So you’re aware of the value your product brings to customers and what sets it apart from the rest. Your adoption rate is starting to pick up. You are growing quickly. Attaining hyper growth should be a breeze, right?
It is difficult for a SaaS company to get started and grow without some form of capital as investments are needed for R&D/engineering talent, sales and marketing, and company building activities. No matter what stage a SaaS company is at, additional capital is needed to expand and build the business.
The SaaS business model is well understood, the playbook has been written, and continues to be refined by Founders and VCs. This allows for different forms of capital to be used at various stages of company building, improving capital efficiency, and eventually returns for Founders and early stage investors. It is time to be more sophisticated about your capital structure.
In this article, I take a look at different types of SaaS funding options, each carrying their own benefits and drawbacks.
Bootstrapping is the process of starting a new business without any external funding. It’s one of the most common methods employed when starting an enterprise SaaS startup.
A bootstrapped SaaS startup will rely on the revenue it generates. Generally, startups that bootstrap live on the founders’ overdraft, credit cards or savings. These companies are dependent on having a great product and providing great customer support. However, the odds are definitely stacked against founders opting to go for this route.
Why should you bootstrap?
- Founders maintain complete ownership of their company. Your lifestyle, business decisions, and profitability is all on your terms. In some cases, this leads to more motivation to produce results within a shorter time frame.
- Your expenditure is dependent on what you think is best for your business. With no external capital, founders often manage capital more efficiently.
- Customers are the number one priority. For bootstrapped companies, your customers fund the company. You have plenty of opportunities to learn, and you’re going to be more motivated to create a product that your customers will love while operating with limited capital. Without the burden of chasing targets and deadlines of investors, you can spend much more time working on a product that serves your customers.
What are the risks involved in bootstrapping?
- Can take much longer to build a SaaS company without external investment. Majority of available market opportunities will not wait for you to grow organically. They require you to inject a lot of capital in order to secure a more dominant position in the market
- Founders take on significant financial risks. You are essentially managing your cash flows without input from external investors, some of whom may have significant experience in building SaaS businesses. Finding the product-market fit, developing a prototype, investing in marketing and building a management team are all skills that can be learned, but the timeline can be shortened with smart capital.
- Difficult to attract high quality talent. Companies starting out rarely get it right the first time around the perfect team mix. External capital attracts high quality talent.
2. Equity Financing
With equity funding from investors/VCs, SaaS founders do not need to worry about loan payment deadlines and credit card overdrafts. VC firms are your partners. Not only do they provide Founders with capital, but also access to critical company development skills through their network, which will help your business grow.
The downside of this approach, is that VC investment typically take anywhere between 2–6 months to close, and is generally very expensive. Founders are typically diluted to less than 10% ownership by the time they reach Series D.
Why should you go for equity-based financing?
- Confidence from your investors. Equity investors do not expect to receive an immediate ROI. They are there for the long term, and landing a cheque from them means that they see your SaaS product as one with a very high growth potential.
- Less risk. VC capital is a less risky form of financing for early stage SaaS companies that are not cash flow positive, and are still in R&D stage and seeking product-market fit or predictable customer acquisition metrics. Incurring debt during this phase can be risky for Founders.
- Resources and expertise can accelerate your growth. Taking on investors with good track records can add much-needed credibility and value to your product, especially for early-stage SaaS companies. If you perform well enough, your investors will likely be able to help you raise follow-on capital.
- Gain exposure. For many, successfully closing a VC round is viewed as a significant milestone which could help your business gain exposure give you access to a wider audience.
What are potential trade-offs to consider when giving up equity?
- Raising capital this way is very costly and time-consuming. The effect of sharing risks of ownership is that founders have to give up some opportunity to profit. Equity financing is typically expensive for founders and early stage investors.
- You lose control over time. As your SaaS startup goes through the motions and enters critical stages for growth as a founder, you have to give up some control of your company, sometimes more than 50% ownership which means you don’t get to decide the future direction of the business.
- You might not agree with the business direction. Most equity-based investment firms have a 7–10 year fund life. With an expectation that you will provide returns to your stakeholders within this timespan, new directives and targets may potentially force you to modify your existing strategy to fulfil KPIs.
3. Venture Debt
Venture debt is a form of financing for companies which lack the assets or sufficient cash flow for traditional debt financing. This option is only available to venture-backed and growth stage companies and usually takes the form of a non-convertible loan that is paid back in monthly instalments over the life of the loan, typically 2–3 years.
Venture debt is often offered by some banks and dedicated venture debt funds. These loans typically include warrants which give the lenders the right to buy equity. Essentially, venture debt lending firms are betting on your SaaS company to maintain your high growth trajectory and contingent on your ability to raise funds further, i.e. they typically come in alongside an existing equity raising round.
Venture debt takes time and there is significant due diligence. Debt funding also comes with covenants and other restrictions for the company.
Why should I take on venture debt for my SaaS business?
- More equity, less dilution. Venture debt generally results in lower equity dilution for founders and early stage investors than traditional equity financing.
- You have more say on the direction of your business. SaaS founders can continue to grow their companies without giving up voting sharers, equity or board seats. In this sense, debt is cheaper than equity.
- You have more cash. It works as a good add-on to extend the runway of your existing raise further without having to let go of a lot more upside. With a solid growth plan and a fresh cash flow to work with, you have more opportunities to scale.
- More capital efficient. Debt capital brings more discipline to operations and a focus on cashflow compared to an all-equity capital structure.
What are the downsides of venture debt?
- You’re under a lot of pressure. A SaaS company needs steady cash flow to make the payments. If you’re unable to meet certain metrics that are stipulated in your loan document, this can lead to default or conversion of debt at low valuations leading to further dilution.
- Some investors do not like debt on the capital structure. It can impact a SaaS company’s ability to raise future funding as some investors are not do not want to commit equity capital to pay off debt.
- Their risk mitigation can be a huge downside for your SaaS business. Most importantly, lending to earlier-stage businesses is riskier than the interest rates would indicate. As such, lenders often attach warrants in the form of common or preferred stock that could further dilute ownership. In the event of an exit, they get a slice of equity and a large upside.
4. ARR SQUARED
The ARR Squared product is specifically designed to support enterprise SaaS and other recurring revenue business models. ARR Squared views your subscriptions as valuable assets. We do so by offering an instant cash advance against the full annual value of a SaaS subscriptions for companies. SaaS companies benefit from this form of immediate payment because they don’t need to discount revenues to push customers to make prepayments, which eventually impacts valuation.
The ARR Squared product can be accessed by qualified companies once they have achieved product market fit and some stability in their customer acquisitions metrics. ARR Squared can help companies extend their runway and allow them to use their expensive equity capital for R&D and company building, while using ARR Squared for customer acquisition and growth. It works alongside VC capital to build a more capital efficient company.
ARR Squared does not come with equity warrants or other forms of dilution and does not require personal guarantee from the founders. You can typically get 4–6x MRR with ARR Squared.
Finally, ARR Squared allows Founders to access capital as and when required, on a monthly basis to drive customer acquisition initiatives. It lowers the overall cost of capital and keeps the balance sheet flexible considering the 12-month tenor of the ARR Squared product.
As your SaaS platform achieves product-market fit and predictable customer acquisition metrics, your funding options expand. With so many options available, it’s vital for SaaS founders to understand these different structures available to their businesses that best suits their needs.
When deciding what makes the most sense for your SaaS venture, consider your company’s goals, metrics, funding requirements and timing. How much are you willing to give up in terms of equity? What risks are you willing to face in the road ahead?
These are just some of the things that you should keep in mind, but ultimately, doing your own research and taking the time to review your options based on your circumstances will determine the trajectory of your growth and your future success.
For more information, visit our website: https://arrsquared.com