Founders of Software as a Service (SaaS) companies use various sources of capital through the different stages of the companies’ development. Based on conversations with hundreds of SaaS businesses over the last couple of years, this article provides an overview of how founders of SaaS companies evaluate the alternatives available, with particular focus on the scale-up phase. While the traditional sources of capital are working well in many situations, founders have encountered particular difficulties during the scale-up phase and found that capital is scarce generally and that traditional sources are less suitable to their needs. The table below provides an overview of commonly used sources in Europe in different stages of development. With the arrival of revenue-based financing, SaaS founders gain access to an alternative source of capital that offers several advantages compared to the traditional financing methods and has an ideal fit with SaaS, particularly during the growth stage.
What is it Revenue Based Financing?
Revenue-based financing (RBF) is a simple type of funding in which a company receives a capital investment in exchange for a share in its future revenue until a pre-defined absolute amount – the cap – is repaid. Once the cap is reached the transaction is finalized, no exit is required. Capital is provided in the form of a sub-ordinated loan, meaning that owners do not need to give up ownership nor is a valuation of the business required. It is common that the funding amount is increased stepwise as the company’s revenues grow over time. The capital is expected to be invested in the future growth of the business. The interests of the owners and the RBF investor are well aligned; the faster the company grows the higher the value of the business and the higher the return for the RBF investor.
What are the benefits vs other financing options?
RBF financing can be secured relatively quickly in comparison to bank or VC funding, as the due diligence requirements are less onerous and as there is no need to negotiate a valuation of the company. Most RBF transactions can be arranged in between 3 weeks and 3 months. The SaaS owner’s personal risks associated with RBF may also be lower than with traditional financing options, no personal guarantees are required, nor does it lead to dilution of ownership control. An additional benefit is that RBF repayments fluctuate with the sales turnover, breathing with the natural rhythm of the company’s asset turnover cycle.
To obtain bank financing, banks will require tangible assets as a security, which often is a problem for SaaS companies built primarily on intellectual property. This is also why founders report that bank financing is not available to them during the growth stage. If available, the experience from using banks’ term loan facilities are also mixed. While bank loans are relatively cheap, founders experiencing fluctuating cash flows sometimes had difficulties in meeting the quarterly fixed loan repayments that are typical for these facilities and/or faced a breach of loan covenants, putting the company’s survival at risk.
The VC investors on the other hand, need to exercise certain control over the company, usually by taking seats on the board. To get its returns, the VC is depending on a successful exit. While these requirements may be well aligned with the SaaS owner’s own interests, the experience some founders have is that interests may quickly diverge. In particular, founders report that the need for an exit which is timed to the life cycle of the VC fund, have led to situations where founders are pushed to an exit at a time that is disadvantageous to them.
Why is RBF particularly suitable to SaaS?
SaaS founders with experience from different types of financing have stated the following:
- The RBF transaction does not require an agreement on the valuation of the company. This is allegedly the most complex issue to deal with in connection with equity financing and founders claim that they save a lot of time and avoid painful discussions among shareholders by avoiding agreement on a valuation.
- RBF transactions can incorporate a stepwise increases in the funding amount, which is drawn down as sales increase over time. Taken as a whole over the scale up phase, this provides SaaS founders with an easy access to substantial amounts of capital with a minimum of effort and time spent on fund raising.
- Using RBF, founders can potentially avoid or at least postpone a round of equity financing until a point in time where the valuation of the business is more advantageous to the founders and involving less dilution of ownership and control.
- Although debt, the repayment of RBF fluctuates with sales and the company cannot be forced into an insolvency situation due to a rigid repayment schedule based on fixed amortizations, substantially lowering the risk related to the financing.
- No need for owners to provide personal guarantees, which is often a requirement for obtaining bank financing.
- For fast growing SaaS businesses, the cost of financing using RBF is lower than the cost of equity due to avoidance of dilution.
Being asset light means that SaaS companies do not have the collateral needed to secure a traditional bank loan during the early stages of development. Having an innovative and/or disruptive business model and therefore above average sales growth makes equity financing expensive due to ownership dilution. SaaS businesses are usually highly scalable with high gross margins. The variable repayments of RBF turn financing cost into a variable cost helping to sustain operational leverage. Finally, if RBF capital is used to finance a proven growth case it typically also leads to predictable returns on the capital invested.