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Venture Debt Financing: A Strategic Option for SaaS Businesses

Published on April 16, 2024
Joe Garafalo

Founder and COO

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For startups, the journey between funding rounds is a bit like traveling from island to island. Your cash runway builds a bridge from Series A to Series B, from Series B to Series C, until finally, you reach the fabled land of IPO (or acquisition). The problem is equity funding rounds aren't always enough to bridge the gap, especially if things don't go according to plan.

Rather than being forced to turn to bridge financing or raising a down round, venture debt provides an accessible, non-dilutive source of funding to early and growth-stage startups. By boosting cash reserves, venture debt allows you the space and time you need to achieve milestones and ride out uncertain waters.

Table of Contents

What Is Venture Debt?

Venture debt is a type of loan granted exclusively to venture-backed startups, typically raised in conjunction with a round of venture capital.

Unlike venture capital, however, venture debt financing is much less dilutive, meaning it doesn’t require you to give up a significant portion of ownership in the company.

Venture debt allows a company to squeeze additional mileage out of VC funding rounds, extending cash runway without giving up board seats or huge slugs of equity. That’s extra cash to fund expansion, research and development, or simply to cover operating expenses, as venture debt terms are usually flexible.

But just like any other loan, SaaS venture debt requires you to make interest payments each month. Venture debt loans last between 1 and 5 years and typically have interest rates of 10-15% (6-10% higher than the prime rate, which has been 8.5% in 2024). After an interest-only period — usually around one year — the loan will become fully amortized, at which point the payments switch to principal and interest for the remainder of the loan term.

Venture Debt vs. Revenue-Based Financing for SaaS Companies

Venture debt and revenue-based financing (RBF) are both types of non-dilutive loans available for early-stage companies. What’s the difference?

First, revenue-based financing involves paying the lender a fixed percentage of monthly or quarterly revenue. RBF loans can be either term-based, or canceled once you hit a predetermined amount.

To get approved for a revenue-based financing loan, you’ll need to have a solid history of generating revenue.

The main advantage of revenue-based financing is that since the amount you owe is directly proportional to your revenue,  you won’t have to pay as much during slower periods. The flip side of the coin is that during high growth periods, you will have to pay more.

In contrast to RBF, venture debt requires a fixed, interest-based payment each month. One of the most notable advantages of venture debt is that it’s available to startups that haven’t generated much revenue. However, these startups need to be VC-backed.

When deciding between RBF and venture debt, there’s no objectively better option — which works for your company really depends on the terms of each loan, your history of generating revenue, and whether you’ve raised VC equity.

Venture Debt Financing Benefits and Drawbacks

Like any type of loan, venture debt comes with advantages and potential risk. To determine if venture debt is the right type of SaaS funding for your startup, weigh out the pros and cons.

Pros

The benefits of venture debt financing include less dilution of ownership, more cash runway, quicker access to funding, and flexibility.

Less dilution

Unlike venture capital, venture debt doesn’t result in a high amount of ownership dilution.

Since debt is always cheaper than equity, less dilution is the single largest advantage of venture debt, especially when compared to traditional funding options.

However, it’s important to note that SaaS venture debt doesn’t necessarily come with zero dilution. Stock warrants are often included in venture debt deals, either for preferred or common stock, allowing the investor to buy at a predetermined price within a specific timeframe.

But even with these stock warrants, a venture debt loan will be much less dilutive than an equity raise.

Extended runway

Venture debt financing is meant to pad out your most recent equity round. This not only extends your cash runway, but also provides you with wiggle room if you need more time to achieve milestones before your next funding raise. To get the most usage out of venture debt, opt for a bullet loan that guarantees an interest-free period.

Can be accessed quickly

Getting access to equity funding can take a long time and a lot of paperwork. The venture debt process, on the other hand, is usually quick, lender due diligence lasting no more than a few months.

Flexible

Once the money’s in your account, venture debt is yours to use.

Venture debt can be used for marketing, product development, scaling operations, or hiring talent. You might also just use it as working capital or as a sort of “rainy day fund” or cushion if you need more time to reach milestones and raise your next round at a higher valuation.

Venture debt loans are also flexible in that they can be refinanced, often in line with further equity rounds.

Cons

The drawbacks of venture debt financing are that you’ll need to adhere to debt covenants, you’ll likely incur higher interest rates, it’s a type of senior debt, and it may negatively impact your ability to raise additional funds down the road.

Debt covenants

The ease of access to venture debt comes at a cost. Debt covenants stipulate certain benchmarks you’re expected to follow —  for example, you may need to grow revenue by 3% each month, or always have $250,000 in the bank. If you don’t, the lender could hike interest rates or even demand payment of the loan in full.

Debt covenants are the biggest drawback of SaaS venture debt  — watch out for these when evaluating loan options.

Debt covenants can also add work for the finance team, as you’ll need to make at least quarterly —  but more likely monthly — reports. So, make sure your data reporting systems are organized before taking on venture debt.

Higher interest rates

Given that venture debt is risky for lenders, interest rates are typically higher than equity financing. The average annual interest rate of a venture debt loan is between 10-15%. However, when you consider these higher interest costs against the cost of giving up equity, they really aren’t that substantial.

Senior debt

Venture debt is usually a type of senior debt, meaning lenders have first dibs if you default. This could mean equity investors don’t get a piece of the pie at all if things don’t work out.

Could limit future options

Some future VC providers may be turned away by seeing debt on your balance sheet. They may not like the risk or may not appreciate that their investment is going towards paying that debt.

The Role of Venture Debt for SaaS Startups

Ask any founder, and you’ll find no startup sticks exactly to their initial growth plan. Your company may need more time than expected to find that perfect product-market fit, or to hit a specific revenue target.

And, as mentioned, VC rounds may simply not provide enough cash to get to that next round of financing. Venture debt can function like bridge financing without actually being bridge financing. It helps you avoid bridge rounds that potentially send negative signals to investors.

When you have extra space to achieve milestones, SaaS venture debt also helps you prevent down rounds.

By extending your runway without giving up substantial equity or lowering your SaaS company valuation, venture debt is an excellent means of boosting your startup’s capital efficiency.

But remember: venture debt should only be used when you’re in a position of strength, within six months of a successful round of financing. It should not be a “bail-out” if your cash runway is short. Think about how you’re going to use it before you apply, and work that into your financial models (along with interest payments).

Comparing Venture Debt Lenders

Since venture debt is a specialized type of loan, the field of lenders is small compared to equity financing.

Some of the biggest providers include:

  • Silicon Valley Bank (SVB)
  • TriplePoint Capital
  • Hercules Capital
  • Comerica Bank
  • Orbit Capital
  • Kreos Capital
  • European Investment Bank
  • Viola Credit

How do you compare all these options? When evaluating different lenders, one of the most important things is finding a partner who understands your business, both in terms of space and growth stage.

“As a startup founder, you’re oftentimes venturing off into a land of uncertainty,” says Jeremy Tsui, CEO of Finley. “One thing your capital provider does owe you is understanding your business…showing you, ‘Hey, I have helped other Series A, Series B companies get to Series C and D; I understand FinTech or software…and here’s my track record.”

But what about terms? Besides the obvious interest rates and loan size, does the term sheet make sense for your business? “How will they let you use the debt that you take out?” asks Jeremy.

You’ll also need to consider the unique features of venture debt financing, namely debt covenants and stock warrants. This is one area where accurate, data-backed financial projections can help.

The Two Types of Venture Debt

There are two main types of venture debt: term loans and revolving credit facilities (revolvers).

1. Term Loans

Term loans are your typical venture debt — you get the entire amount in one go and have fixed interest payments over a year or two until the loan becomes fully amortized. Term loans are best if you have a specific plan for using the funds: developing a specific product, making a certain amount of hires, etc.

2. Revolvers

Revolving credit facilities (revolvers), on the other hand, are like a line of credit. You can draw upon the funding when you need it and aren’t required to use the whole amount. Revolvers are better if you frequently need small injections of cash. They also make interest payments more flexible.

Navigating the Application Process for Venture Debt

Applying for venture debt is similar to applying for venture capital. Some items you’ll need to bring along include:

  • Your most recent board deck or investor presentation
  • Historic financials (last 12 months)
  • Projected financial statements
  • A detailed cap table of investors, with number of common and preferred stock and price per share
  • Your most current AR/AP reports, aged by invoice date

Just like with venture capital, you’re making a pitch. What’s your total addressable market? Product roadmap? While venture debt is available to startups that don’t have a strong history of generating revenue, you’ll want to show your potential to generate revenue quickly. Build strong financial models based on your latest data that project ARR or MRR growth.

Next, remember there’s no venture debt without venture capital. Venture debt providers will want to see that you’ve already accessed VC. They’ll want to know for what amounts and will scrutinize the track record of each investor. Venture debt providers are closely connected with the VC community and see VC funding as a vote of confidence in your business.

Venture Debt: Is It Right for Your Startup?

Venture debt is a strategic funding option that can be excellent for startups looking to extend their runway without further ownership dilution.

But, as with all loans, you have to play your cards right. Only raise venture debt when you’re in a position of financial strength, watch out for stringent debt covenants and unreasonable stock warrants, and work with a lender that understands your space.

If you do secure a loan, make sure interest payments and amortization schedule are properly reflected in your financial model, month by month, and that you use those models to stay in line with debt covenants. Mosaic can help — by forecasting how a venture debt loan will affect your cash inflows and outflows over time, you can build out your strategy, optimizing capital allocation and, ultimately, the value of the loan to your company. Request a demo of Mosaic today.

Venture Debt FAQs

What are the typical terms for venture debt?

Venture debt typically lasts 1 to 5 years, with annual interest rates of 10 to 15%. After an interest-only period, the loan becomes fully amortized. Venture debt often includes debt covenants and stock warrants.

Can venture debt be refinanced or renegotiated?

What are the key metrics lenders look at when considering a SaaS company for venture debt?

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