Taking the entrepreneurial plunge takes grit, a growth mindset, and perseverance to succeed on this journey. One of the most important job requirements of startup founders is being diligent about financing growth while also navigating the ebbs and flows of business.
To fuel growth initiatives, entrepreneurs kicking off the fundraising process as an early stage startup find themselves navigating a complex number of options available to them.
Those who seek startup funding through traditional banks, for instance, find that banks are cautious of new business models, particularly those with SaaS or software solutions. From a bank’s perspective, it can be difficult to understand a startup’s growth potential and evaluate risk with new or unproven business models. VCs generally seek companies growing at more than 100% per year. It’s no surprise, then, that startup founders often get lost navigating the morass of finding funding to fuel growth initiatives.
Startup Funding Options Differ by Growth Stage
SaaS companies tend to begin generating revenue and profitability much earlier compared to startups in other tech categories. Reaching revenue earlier in the product life cycle gives entrepreneurs the option to bootstrap, raise equity, or pursue non-dilutive debt capital.
The startup funding choices you make today will determine what you can and cannot do with your business in the future. While angel and VC funding tend to be top of mind for early stage companies, Lighter Capital provides non-dilutive debt capital that might make more sense at certain times in a company’s life cycle.
Debt Capital vs. Equity Capital
Taking on equity investors means giving them seats on your board and conforming to their expectations of how your company should grow; they can limit your control over the business you started, or, in the worst-case scenario, oust you from your own company. The cost and control components of taking VC or angel money too soon – along with the time required to fundraise – might not align with your goals at an early stage.
Startup founders are increasingly financing their healthy growing companies with non-dilutive debt capital to delay or forgo equity rounds. In 2019, Lighter Capital unveiled the first alternative financing industry report showing how revenue-based financing has become the most popular form of debt capital for startups generating at least $15K in monthly recurring revenue with gross margins of at least 50%.
This is due in part because our fast, non-dilutive debt capital model empowers entrepreneurs to reach their next growth milestone, bring on critical new hires, and get a better valuation that is attractive to VCs.
The benefits of debt capital for startup founders
Startup founders who opt for revenue-based financing, as opposed to VC deals, hold on to all their equity and aren’t forced to continuously accept VC while losing more and more equity as a means of pleasing investors.
For example, our alternative debt capital model is better than traditional debt rounds because with revenue-based financing a company agrees to share a percentage of future revenue, typically 2% to 8%, in exchange for capital up front – up to ⅓ of your annualized revenue run rate. The loan payments are tied to monthly revenue, going up for strong-revenue months and down for low-revenue months. Eventually monthly payments come to an end, usually 1.35 to 2X the principal amount, a multiple referred to as the “cap.” Three to five years down the line, any unpaid amount of the cap is due.
A revenue-based financing round from Lighter Capital may be structured as follows:
$500K loan funded on January 1, 2020
1.4X cap ($700K in total payments, including $500 in principal and $200K in interest)
Monthly payments equal 5% of net customer payments
The result is entrepreneur-friendly debt capital, where founders are able to maintain control and ownership of their company, without giving up equity, board seats, personal guarantees, or stock warrants.
And payments are flexible: the borrower only pays a percentage of customer cash payments, so they don’t suffer cash crunches. This ideal form of debt capital enables startups to grow with the support of non-dilutive funding.
Once founders have paid back the initial loan, they can opt to raise additional revenue-based financing, turn to VCs, or tap into a tech bank to help them reach their next growth milestone.
Debt capital keeps future funding options open
Lighter Capital’s revenue-based financing allows founders the optionality of pursuing different funding paths in the future, which is often not possible when founders take VC too early in their company’s lifecycle. As a startup grows and becomes more established, traditional forms of financing – bank financing, angel/VC equity – become more realistic.
More options means startup founders can:
Raise VC later: Revenue-based financing helps delay raising VC, but it also isn’t a barrier as it serves as a catalyst to raise VC later.
Sell the business: Raising VC funding can eliminate a near term exit, since VC investors expect large multiples on their investments and may have veto power over a decision to sell the company. Revenue-based financing places no limitation on the sale of a business – if the loan is repaid, the entrepreneur can do as he or she pleases.
Continue running the business long-term: VCs and angels need an “exit,” usually in the form of a sale of the business, because they own equity. Revenue-based financing does not require a sale of the business, since the loan is repaid over time, empowering entrepreneurs to keep their business for as long as they want.
Revenue-based financing, as well as Lighter Capital’s other non-dilutive financing solutions, are safe debt capital options for startups at various stages of growth, from moderate growth to hyper-growth.
Companies do not need to be profitable to qualify; in fact, most companies raising revenue-based financing are burning cash. Lighter Capital’s startup funding model fits companies that have raised VC, plan to raise VC later, or never to plan to raise VC.
Which is Cheaper: Debt or Equity?
For startup founders looking to finance your company’s growth in the most cost-effective way, think about the true cost of capital that’s associated with each funding option; debt is almost always the cheaper option than equity. If you want to run a capital-efficient business that will grow with you, and you only want to borrow what you need while preserving equity and control of your company, revenue-based financing is a great alternative funding solution. Best of all, with our fast funding model, you’ll have more time to focus on running your company instead of fundraising.
Take your company to the next level without giving up equity, board seats, or personal guarantees.
Apply today to connect with Lighter Capital’s Investment Team and we will reach out to share how we can help you achieve your growth goals.
A version of this article originally appeared on TechCrunch.