• Causal Engines

The Lurking Debt Opportunity in Software - Part 2

Now that the debt opportunity is clearer, let’s dive into the debt options.

At the earliest stage, from bootstrapped to before a series A, we see players such as Pipe and Founderpath. With at least 25K MRR and reasonable churn, these providers will offer an average three-year term loan with 15% interest to SaaS firms in under 72 hours. The attractiveness of this opportunity stems from quick, non-dilutive capital without personal guarantee requirements.

Once a SaaS business has raised equity from a reputable VC, it will be more eligible for institutionalized debt financing. The cheapest option is bank debt, also known as venture debt, which looks to establish a relationship with their clients as deal terms often permit scalability within deposits as the debtor grows MRR. The banks will be the most senior lien and often enforce covenants to maintain transparency and prevent risk. The most well-known financer in this space is Silicon Valley Bank with the largest market share. These banks offer the lowest cost of capital and can thereby be an accretive financing option.

Another option for fast-growing SaaS companies that have raised reputable equity is raising money from a debt fund. If bank debt is not available or is too restrictive for your firm, debt funds can provide the necessary short-term capital. This would come at a higher interest rate but without financial covenants. Some funds include Hercules, Trinity, and Multiplier. If your firm lacks liquidity but is growing ARR well, this capital can fuel the initiatives to hit your next milestone.

Debt has become tactically used as of late. MemSQL, a cloud database solution platform, raised $50M in debt from Hercules in May. Growing ARR by 70% in 2020 presented MemSQL with a plethora of term sheets for a new equity raise, but it decided to choose a favorable debt raise as shareholders felt that dilution was not worthwhile. Also, in April, Slack raised $750M in debt for potential acquisitions and working capital.

While debt has a different structure in each part of the lifecycle of a SaaS company, there is an increasing trend of firms of all sizes utilizing the current interest rate environment to lower their cost of capital and improve shareholder value. Debt remains an interesting tool in an operator’s arsenal to figure out cost efficient growth, and is increasingly becoming a more studied asset class when it comes to SaaS revenues.

We would like to thank Zack Mansfield and Ingrid Lunden for their inspiration and research.

This article is a collaboration between Archit Bhise and Sebastian Duluc.