In the “good old days,” companies took raw materials and assembled them into products (inventory), then sold the products to generate accounts receivable (AR). These activities required lots of working capital and created hard assets—inventory and AR. So when a business wanted to get more working capital from the bank, the bank could lend and feel safe; if the business went bust, the company could liquidate their hard assets and pay back the bank.
Now say you’re a SaaS company looking for a loan. Like most SaaS companies, you have pre-paid subscription-based revenue streams. Sounds great, but it’s meaningless to a bank.
Do you have inventory? Nope. AR? Nope. Other traditional hard assets like property, equipment, or raw materials? Virtually none.
If you’re thinking, “But we have IP!” then kudos for thinking like an entrepreneur, but to a bank, IP is hard to value and nearly impossible to liquidate. The bankers will smile and politely refuse to lend against it.
But you have a great business with sticky revenue, happy customers, and lots of great pre-payments—can’t banks see how wonderful this is?
Unfortunately, there are really only two scenarios when a bank will lend to a SaaS entrepreneur:
You have personal assets, like your house, and pledge them with a personal guarantee. Ah, the joys of putting it all on the line!
You have cash in the bank. Yes, many banks will offer give you a line of credit that requires you keep as much money in the bank as you borrow on the line. If you’re scratching your head wondering why you’d ever do that, you’re smart.
Traditional bankers find it enormously difficult to justify the perceived risk on their balance sheets—it’s just not the way they do business. And in banking-land, the crisis of 2008 is far from ancient history; banks are still scared of their shadows. Further, although SaaS businesses are mainstream in tech, in aggregate they comprise a tiny fraction of the overall economy, so banks have plenty of dry cleaners, dentists and widget-makers needing capital to keep them busy.
SaaS-Friendly Capital Investments
It’s no surprise, then, that alternate lenders are marching into this “funding gap” to provide SaaS companies with the capital they need. Of course, you'll still need to choose the right SaaS investors for your business and its goals. Let's compare the options:
1. SaaS investment banks
Tech banks such as SVB and Square 1 have recently started to offer a Monthly Recurring Revenue Line of Credit (MRR Line). This allows you to get a line of credit equal to two to four months of MRR. However, unless you have a VC investor backing the company, you’ll need to have $5-10 million in revenue and be close to profitable to qualify. And in our experience, it typically takes six months to get the deal done.
2. Angel investments and venture capital
If you are an earlier stage SaaS startup, what do you do to get capital? The conventional path has been to sell off a part of your businesses to angel investors or VCs. This is the most expensive capital there is—angels and VCs are shooting for a 10-50x return on their investment. It’s also horribly difficult capital to get, unless your uncle is a billionaire or your best friend is a VC. Plus, you then have to contend with someone else having a big say in how you run your company.
3. Recurring revenue loans
Revenue-based financing is specifically designed for SaaS businesses with sticky subscription-based revenues and healthy margins. There are no personal guarantees or need for hard assets to secure the loan. And business owners keep their equity and control. Revenue-based financing is long-term growth capital. Repayments are a fixed percentage of your monthly revenues, so they rise and fall with the ebb and flow of your business. Should you grow faster than you expect, and your revenues are higher, you’ll pay off the loan sooner than the usual 5-year term.
The challenges SaaS businesses have faced over the years getting financing are the very reasons Lighter Capital came into being—our founders believed there was a better way to provide growing software businesses the capital they needed. That's why we set out to become the most founder-friendly growth capital partner for SaaS startups!
A SaaS investor such as Lighter Capital works with businesses to find the best financing solutions that align with both short and long-term growth goals.
Okay, so it might be a bit extreme to say banks hate SaaS businesses when really they just don’t understand them. The good news is that there are lenders like Lighter Capital out there who LOVE SaaS companies and recognize what great businesses and investments they are.
Raising capital? Find the right strategy for your business
Most entrepreneurs see venture capital as the holy grail of funding solutions, but fewer than 1% of U.S. startups ever raise a VC round.
There are other options, and some of them might make better sense for your business. Our guide, Raising Capital for Tech Startups, will help you decide what kind of capital to raise, when to raise it, and what you need to get it.