Launching a business is hard enough, but scaling it to a successful and lucrative exit is even more difficult. Securing early-stage venture financing is usually the best way to accelerate and sustain growth, but with various funding options available, how do you figure out the best course of action? What is the best alternative to VC, and at what point in your company’s growth do other funding sources make sense?
Choosing the right financing partner can be tedious, as they need to align with your mission, values and objectives. Otherwise, you get stuck in a relationship that doesn’t align with your goals and may lead you ending up with lower ownership than expected.
Here’s a rundown of how alternative financing came to be, how it can benefit high-growth SaaS startups and how to know if it’s right for you.
The evolution of alternative financing
There is a dearth of non-dilutive financing options for growth-stage, recurring-revenue businesses. We’ve found that traditional sources of debt capital (such as banks) simply prefer to provide debt to asset-heavy businesses where collateral can be secured.
Every dollar sitting dormant in a savings account or any traditional short-term/liquid debt instrument is vulnerable to a real loss in value as inflation skyrockets.
When it comes to SaaS or asset-light business models, there simply isn’t an asset base to collateralize, which makes traditional debt providers uncomfortable. Moreover, while subscription or recurring revenue business models aren’t technically new, they have been undersupported. SaaS companies can often only look to traditional banks for financing after achieving profitability and/or receiving institutional venture capital backing.
This rules-based approach is pragmatic, but results in a massive gap in the market for early-stage companies that have achieved product-market fit and serious revenue traction. If they don’t fit the “checklist,” they simply get thrown into the backlog until all the boxes can be checked off, regardless of the underlying traction.
Revenue financing
Revenue financing allows founders to have more control over their decisions without compromising board seats. SaaS companies can especially benefit from this model, as it advances future revenue from customers who are already signed up.
Revenue financing enables companies on a healthy growth trajectory to instantly access future cash flows from their customers’ monthly payments. Another benefit is that the borrowers’ credit limits can adjust according to their monthly expected growth, and they can draw funds when they need them.
This revenue-based finance option enables founders to have more control over their decisions. The structure is similar to a revolving line of credit that flexes up on a monthly basis as ARR increases. For example, clients typically engage with us at Capchase for bridge capital prior to a priced VC-raise in order to hit key financial KPIs, or post-raise in order to secure additional capital to scale growth initiatives like hiring or customer acquisition without draining costly equity reserves.
Maximizing VC dollars
In an environment where raising large sums of venture capital is the norm, earning a riskless positive return on excess cash reserves can be a game changer. For a CFO or anyone managing the treasury function, this truism is quite pertinent, especially as inflation rises to levels not seen in nearly 40 years.
Every dollar sitting dormant in a savings account or any traditional short-term/liquid debt instrument is vulnerable to a real loss in value as inflation skyrockets while debt yields remain stubbornly low. While cheap debt is nothing new in the U.S., an inflationary environment is a new trend with dangerous implications.
These trends are leading to more innovative forms of alternative financing, where founders can generate returns on their excess cash, combating inflation while reducing their cost of capital. Financing is no longer just about borrowing cash or selling equity — it’s about finding new and creative ways to keep your business afloat and use the tools at your disposal.
Expense financing
Expense financing goes one step further in helping SaaS startups maximize cash flow. The concept of expense financing, also referred to as buy now, pay later (BNPL), is relatively new for businesses but has grown significantly as alternative financing has become more available.
Expense financing covers ongoing expenses or one-time expenditures that companies need to make, such as large bills, sales commissions and vendor services. Instead of incurring a large expense all at once, cash outflows are split into installments that are paid over the course of several months, smoothing out the financial hit and allowing founders to allocate those funds elsewhere.
Most one-off expenses are associated with services that will reap benefits over time. Discounts for upfront payments have generally been one of the most prolific solutions to help lower the cost of expenses, but this means that you are parting ways with cash now that would otherwise generate higher returns, which could be invested into growth. Paying those expenses in installments means that you are aligning cash outflows with the benefits reaped from the service, and that you have more cash in hand to reinvest.
Is alternative financing right for you?
At the end of the day, every startup needs capital to kick-start its business, but certain funding options are better suited for certain things.
When founding teams are looking at options, they should consider the following points:
- The true cost of capital (fees + cost of equity).
- The amount the investor is providing and how the funds will be used.
- Any potential risks for the company that raising capital would expose (bosses, warrants, etc.).
It is very important to differentiate between predictable returns and unpredictable returns. For example, if you are able to predict the ROI of an initiative, non-dilutive financing can make a lot of sense as long as the return exceeds the cost of capital. A few examples of this include investments in user acquisition, hiring salespeople, buying software or infrastructure, etc.
If you are uncertain about the return of an investment, it’s better to use equity financing, because that money does not have to be returned at any given time. For asymmetric investments like R&D, new product development and geographic expansion, it’s better to start with equity, and once predictability is built in, then you can scale indefinitely with non-dilutive financing.
Selecting the right funding option can be hard, and there are many options available, but with the advent of new forms of alternative financing, startups are increasingly getting access to capital and resources that accelerate growth while preserving ownership and optimizing cost.