Venture Debt Financing Options for B2B SaaS Companies
The most successful SaaS businesses are moving away from historical analysis to a more proactive, forecast-based approach. With this in mind, exploring your SaaS company’s finance options plays an important role in planning ahead and knowing where your revenue, expenses, and cash flow are going over time.
Venture debt has emerged as a popular financing option for scaling B2B SaaS companies as it can help mature startups grow while minimizing equity dilution.
In this piece, we’ll cover exactly what venture debt financing is, who it’s best suited to, and what you can expect if you choose this funding model.
What is Venture Debt?
Venture debt financing is a form of debt financing for high-growth, asset-light companies. It’s a great option for SaaS companies with strong cash flows and a clear path to profitability.
While some lenders do require VC sponsorship to secure venture debt financing, some lenders like Flow Capital are open to non-VC and VC-backed companies.
According to reports, venture debt makes up about 10% of the venture market, and that percentage is growing every year. Typical loans that fall under this category range anywhere from $500K to $30M, depending on the company’s size and lifecycle stage. Repayment comes in the form of principal repayment, monthly interest payments, and warrants.
How Venture Debt Financing Works
Venture debt financing offers a company additional capital in the form of debt. This helps reduce the amount of dilution founders face when they are starting out.
In many instances, founders have given away a percentage of their business to investors during seed rounds and Series A rounds of funding, but they may still need additional capital to buy equipment, run ad campaigns, or create other assets for growth.
Rather than dilute more, they can add venture debt to their raise, which saves dilution for a future Series B round of funding.
Venture debt is typically structured as a traditional term loan with fixed monthly interest payments over 1-3 years. Some lenders, like Flow Capital, offer flexible structures that are tailored to meet the unique needs of each company.
Let’s outline what this might look like in action.
Say, for example, a SaaS company raised $500K at a $2M valuation in a seed round of funding. Then they raised a further $8M with a $20M valuation through a Series A round of funding. As a venture debt loan usually falls somewhere around 30%, this would give the company $2.4M in venture debt, bringing the total Series A raise to $10.4M.
When Should You Raise Venture Debt?
Choosing the kind of loan that best suits your SaaS business isn’t easy when there are a lot of options available. However, if you find yourself in any of the following positions, venture debt financing could be a great option:
- Your business is revenue-generating with strong cash flows
- You have a clear path to profitability
- You need to purchase equipment during a growth phase without raising a bridge round
- You have eliminated the concept phase risk and have found a solid product-market fit
- You want to avoid dilution while still receiving the capital you need to grow
- You need a bridge to the next equity round
- You need a bridge to an IPO or liquidity event
- You need to top up your equity round with venture debt to extend your cash runway
- You need more time while your company gets to its next milestone
- You want to finance your business without having to set a valuation
- You need a less expensive alternative to equity when funding purchases of equipment or acquisitions
- You need a less dilutive option to bring the company to breakeven
For Elliot Bohn, CEO of CardCash, it was the need to buy more inventory for a busy season that pushed him in the direction of venture debt financing. “We wanted to make sure that CardCash had the capital needed to buy enough inventory for the holiday season. But raising more venture capital in this scenario didn’t make sense,” he says, adding that he wanted to maintain control over strategy and operations. “Giving up equity to capitalize on a short-term opportunity, one that could be funded just as easily with debt, is a shoddy way to run business.”
The Pros of Venture Debt for SaaS Companies
- It’s available for non-VC and VC-backed companies
- Companies do not need to be profitable to secure it
- It has standard terms and usually has very few stipulations
- It is minimally dilutive
- Companies can maintain control because venture debt lenders do not take board seats, unlike equity investors
- The company does not have to make personal guarantees
- It can help bridge the company to profitability without raising an additional round of equity
The Cons of Venture Debt for SaaS Companies
- It is more expensive than traditional bank debt
- It requires significant cash flows in order to finance the loan
- It requires monthly interest payments
- It typically requires warrants, which can cause dilution if exercised
An Alternative Option: Revenue-Based Financing
Revenue-based financing is also available to both VC-backed and non-VC-backed B2B SaaS companies. It’s essentially a form of flexible financing where payments are based on a percentage of monthly revenue.
This means it’s great for scaling SaaS companies because payments match the natural ups and downs of the company as it grows. However, the costs are often higher than bank loans, but are less expensive than an additional equity round.
Companies that benefit from revenue-based financing include those with varying growth rates, those that are close to or at profitability, and those that are pre, post, or anti-VC. Since no equity is required, founders that choose this financing model can choose to run their company under controlled growth rates and still have secure growth capital.
The Pros of Revenue-Based Financing for B2B SaaS Companies
- It has limited equity dilution
- The founders stay in control
- Companies don’t have to make personal guarantees
- Payments are flexible
- There is an aligned focus towards revenue growth
- It’s less expensive than an equity round
- It’s available to non-VC-backed companies or companies that aren’t eligible for venture debt financing
The Cons of Revenue-Based Financing for B2B SaaS Companies
- It’s more expensive than bank loans
- Companies must be generating revenue
- It requires monthly payments
- It usually comes with some warrant coverage
Read our in-depth Founder’s Guide to Revenue-Based Financing here to learn more.
An Alternative Option: MRR-Based Credit Facilities
Again, monthly recurring revenue (MRR)-based credit facilities are available to both VC-backed and non-VC-backed B2B SaaS companies. It’s a funding method typically sought out in lieu of a small equity round and, while costs are often higher than bank loans, they are less expensive than revenue-based loans. Often, they fall into the same ballpark as venture debt terms.
This type of financing is only available to businesses with a SaaS model and those which are of a significant scale – usually, companies need to be bringing in more than $3M in ARR to qualify.
The Pros of MRR-Based Credit Facilities for B2B SaaS Companies
- It is interest expense efficient
- It has the greatest runway extension and can even be self-sustaining if a company is not yet profitable
- It’s available to non-VC-backed companies and those not eligible for venture debt financing
The Cons of MRR-Based Credit Facilities for B2B SaaS Companies
- Companies need to carry out monthly reporting
- There are often operating stipulations, like maintaining a minimum retention rate
- It usually comes with some warrant coverage
Choosing the Right Venture Debt Financing Option for Your B2B SaaS Company
Financing your SaaS brand is of great importance, especially if you’re on a heavy growth trajectory. Planning ahead and knowing where you’re going to secure funding from to meet growth goals, maintain revenue, and generate cash flow is crucial to success.
Venture debt financing allows you to continue to grow your B2B SaaS brand without running multiple small equity rounds that hand over control to investors. Through this funding model, you can continue to secure growth capital while maintaining operational control in your journey to profitability.
About Flow Capital
Flow Capital provides venture debt and revenue-based financing for scaling B2B SaaS companies. We offer fast funding with flexible terms that are tailored to meet your company’s unique current and future needs.
To apply for financing, fill out our online application form here.