Clearing The Financing Hump When You’re a ‘Non-VC-Compatible’ SaaS Company
Back in April, Clement Vouillon from Berlin’s Point Nine Capital wrote a piece on the rise of non-VC-compatible SaaS companies. In it, he argues that bootstrapping a SaaS company to between $300K and $10M ARR is increasingly achievable.
There are three reasons for this:
- The available market is getting bigger, since more businesses—from SMBs to enterprise—buy SaaS solutions.
- Building and distributing a SaaS product is easier, faster, and cheaper than ever before.
- Advice and strategies from bootstrappers are now abundant online.
And there are other reasons to ignore VC money beyond the increasing ease of bootstrapping—serial founders rejecting the VC model, more and more companies operating in crowded spaces, and startups carving a living out of niche markets, to name a few.
These bootstrapped companies fall into three categories, according to Vouillon:
Bootstrapped “scaling” SaaS companies: SaaS companies which manage to pass the $10M ARR threshold without VC money. Ex: Mailchimp or Atlassian (which raise VC money but at a very late stage) have reached the hundreds of millions dollars of ARR without VC money. These “unicorns among unicorns” are very rare.
Bootstrapped SaaS companies: bootstrapped companies which manage to reach the $300k — $10M ARR range without VC money.
Bootstrapped Micro SaaS: “1 to 3” people companies which operate in the $1k — $300k ARR range, without VC money.
The chief consequence of being non-VC-compatible is a lack of financing.
Breaking out of the micro SaaS stage or getting the capital you need to scale past $10M ARR can be a real challenge when VC money isn’t an option. Many companies will never do it (but when they don’t have investors looking for a big exit, that’s fine).
Other companies are turning to alternative financing.
There’s currently a clear gap in early stage financing for these ‘non-VC-compatible’ SaaS and this is why we’re witnessing the multiplication of debt/cash flow/crowdsourcing-based financing vehicles, and also of startup studios / specialized funds that build portfolio of lean SaaS companies.
Exploring the financing gap
Bootstrapping is a great way to build a company—customer subscriptions, while not free, are still the cheapest money your company will ever get—but it’s not fast.
Jason Lemkin notes that bootstrapped companies take up to four years longer to hit $10M ARR than their VC-funded cousins.
And there are a few situations where accessing capital quickly can be important:
- If your minimum viable product requires a lot of capital to get off the ground.
- If you’re moving fast to take a crowded market.
- Your total addressable market (TAM) is large enough to justify growing quickly.
How might founders uninterested in being part of a VC’s portfolio raise the capital they need? If you’re not selling equity, you need to take debt. Here’s a range of debt options suitable for bootstrapping SaaS companies of various sizes that won’t dilute your equity.
Good for: Scaling SaaS companies (and net income positive companies).
Since bootstrapped SaaS companies haven’t raised VC, that basically rules out venture debt, the preferred debt structure of many startups. Without a VC’s future interest to leverage against, startups looking for a low-interest debt solution turn to traditional bank loans.
But banks often have a hard time underwriting SaaS companies. Their underwriting models tend to measure the value of a business by inventory and receivables, two nearly-irrelevant indicators for SaaS startups, which live and die by MRR brought in through subscriptions.
Young tech companies don’t have the assets to collateralize a loan either, so founders often have to choose between signing a personal guarantee or not taking the loan at all.
Traditional bank loans also generally come with restrictive financial covenants. Miss your bank’s milestone by a percentage point and you’ll risk defaulting.
Still, for larger SaaS companies with assets to collateralize and revenues high enough to leverage favorable terms, traditional bank loans are a great choice. The interest rates are low and banks can give you the shot in the arm your scaling SaaS company needs.
Cost: If you take a loan from a tech bank, you’ll likely pay interest somewhere in the neighborhood of LIBOR + 8%. Traditional banks’ interest rates will be lower. A line of credit from a major bank might charge you interest in the 4–6% range (although it will flex with the Fed).
Good for: Bootstrapping SaaS companies.
If your company has at least $2.5M in annualized revenue, you may be able to find lenders willing to lend you 3–5x your MRR to help accelerate your growth.
Designed specifically to fill this funding gap for for SaaS companies, MRR lines can provide relatively cheap, safe money when your business requires it.
However, MRR lines do share a few drawbacks with traditional bank loans: most lenders will require personal guarantees, and there are often financial covenants.
MRR line covenants are often built around churn. If your customer success department has a rough quarter, you may find your MRR line gone or significantly reduced in availability.
Cost: MRR lines behave like credit, complete with compounding interest. Expect to pay rates between 12–18%, depending on your credit risk, along with a variety of fees. Many MRR line lenders will charge you up to 0.25% of the total line per month just for making that capital available to you.
Good for: Micro SaaS and bootstrapping SaaS companies
Revenue-based financing is a funding mechanism that’s gaining traction among SaaS companies and other startups with sticky revenue streams.
In a revenue-based financing agreement, a company agrees to share a percentage of future revenue with an investor in exchange for growth capital up front. The loan payments are tied to monthly revenue, going up for strong-revenue months and down for low-revenue months.
This is actually a very old funding strategy. Oil and natural gas companies used it to fund prospecting in the late 19th and early 20th centuries.
It was later adopted by the pharmaceutical industry, and Hollywood films are financed on a similar model. It wasn’t until this decade that lenders realized it was a perfect fit for the SaaS model.
Revenue-based financing typically has no equity component, which makes it attractive to bootstrappers. It also doesn’t require a personal guarantee—as it’s essentially collateralized by future revenues—or include financial covenants.
It does, however, require healthy, sticky revenues. The cost of capital is typically higher than a traditional bank loan as well. A number of investors, including Lighter Capital, can provide revenue-based financing to companies that have already hit $15K MRR.
Cost: Revenue-based financing terms can vary widely from lender to lender. Lighter Capital loans between $50K and $2M in exchange for a percentage of monthly net cash receipts (usually between 2% and 8%, never more than 10%) until a repayment cap is met (caps are multiples on the principal and range from 1.35x to 2.0x).
A/R factoring. A/R factoring can get you the working capital you need when a client is slow to fulfill an invoice. It’s a little like a payday loan—and predatory lenders can sometimes require similarly high APRs.
Personal credit. Most banks can provide a small personal line of credit (up to $50K). It’s not personally guaranteed, operates similarly to a credit card, and can be helpful for short-term working capital needs.
Customer self financing. Many SaaS companies get paid up front for an annual contract, then recognize 1/12 of the revenue as each month passes. Using more of those payments up front can help afford you some extra spending—just make sure you have enough to service and fulfill your end of the contract!
Whichever option you choose, it’s important to understand the pros and cons. You may not be signing away equity, but you’re still making a financial choice that will impact your company for years to come.