
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. 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. Your ability to get the loan approved will depend 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 or less established.
5. An MRR line of credit
The monthly recurring revenue or MRR line of credit is a relatively new lending instrument. 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 $5 million in annualized revenue, a tech bank may 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 before you sign.
Typically, lines of credit are ideal for short-term working capital expenses, not investing in long-term growth, since the capital can become very costly if it’s not paid back quickly.
Considering debt financing for your SaaS business?
There are more startup growth capital options than ever before for SaaS entrepreneurs.
Since 2010, Lighter Capital has helped more than 500 startups grow through more than 1,000 rounds of funding and over $300 million in non-dilutive financing. More than 20% of our portfolio clients have been acquired to date by companies that include Amazon, Salesforce, and Eventbrite. We know what it takes to help entrepreneurs realize their dreams on their terms.