Non-dilutive growth capital is becoming an option at earlier and earlier stages in the startup space, and for good reason. Find out about the unique problems SaaS startups face and why traditional financing isn’t always the best option for them as they grow.
Recently on the Techstars Startup Capital Stack AMA Series, Jennifer Jordan talked with Miguel Fernández, Co-founder & CEO of Capchase. They talked about what non-dilutive growth capital is, how startups can leverage it most efficiently, and what can be financed with revenue.
Watch the recording and read on if you want to learn more about what SaaS founders should be looking at in terms of financing that will help accelerate growth.
There has been an increasing trend over the last few years for startups to be more sophisticated about financing at an earlier stage and taking a big-picture view of how to obtain capital for the business. Traditionally, startups focus on equity funding until they become established and only look at obtaining debt financing once the company has matured. But that can really hinder growth, especially for certain industries.
“If you look at S&P 500 companies, you can see that they often have a debt to equity ratio of about 30%, while startups often have a ratio closer to 2%,” Miguel said. “But that doesn’t make sense for SaaS companies and subscription models that have consistent, recurring revenues.”
By adding non-dilutive financing, startups can leverage a 12-month funding runway provided by equity, for example, and extend it to something like 24 months. And that reduces the time the business spends on the process of obtaining financing, which can take weeks or months, and work continually on growth.
As startups know, obtaining equity dollars can be very expensive, and while they are essential for certain costs in the business, it doesn’t make sense to use them for all aspects of growth. Drawing non-dilutive financing on a more regular basis can allow companies to save those equity dollars for the purposes they are best suited for, and spend less ‘expensive’ money on the consistent parts of their business. By extending the runway, companies can look to raise the next series of equity funding later, when their metrics are more impressive, resulting in a bigger and better round of funding when they are ready.
“There are certain initiatives that are unpredictable, like R&D, and new product development. In those cases it makes sense to use equity,” said Miguel. “But for things like user acquisition, market development, or places where you have figured out your process, then it makes sense to use non-dilutive capital to scale infinitely without tapping into your VC money.”
It can be incredibly efficient to work with growth capital. “With VC money, you agree on an amount of funding, then it all arrives on your balance sheet and you have to start paying interest on the total sum,” explained Miguel. Programmatic financing, however, is about drawing money as and when you need it, rather than receiving a large lump sum. “With programmatic financing, there is no requirement to take all of the offer upfront. Companies can draw down funds as and when they are needed. Then you’re not paying interest without generating returns.”
That means that there is no need to negotiate multiple rounds of financing, as programmatic financing usually grows with the business. Raising rounds of equity funding involves approaching a funder with metrics on where you are on a set day. Weeks and months of paperwork and proving those metrics are involved before you receive the funding. With programmatic financing, an automatic re-underwriting takes place in the background every month in order to increase capital availability as the business grows. As a result, companies can tap into larger sums of capital as their needs rise without the need to do a long and tedious re-underwriting process.
Miguel explained that the problem many SaaS companies face is the conflict between needing immediate payment to recover client acquisition costs (CAC) and their client’s desire to split payments monthly over a longer time period. “It led to us at Capchase essentially funding ourselves with our equity, which is an expensive way to run a business, but one that most SaaS companies just accept as a necessary pain as they grow.”
When you have predictable annual recurring revenue (ARR), it’s frustrating and unnecessary to have to wait to access that capital. Programmatic financing can fill that gap and allow startups to draw only the money they need and not have to pay interest on a lump sum that arrives on their balance sheet immediately after equity financing is agreed, whether they need it then or not.
Many alternative financing companies focus on one specific industry or vertical, and as a result, can understand the nuances of their field in great detail. This allows them to collect a wealth of data about the industry and then make very quick informed underwriting decisions as a result.
“We know that sometimes as a business with just your own data, it can be hard to understand when to utilize growth funding in the most efficient manner,” Miguel explained. Alternative financing funders are used to help educate founders and CFOs on how to use their solutions in the most cost-effective manner possible, based on the solid understanding they have about the vertical as a whole.
The generally accepted revenue-based financing model allows for payments to be made as a percentage of revenue paid every quarter. This can be great for ecommerce businesses that have a fast sales cycle and short period between marketing and selling. A high annual percentage rate (APR) cost is less relevant if loans are being paid off quickly.
This model is not optimal for SaaS and subscription-based businesses, however. “The sales cycle is much longer, and what happens if you close a massive deal you’ve been working on for months right after agreeing on the financing? It doesn’t feel fair,” explained Miguel.
That has resulted in an alternative financing process that mirrors how SaaS and software businesses receive payment from their customers — with an agreed dollar payment each month. “It is more predictable and less punitive, and can really allow companies to focus on growth,” said Miguel.
Some companies make draws on a weekly basis, for highly focused business initiatives, and as the company and its ARR grows, the offer, which is based on ARR, grows with it.
Founders of startups are pulled in all directions and it can be hard to focus on those issues that need their attention the most. Spending time collecting metrics for financing and stalling company growth while waiting for equity funding can really dampen the acceleration of a startup at a critical time. That’s why alternative financing is growing, especially for verticals where consistent, recurring revenue means startups can prove their worth during underwriting.
Combine that with programmatic financing which means companies only receive financing and pay interest when they are actually using funds, and founders can put their full attention where it matters most - growing their business.
“The technology available allows us to connect seamlessly with businesses - just 3 clicks and we’re connected to all their data, and in 24 hours or so we can have been through underwriting and providing an offer. And once it’s set, a founder can forget about it, because we are connected in real time to the company’s metrics. The availability of funding can scale with them as they grow.”
– Capchase is a Techstars partner and provides non-dilutive and programmatic financing to SaaS and recurring revenue businesses. If you are interested, you can find out more at www.capchase.com/partners/techstars.