Once a SaaS startup hits initial traction, shouldn’t it only raise debt instead of equity?

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JASON LEMKIN

It would be nicely to do it all on debt, and debt done properly is a great way to get leverage on your equity … but typically debt alone doesn’t quite get you there.

There are three main reasons debt alone usually isn’t enough:

  • You can’t raise as much. Usually you can only raise 25-50% in debt what you could in equity, and you have to pay the debt back over 2.5-4 years, and it has covenants.  The payback period alone cuts the effective purchase power of debt by as much as an additional 50%.   Revenue-based lending often offers 25% of your ARR, up to 50%.  At 50% it begins to approach an equity substitute, but even there, it’s likely less than you’d raise in a true venture round.
  • Venture debt is usually coupled with equity anyway.  There are different types of debt, but venture debt, which is fairly cheap … is cheap for a reason.  It assumes there will be more venture equity coming in, and generally requires at least one strong VC already be in the deal.
  • So you usually can’t get to the “50% of ARR in the bank” rule from Josh Stein on debt alone.  At say $10m in ARR, you want at least $5m in cash on hand to fund new hires, etc.  It’s hard to get enough debt alone to get you there, and even if you can meet this rough rule at a moment in time, as you grow quickly, you’ll find it hard to maintain on debt alone.

This isn’t to say debt is bad.  Debt is good, if you are growing quickly, can repay it easily, and use the debt to make extra, accretive hires and investments.

It’s just usually not enough.

Sometimes it can be, but usually, you can’t raise nearly as much debt as you could equity, at least up to $20m-$40m ARR or so.

Combining the two can be magic, done right.  You can use them together to both grow faster, make more accretive hires with less stress, and maybe even, skip half a round (more on that here: SaaStr)

Done wrong, you end up with debts you can’t repay and a disaster on your hand, however.  Use debt to make accretive hires with a paypack in 6-8 months or less.  Use debt to extend your runway if you can, if you have no better way to do it.  But use it just to spend more … can get you in a deep hole.

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Published on April 18, 2016
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