I believe in SaaS capital efficiency and managing for profit and self sufficiency. That doesn’t mean eschewing outside capital. But, like a lot of founders, I bristle at the loss of control and the high cost of equity raises.
Capital Efficiency is a Dance of Metrics
Over the course of 25 years of profitable entrepreneurship—mostly in double-digit growth mode—I have certainly needed outside cash (or at least the potential availability of cash). Recurring revenue businesses, often billed and paid in advance, have particularly interesting growth funding dynamics. They take in a lot of cash, but then often leverage it to fund growth. As that machine revolves, it needs to continue producing cash in advance—especially if the reinvestment in growth is aggressive. The need for cash becomes insatiable and potentially dangerous if revenue churn, cost to acquire a customer (CAC), cost to deliver revenue, or even expenses climb. Expense variance is the easiest one to manage out of, where the others can get dicey.
All in all, there’s a lot to balance. And, the more you scale, the higher the stakes with receivables and payroll—the two least malleable cash stressors. So, even when you manage an efficient and predictable SaaS P&L, the liquidity in your balance sheet can keep you up at night. Since even founders need to sleep (a little), we need ways to shore up that liquidity without ceding board control or mortgaging our homes.
SaaS Capital: Friends & Family
Back in 1992 when I started my first business, I launched it purely out of my bank account. When it grew quickly, I found myself with friends and family asking to invest. This would turn out to be my only equity round (so far). I ended up buying those folks out within a couple of years.
SaaS Capital: Equity, Debt and Credit Lines
Before you rain all over me for equity ignorance, I completely understand the equity tradeoffs and economics. I also fully believe that I would take equity capital under the right circumstances. (I’ve come very close more than a few times.) But, so far, I’ve avoided that drug.
Debt is often painful in other ways. First, when you need it, you can’t get it. And, when you don’t need it, you may be able to get it, but with personal guarantees or other unsavory strings attached. I’ve been fortunate to maintain strong enough balance sheets, customer rosters and receivables aging to raise bank credit without guarantees. If the business is too young or too weak for underwriting, banks will require a personal (especially if you’re in a pass-through structure like a sub-s).
Credit lines essentially revolve. They have a limit you can draw against and you typically have to run them back down to a zero balance periodically—so you can’t just turn a credit line into a term loan. The first credit line we did was for very little (five figures) with a local bank and was literally never used. We put it in place to satisfy our CPAs, who wanted us to have some kind of safety net. (That was smart and we slept better.) The second line we did, with a large bank, was mid six figures—an amount again recommended by the CPAs for the growth of the business. We didn’t need it, and used it only enough to keep it active. The bank then offered to triple that one (on renewal), which got us into a seven-figure line (again, scaling with the business). We still used it very little, but we were sleeping well.
Cautionary Bank Credit Line Tale
I’ve pivoted businesses in flight several times. It’s challenging to make those types of changes while maintaining normalcy within the business. Financially, pivots can be especially challenging as pricing/packaging and consequently cash flow, are often impacted. Prior to one of our pivots, when we had a comfy seven-figure, seldom-used credit line at our disposal, I let our banker know that we would likely be leveraging the line more over the pivot year. I’d done the math, and we could leverage that cash to accelerate our growth out of the pivot (cutting months off of our transition). Our banker understood the plan, and we moved forward.
Midway through our pivot, our annual credit line renewal came up. This was typically perfunctory. But, that year, when we were actually leveraging the cash for the first time, our longtime bank responded with “underwriting changes” and cut the line by 50%. Without warning. Without remorse. This screeched the brakes on our pivot growth and forced us to pull back on investments. The core business was fine, but the slingshot growth was stopped pretty much dead in its tracks. (Yes, I’m bitter. This was costly.)
There’s the moral on bank credit lines. They’re potentially unstable. I didn’t know that then, but learned quickly. Because they’re annual, that’s all you can count on. And, bank underwriting, no matter what they tell you, is subject to change with the economy and markets.
Recurring Revenue Dynamics as a SaaS Capital Raise Advantage
If you’re in martech SaaS, or just tech in general, you know that the equity offers are numerous. I think it goes without saying, but throughout our history we could have executed a number of favorable equity deals and came very close on several term sheets. So when half of our credit line went poof, we once again considered equity, but then something refreshing landed in my inbox.
There’s a reason that growth-stage recurring revenue businesses are so economically attractive. The predictability of performance is built into the model. And the numbers—ARR/MRR; revenue churn and customer churn; and CAC—really provide a complete picture of health and growth potential. Turns out there are lenders that understand the recurring revenue levers (unlike banks) and are willing to lend on them. This makes perfect sense, but it was still an epiphany when I first heard about. You get to borrow against your annual recurring revenue—brilliant.
Recurring Revenue Specific Venture Debt
This type of lending is not a credit line, but rather a term loan structured to help the business grow. You book the liability for the loan against the cash added to your assets. Short-term debt service is often limited in exchange for increasing payments over the latter portion of the term. Again, this makes sense, because if you use the capital to grow the business, than the business is larger and can pay more later. And, as ARR increases, so can the availability of additional rounds of capital. (Sounds more like equity than debt, right?)
In general, the downside of the term loan is that you’re paying for the use of money that may just be sitting in the bank—unlike a line of credit, where you’re paying for only what you’re actually using. The upside is that the cash is sitting in the bank and can’t be taken away.
Using a specialized, SaaS-specific lender meant we could avoid dilution, maintain control, stay away from personal guarantees and leverage our strengths—recurring revenue, customer roster and capital efficiency. And, the availability of capital was stable—unlike our bank credit line. This let us predictably invest in the growth of the business without the concern of losing the momentum because of something as mundane as banking. The downside was a non-trivial interest rate, but in the scheme of potential expenses for SaaS capital, it was still relatively low.
The process we went through was very much like that of an equity round. There was diligence. There were covenants. There was a warrant. There was monthly compliance reporting. None of that was a big deal. But there wasn’t a board seat. There wasn’t a complex cap table. And there wasn’t anyone meddling in our decision making. It was capital for control freaks and it gave us the freedom we needed to get our growth slingshot revved back up. Ultimately, we used it as a boost to our exit.
Postscript—never factor your receivables. It’s incredibly expensive and, contrary to the pitch you’ll hear, it’s NOT good for your business. I did it once when I was young and dumb, and I can tell you it was a costly mistake.