If you work in software, chances are you’ll apply for a SaaS loan at some point. There are a few different options available to SaaS entrepreneurs that can help fund your product’s development and push your business forward.
This is a guide to everything you need to know about the different types of SaaS financing available, and how to get a business start-up loan—including which SaaS loan is best for each stage of growth.
What are SaaS loans?
SaaS loans are a type of financing designed to help companies that sell software as a service (SaaS).
SaaS companies have huge potential for growth thanks to their recurring revenue, relatively low churn, and high gross margins.
However, their subscription-based business model can lead to frustrating cash flow challenges as they have to invest in sales and marketing expenses to acquire customers, and sometimes only receive payment after a delayed period of time (such as after free trials).
Traditional banks tend to avoid start-up business funding for SaaS companies as these start-ups often lack the required collateral assets or trading history.
How do SaaS loans work?
Many SaaS loans offer a financing model that allows you to borrow against recurring revenue instead of borrowing in exchange for an equity stake in your company.
It’s non-dilutive, meaning you retain full ownership of the company, as opposed to equity financing which involves raising finance through the sale of shares of your company. In some cases, the SaaS loan may even be tax-deductible (at least, the interest you pay on it will be tax-deductible).
The loan provides you with cash across several instalments to invest directly into your business.. The cost of the debt is taken from the total value created to determine the increase in net equity value. The calculation considers the number of months of runway each debt option provides and how much value is created each month.
Companies can use this equation to determine value creation:
(incremental monthly recurring revenue (MRR) * 12 * valuation multiple) – (debt principal + loan costs)
How to qualify for a SaaS loan
Although SaaS loans cover a range of different financing types, SaaS start-up business loan requirements generally include:
- Selling a SaaS solution (of course)
- Strong evidence of consistent Monthly Recurring Revenue (MRR)
- Strong customer retention rates
- Current profitability is not always required
Depending on the lender you go with, your application shouldn’t be too extensive. Many only require your contact information, your recurrent revenue history, and an explanation of what you’re looking to do.
After the initial application, you may need to provide the lender more information about your company. Typical information that you’ll need to supply includes:
- SaaS metrics (CAC, LTV, churn, etc.)
- Details about your product offering,
- A list of your management team
- Well-structured, detailed business plan
- Financial statements
- Business forecasts
- Current contracts to determine subscription revenue and customer makeup
- Information on your sales process
Once this information is complete and you’ve been approved for the SaaS loan, you’ll receive a term sheet for review and negotiation. You should receive funds quite quickly, often within a few days, once everything is approved.
However, bear in mind the above is an outline of a standard SaaS loan, lenders’ actual loan qualification requirements will vary.
Which SaaS loan is best for each stage of growth?
Successful SaaS businesses will go through four phases: setup, growth, stabilisation, and further growth/exit.
Setup stage
During the setup stage founders focus on the development of their SaaS product. During this stage they’ll create the product, identify their target market and plan a campaign to bring their product to market.
Bootstrapping, or using your own funds, is common for SaaS startups as most SaaS loans require you to have a certain level of MRR coming in already.
Growth stage
When customers have their hands on their products, the company will enter their growth stage.. There’s likely to be sudden demand for marketing, sales, and customer service teams in this stage. Additional needs may require more capital to meet user demands.
Most SaaS companies will start to seek funding in the early stages of growth. If you already have a decent MRR, then you can consider venture debt. Step-up structure venture debt is an ideal option if you want to retain more of your profitability earlier in the life of your loan and start paying off principal as you grow.
Interest-only venture debt helps stabilise operations and accelerate growth while only paying interest on the loan amount.
Revenue-based financing is also an excellent option for scaling SaaS companies because payments match the natural ups and downs of the company as it grows. This loan type also doesn’t require profitability. Most companies that opt for revenue-based financing have found they can make repeatable revenue, and want to invest more in channels that are working.
Stabilisation stage
At this point, SaaS companies continue to acquire new customers and should have stabilised overhead costs. During this stage, companies tend to reinvest into product updates to keep pace with customer demand and compete with their more established competitors.
MRR-based credit facilities usually become available to SaaS companies at this stage. Usually, companies with a SaaS model need to bring in more than $2.5M in ARR to qualify.
Further growth/exit
SaaS companies' final growth stage usually sees them exit by selling or merging their software, or focusing on continued growth. Companies at this stage are more likely to take private equity financing than a SaaS loan.There are so many great non-dilutive financing options available to SaaS founders, but with more choices comes more complexity. Each loan type has its own pros and cons, and it’s important to understand specifically what each lender is offering before deciding on the one that’s best for you.
Venture debt financing vs alternative options
Venture debt financing offers SaaS companies capital in the form of debt. More later-stage SaaS companies are taking on venture debt as either their only form of financing or to complement their equity-based investment strategy. When used within an equity strategy, it’s usually to extend funding from one round to the next.
Venture debt financing also helps reduce the dilution you face when starting out, meaning that your equity in your business grows proportionately to your business’s revenue.
The different types of Venture Debt
There are three main types of venture debt available for SaaS companies:
1. Standard instalment loans
Like a bank loan, standard instalment loans are repaid over a few years and include principal and interest. You can either take funds in a lump sum or use portions of the total loan over time, called tranches. Taking advantage of tranches eliminates the need to pay interest on the total loan amount and instead requires P&I (principal & interest) payments on the tranche.
A standard instalment loan is best used when you already know where you’re going to use the debt capital and are in a strong enough position to make the repayments. In this case, it helps to only take out what you need, when you need it. For example, you may need the full lump sum to cover development costs up-front or, if you’re using the capital for marketing, you may only need portions at a time.
2. Interest-only
Interest-only debt financing is a flexible type of venture debt. It requires you to only pay the interest on your debt capital investment for a predetermined time. When ready, you can either pay the loan in full or start P&I payments.
P&I are periodic payments, usually paid monthly. The payments include the interest charges for the period plus an amount applied to the amortization of the principal balance.
The key benefit of interest-only venture debt is that the initial repayment obligation is more manageable, so you can keep more of your revenue and profit to put toward other growth opportunities.
3. Step-up structure
Step-up structure venture loans are pretty similar to revenue-based financing. Your repayments scale according to your monthly revenue with defined terms. With the step-up structure, you know exactly how much to pay at all times as your revenue and profitability increase.
This is an ideal option if you want to maintain profitability and only start paying off the loan as you grow.
The pros and cons of venture debt
Pros of venture debt:
- No personal guarantees required
- You don’t need to be profitable
- Founders can maintain control and ownership
- It’s available to non-VC and VC-backed companies (lender dependent)
- Standard terms, structures and few stipulations
- It can help the company reach profitability without giving away more equity
Cons of venture debt:
- It can be more expensive than traditional bank debt
- Requires monthly interest payments and fees
- Often requires warrants coverage
- Some lenders require VC sponsorship
- Less suitable for financing long-term growth
What alternative options are there?
A decade ago, debt wasn’t commonly used as a form of start-up business funding. However, now there are a growing number of debt financing options available to SaaS companies.
In addition to venture debt SaaS financing, alternative SaaS loan include:
- MRR-based credit facilities: A funding method typically used in place of a small equity round and only available to businesses with a SaaS model
- Revenue-based financing: A form of flexible financing where payments are made based on a percentage of monthly revenue
- Bank loans: A traditional form of loan where you get a certain amount of capital to be repaid with interest over a specific period of time
The pros and cons of each alternative option
Pros of MRR-based credit facilities
- Both VC and non-VC backed companies are eligible
- The interest can be tax-deductible
- Perfect as a runway extension for companies not yet bringing in a profit
- Founders can maintain control and ownership
Cons of MRR-based credit facilities
- Necessary to do monthly reports
- Companies must maintain a minimum retention rate
- Comes with warrant coverage
Pros of revenue-based financing
- Founders get to keep majority control and ownership of the company
- Only so much equity dilution
- Repayments can be extremely flexible to match a company’s needs
- Founders don’t have to put up any assets or personal guarantees
- Particularly focused on growing revenue
- Non-VC backed companies are eligible
Cons of revenue-based financing
- Less cost-efficient than traditional bank loans
- Businesses have to be generating revenue to qualify
- Companies must commit to monthly payment
- Comes with warrant coverage
Pros of bank loans:
- Fairly cheap and flexible
- Inexpensive and flexible
- Low-interest rates
- Founders can maintain control and ownership
- Occasionally available to non-venture-backed and unprofitable businesses
Cons of bank loans:
- Typically require assets, such as property and equipment, to qualify
- Limited availability
- Often requires profitability
- More complicated paperwork
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