7 Things You'll Need to Qualify for SaaS Financing

June 29, 2020

So, you've gotten your SaaS company off the ground, tested your product, and started to scale. Unfortunately, it probably didn't take long to discover the funding gap between the customer acquisition cost and lifetime value.

After you acquire a new customer, it takes a long time for them to return your investment and become profitable for your business. This payback period slows growth because it delays future investments into sales and marketing.

This gap affects most SaaS companies today–especially as customer acquisition costs continue to rise as the SaaS market gets increasingly competitive. So, if 'you're ready to scale your sales and marketing, venture debt might be the best way to do it.

To qualify for venture debt, 'you'll need the following:

1. A STICKY Product

A beloved product being used frequently by customers is what makes SaaS revenue so appealing. Whether 'you're looking for revenue-based financing or a term loan, SaaS lenders secure their investment on your revenue, so they want that revenue to be rock solid. When customers love your product, lenders will see that reflected in your customer churn and retention rates.

SaaS financing providers have to ask: What happens to our money if something happens to this company? Your revenue is their collateral. No lender wants to be in a situation without any collateral. To validate your revenue, your product needs to be sticky with a low churn rate.

2. Enough Recurring Revenue

Every lender is different, but most lenders limit the size of their loan to a multiple of your monthly recurring revenue. Typically, that multiple is between 1-7x your MRR (monthly recurring revenue).

So if you need $1m, 'you'll want to be doing north of $2m in annual recurring revenue.

3. A Diverse Customer Base

Many companies use large contracts with individual corporations to catapult themselves to the next level. However, if too much of your revenue comes from a handful of contracts, lenders may have a hard time getting comfortable with the reliability of your revenue (customer concentration).

Lenders favor companies that have lots of customers, which diversifies the revenue concentration risk.

4. High Gross Margins

SaaS companies should have high gross margins. These margins allow them to re-invest their gross profits into growth by spending on product development, marketing, sales, and strategy.

High margins also allow a company to achieve breakeven fairly quickly by reducing the growth spending if needed. When this is in place, lenders are more confident they will get their money back in a worst-case scenario.

Mostly, they want to lend to companies with gross margins greater than 60%.

5. A Well Managed Cost Base

With high gross profits, you have to decide how much to spend in different areas to achieve growth. These can include developers, marketing and sales teams, or paid advertising. All companies need to adapt to changes. A flexible cost base is often vital in hard times, even for large, profitable companies.

A growing company raising venture debt will burn through cash to achieve growth. If a company is burning money furiously, then a loan will probably not be enough to sustain them long enough. VC is perhaps better in this situation.

However, if you are burning a reasonable amount of cash in relation to your 'company's size, debt may allow you to grow further. At some point, growth should catch up with your cash received each month, allowing you to get to breakeven or profitability.

6. A Clean Balance Sheet

Your company needs to have very little debt. Lenders prefer to be in the first position for repayment. I.e., if your company starts faltering, they want to get their money out before anyone else.

Many lenders will happily refinance debt already in place. Still, they will need to ensure that there is enough available finance for the company after refinancing to grow their business. So the amount of funding you need should be less than that 1-7x MRR number minus any amount that needs to be refinanced.

At Element, we like SaaS companies to have less than 6x their MRR in total debt after financing.

7. Healthy Deferred Revenue and Cash Cycle

The amount of deferred revenue on your balance sheet alludes to your company's billing cycle with its customers. This is because, for example, if most of your customers pay annually rather than monthly, you will have a larger deferred revenue balance than a company billing monthly.

While annually paying customers are great for cash flow, we have seen companies bill solely on an annual basis and receive most of their cash over a few months. This type of billing means they have larger parts of the year in which they need to survive with very little cash flow from operations.

As part of digging into your balance sheet, lenders will also look at your accounts receivable and accounts payable balances to understand what is going on in your business.

For every rule, there are exceptions.

If you are seeking new ways to fund the growth of your SaaS company, talk to us and start the conversation with our finance experts to see whether an Element SaaS Finance loan is right for your business.