A lot of companies are out raising money at the moment to get through the current economic climate. Some companies are raising debt, like Airbnb, and several commentators see it as a sign of weakness. “The company may be in trouble.” However, they are doing what all businesses are doing now—only there are more zero’s at the end.
They want to maximize the cash available to get through this crisis. However, this also means they have to make tough decisions, such as cutting costs. Unfortunately, a lot of the time, that means layoffs. It must be very difficult for founders to do this to people who have helped build their business and even harder for the employees themselves.
Let’s look at Airbnb’s recent funding strategy in a bit more detail.
Airbnb’s recent debt raise
Most companies take on debt at some stage – whether they are a local coffee shop or a multinational billion-dollar tech company. Growing companies need to somehow finance growth by investing in more employees, office space, marketing, or something else, which eats money but is needed to grow the company.
The main question asked of the likes of Airbnb is why debt makes more sense than equity at this time and why they are willing to pay higher rates than we see in our main street banks.
Reports on the debt raised by Airbnb tell us that they are the first lender to the company with a senior position (no other debt gets repaid ahead of them). The insights tell us that this may be the only debt the company has in place and may not have used debt before.
Many banks do not value SaaS companies like they do other sectors. This is because they have no physical assets to speak of (e.g., buildings, equipment, servers) but lines of code and some laptops. Therefore, big banks find it hard to lend money to them. For example, think of a bank that lends to your local restaurant to purchase ovens, which the bank can sell if the restaurant goes out of business; banks cannot sell lines of code.
With big banks off the table, SaaS companies often have to seek alternative providers of finance, who have a higher cost of capital than banks. Hence, Airbnb is paying rates of 10% – 12% for debt, plus a warrant.
Debt v’s Equity
Equity is long-term capital, which often comes at a cost not assessed in the same manner as debt. So, for example, taking debt may cost Airbnb 12%, and maybe they will repay it in a year when they get a cheaper source of capital or follow through on an IPO like Airbnb might.
Buying back equity is usually expensive, and you have to get an agreement from shareholders to sell it back. It also normally costs a premium if you are growing and might IPO.
Airbnb has raised money continually over the last decade as they traveled on their quest to change how we looked at short-term accommodation.
The last round of capital raised was a Series F in 2017, at a $31bn valuation, completed in an excellent market for raising capital. Raising capital in a downturn is much more difficult, and investors will pay less for the same sized stakes.
Why Airbnb might have raised debt
When a company raises capital at a valuation less than the valuation they had previously raised, the latest round is called a downround. Investors generally do not look favorably on a down-round and put in protections against this—such as a penalty to founders/other shareholders if there is a downround.
These penalties could be a dilution of founders. Investors try to protect against this as their shares are now worth less today than when they invested, and the investor probably has to write down the value of the investment on their books.
Avoiding a penalty like this is in the founders’ best interest. Unfortunately, raising debt may have got Airbnb around such a condition, as they were once valued at $31bn and then later at $26bn. So they may have had to do a downround to raise equity in a highly turbulent market.
Raising debt avoids down rounds, provides flexible capital to take and repay easily, and prevents diluting for shareholders.
Many companies are raising capital now
Ford, US Cinema company AMC, and many others are all raising debt. Expedia just announced they are raising equity from some of the same providers of debt to Airbnb. At the end of 2019, Expedia had over $4billion in debt, so debt was probably not an option for them.
Let us not forget how Airbnb has changed the short-term accommodation market. It has been a huge success. But, like many companies today, they are unfortunate in the current climate that their business has all but ceased while we get to grips with the pandemic.
Very few companies IPO in turbulent markets when investor confidence is low. They won’t get the valuation the business deserves.
So, in my opinion, Airbnb has delayed its IPO until markets get back to some sort of normality and have shored up their cash balance with some debt in the meantime. Airbnb will be back on the IPO trail soon enough and continue the successful journey they have been on for the last decade.
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.