Of the last 6 IPO’s of SaaS companies, the average amount of venture capital raised was $76 million prior to IPO. This amount of capital is not only dilutive to the founders and common shareholders; it’s dilutive to the VCs as well who are striving to be equity efficient.

Current Options
Since SaaS companies can take 50% to 300% more cash to build than traditional perpetual license software companies, financing all the additional cash needs with equity funding is not an efficient use of capital for the VCs, founders or management team. It’s an expensive way to do it both for the VCs and all the other shareholders, including dilution to management, as the model tends to lead to Series C, D, E, and then AA, etc.
On the flip side, technology-focused banks are constrained by the lack of traditional sources of repayment, namely profits and/or assets, both of which are in short supply for an emerging SaaS business. Unprofitable businesses with little in the way of assets are a mismatch for banks. As a result, few of these institutions are willing to lend much in the way of funds to SaaS companies to meet their working capital needs. The structures they do provide can help, but are typically confined to 60 day accounts receivable loans, or loans to purchase servers or other hardware.

The emerging products of venture debt companies are an option for SaaS companies. These lenders are more aggressive in their approach and are not constrained by regulatory issues. The big drawback with venture debt, however, is the structure. They are most aggressive about lending to SaaS companies when they have just raised an equity round. That is precisely when the company does not need the cash. Borrowers end up spending a lot of money paying interest on debt they don’t yet need. By the time they do need the cash, the loan has been amortized down and they are left with debt service, not liquidity. Venture debt can be even more expensive when the value of the warrants is considered.

New Alternative
Unlike perpetual license counterparts who typically have highly variable revenue streams, SaaS companies are actually good candidates for debt. The stable cash flows, high margins and discretionary expenses of SaaS provide a strong foundation for lending for those who understand the model.

SaaS Capital has created a new approach to debt financing for SaaS companies. By looking past the lack of profitability or assets, SaaS Capital focuses on the key strength and inherent value of the SaaS model in order to let SaaS companies monetize a portion of their unbilled future cash flows. Set up much like a line of credit, the debt facilities are designed to provide growth capital when needed and also to grow with the business. So, as a SaaS company’s bookings grow, so does the size of the line. Typically, SaaS Capital is structuring facilities, which advance three to four times monthly recurring revenue. For software companies with long-term contracts, SaaS Capital typically advances 30% to 50% of the unbilled contract value.

Additionally, SaaS Capital has the capability and expertise to provide operational/technical services. They have the capacity to run an underlying SaaS application if they need to, which is what allows them to lend against future unbilled and undelivered revenue. It’s also a capability that many of their customers discuss with their larger clients and prospects who might be concerned about vendor viability issues.
Because of its specific focus, SaaS Capital can assess the debt service capability of SaaS companies quickly and lend them enough capital to meet their operational needs. It’s also very important not to over leverage the business too early in their growth cycle. Debt is not a substitute for early stage venture capital, and SaaS Capital’s customers have already reached more then $3 million in recurring revenue before they leverage their business in a meaningful way.