SaaS Startups – Debt Financing, Equity Financing, or Both?
SaaS startups can access much-needed capital by considering debt or equity financing. Keep reading to learn more about both options.
Raising capital is a fundamental challenge for any startup. With the cost of customer acquisition often outweighing early revenue levels and the need to invest heavily in product development, SaaS startups must carefully consider their options when raising money.
Debt financing involves a startup receiving money from an outside source and agreeing to pay it back with a fee over time. On the other hand, equity financing involves the startup selling a portion of its ownership stake in return for capital.
In this blog post, we’ll explore certain questions SaaS startups need to consider in deciding what kind of financing options to go for, how they differ, and why a combination of both may be the best path forward for your SaaS startup.
How Quickly Does Your Startup Need Funds?
The first factor to consider when deciding between debt and equity financing is the urgency of your company’s need for funds. Launching a startup is often more challenging and requires much more capital than many envisage.
The cost of building your product, hiring crucial staff, and the day-to-day running of a startup can amount to a lot, especially at the initial stages of operation when there is no revenue coming into the company.
Debt financing is typically faster; you can apply for loans or issue bonds quickly and receive funds within a few weeks. On the other hand, equity financing requires more time. It can take months to find an investor interested in your startup. It could take even longer to negotiate the terms of an investment deal.
There are also conversations about future projections and powers investors can exercise over the company’s affairs based on their contributions.
Are You Willing to Dilute Your Startup’s Equity?
As a startup founder, you must come to terms with how much control you want to exercise over your startup. If remaining in total control of your company is more important to you than access to investor funds, then debt financing might be a better option.
Equity financing involves dilution — meaning that founders and other early investors will have to share their ownership stakes in return for capital. Investors may end up owning a majority of your startup, meaning they can override your decisions, and you can be kicked out.
Another angle to consider is the future value of your startup. Just 2% of your startup today might be worth a significant sum in the future. Is this something you are willing to stomach?
What Funding Do You Qualify For?
Generally speaking, debt financing is more accessible because capital providers evaluate a business’ ability to pay back the capital based on its current financial performance. Lenders typically evaluate based on the following criteria:
Character – Capital providers want to know that borrowers have the willingness and integrity to repay. Character is determined by examining a client’s credit history, references, and other information.
Capacity – Capital providers want to know that borrowers have the financial means and ability to repay. This includes looking at current income levels, monthly expenses, and other debts.
Capital – Capital providers look at how much of their own money a client is willing to put into the project. A good investment of the client’s money signals commitment.
Collateral – Capital providers want to know that their clients have assets that can be used as collateral in case of default. This includes real estate, vehicles, and other assets.
Conditions – Capital providers assess the external factors that may affect the client’s ability to repay, such as economic trends and industry conditions.
Equity investors primarily focus on the potential of a startup to succeed and make money. They will evaluate its market size, competitive landscape, growth trajectory, team dynamics, etc. You must be able to convince investors that your idea or product is sound and that the company can generate returns for investors in the future.
How Do You Prefer to Pay for Financing?
Startups need to assess financing options and decide which type of funding makes the most sense. Debt financing has a lower risk of dilution but requires careful consideration of repayment terms. Are you at a point in your business where you can afford to start repayment in a time frame of typically fewer than three months?
Recurring expenses in your business might not allow for repayment servicing. You want to avoid creating a track record of defaulting on your terms at the early stages of your business. It makes access to capital tricky.
Equity financing gives your business the ability to grow without having to make immediate repayment. However, when your company is successful, equity financing can become very, very costly when you consider just how much long term value you gave away. And, it’s not uncommon for e financiers to even want to be a member of the board.
Ultimately, each startup should consider its unique situation when deciding on a financing option. For some SaaS startups, combining debt and equity financing may be the best approach —allowing them to raise the capital they need without giving up too much control.
Other Options Beyond Equity Financing
Regardless of which financing approach you opt for, there are other options available to SaaS startups besides equity financing and debt for startups.
These include government grants, venture capital funds, angel investors, crowdfunding platforms, peer-to-peer lending, pitch competitions, and corporate partnerships. Each can provide a different type of funding that could uniquely benefit your business.
Key Takeaways
- Several options are available for financing SaaS startups, including debt and equity financing, the commonest forms of financing.
- Debt financing provides ready access to funds without giving up control of the company.
- Taking a holistic, long-term approach to financing is important so SaaS startups can tap into financing options that are well suited for their business. Startups can consider government grants, angel investors, peer-to-peer funding, etc.
- SaaS startups can ensure they have enough money to grow while preserving their autonomy and ownership stake in the company. Intrepid Finance offers access to revenue-based financing that takes the burden of sourcing equity investors or lenders off of startups– allowing them to focus on building great products and services that customers love. Reach out to us to get started.
