Decoding Debt: Golub Growth's Guide to Debt Financing for B2B SaaS Startups
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Decoding Debt: Golub Growth’s Guide to Debt Financing for B2B SaaS Startups
Our team helps growth-stage SaaS startups confidently assess their financing options across an expanding spectrum of equity and debt solutions. We believe one of those options, growth debt, is a key strategic tool for growing SaaS companies—but is often misunderstood.
Below, we’ve defined some common terms and phrases to help you better understand debt financing.
Types of Debt | Debt Structures & Related Terms | Economics | Covenants | Process
Types of Debt
Bank Debt
Revolvers and term debt structures provided by banks. Banks’ regulatory requirements and internal policies often limit the scalability and flexibility of bank debt. Often used as an “insurance policy” when companies’ coffers are full of equity dollars. When calculating the true cost of capital of bank debt, it is important to keep in mind that:
- You are contractually required to keep cash and current assets on the balance sheet to offset the loan’s principal.
- You should also include any current or future additional equity you will be required to raise due to a bank’s inability to scale on its own.
Tip From Our Team
On its face, bank debt is typically the most “inexpensive” form of debt capital. However, when considered in conjunction with future additional equity you may need to raise, this type of solution is often more expensive in the longer-run compared to other forms of debt capital.
Venture Debt
Mostly structured as term debt and provided by venture lenders. While more scalable and flexible than bank debt, it is also more costly (though still considerably less expensive than equity).
- Royalty Debt: A type of venture debt that is repaid either in whole or in part by taking a share of a borrower’s revenue streams. This tends to be short-term in nature and often carries a higher overall cost of capital than traditional venture debt.
Growth Debt
Often provided in lieu of equity, whereas bank debt and venture debt are dependent upon the raising of fresh equity.
Tip From Our Team
Given the later-stage focus of growth debt, it is typically less expensive than venture debt—and also has greater scale and flexibility than both bank debt and venture debt.
Debt Structures
Debt Structures & Related Terms
Amortization
The period during a loan term when both interest and principal payments are due.
Commitment
The amount of capital a lender provides at close, plus any other committed (but undrawn) amounts.
Delayed Draw Term Loan (DDTL)
Term debt that is committed—but unfunded—at close. Accessing a DDTL may include maintaining covenant compliance, hitting certain agreed-upon milestones, etc. Borrowers might use this structure when they have a nearer-term need for capital (e.g. to fund M&A, additional growth, etc.) beyond what was funded at close.
Tip From Our Team
Accessing capital under this arrangement is much quicker than with an incremental loan.
Incremental Loan
Not committed at close but funded upon borrower request (and lender approval).
Interest-Only Period
An agreed-upon period when only interest is paid (or accrued) before a loan begins to amortize with principal payments. Some loans offer shorter interest-only payment periods (see our definition of Hidden Covenants), while others are structured in a way in which the interest-only period stretches the whole length of the loan term (with the principal due at the end).
Loan Term
The period of time of a loan agreement before the principal amount is due in full. Revolvers tend to have shorter loan periods than term loans.
Revolver
A debt facility whose availability is based upon a formula. For example, a percentage of outstanding accounts receivable, four months of recurring revenue, or the like. Revolvers are subject to certain adjustments.
Tip From Our Team
In practice, a recurring revenue revolver actually functions more as a short-term (12-24 month) term loan because borrowers rarely ever pay down revolvers upon the collection of payments. This can lead to painful discussions with your bank when the revolver is up for renewal. For example, you may be forced to raise equity to pay down your balance.
Second Lien Debt
Term debt that typically sits “subordinated” to a senior debt facility. Because it is “junior debt,” it is more expensive than senior debt. First lien and second lien structures can be hard to scale because second lien lenders can be wary of any additional debt placed senior to their position and may be hesitant to increase the amounts of their commitments behind more senior lenders. As such, second lien debt is typically not considered a long-term financing solution.
Term Debt
A debt facility that has some or all of the commitment funded at close. Term debt may include an interest-only period.
Loan Term
The period of time of a loan agreement before the principal amount is due in full. Revolvers tend to have shorter loan periods than term loans.
Economics
Economics
Cash Interest
The portion of interest paid in cash on the principal of a loan. Typically paid monthly or quarterly and based upon a base rate (e.g., Prime, SOFR) plus a spread.
Cost of Capital
The total collective cost of both the debt and equity required to fund a company’s growth and operations.
Other Fees
Other fees may include upfront closing fees or fees paid upon a loan’s termination.
Payment-in-Kind (PIK) Interest
Interest earned, but that is added to the principal of the loan (as opposed to paid to lenders in the form of periodic cash interest payments), with ongoing interest calculated on the new principal balance. Typically paid when a loan is paid off.
Tip From Our Team
This could be helpful to companies because it helps reduce cash burn associated with cash interest payments.
Pre-Payment Penalties
Fees that are paid to the lender in the initial years of a loan term if the loan (or a part of the loan) is terminated. Expressed as a percentage of the principal that is outstanding; typically decreases each year the loan is outstanding.
Warrants
Calculated as a percentage of the commitment that grants the lender an ability to exercise the warrant, often during a liquidity event, into shares of the company. Warrants may be exercised into common or preferred warrants (depending upon the agreement).
Covenants
Covenants
Financial Covenants
Varies by lender but may include performance metrics to ensure growth or that companies are within agreed-upon margin of projected revenues and/or EBITDA.
Tip From Our Team
EBITDA-based covenants for growth-stage businesses may not make sense. Sometimes, the best thing for the company and shareholder value may be to keep investing in growth.
Hidden Covenants
Bank lenders and some venture lenders will often use the following measures as means of further oversight:
- Short interest-only periods and/or term lengths: This provides a lender with a near-term opportunity to ensure a company is performing well. Before restructuring a loan facility, a lender might require additional equity to be invested into the business – which would add to the overall cost of the loan.
- Requiring a clean audit opinion: An accounting firm may provide a “going concern” opinion if it does not believe a company has adequate resources to cover current liabilities. If a loan comes to term in less than 12 months, then the balance is considered a current liability. This is one mechanism that banks use to ensure that their loan principal is covered with cash, or that there is at least a year’s worth of deposits on-hand.
Read more about hidden covenants here.
Tip From Our Team
Read the fine print upfront and ask questions. These hidden covenants are rarely in the term sheet; they typically will show up in the full documents when you’re nearing the end of the process.
Liquidity Covenants
A requirement that a borrower keep some level of cash cushion on the balance sheet. For banks, the required cash covenant amount typically covers the amount of the loan principal. Non-bank lenders are typically looking for a reasonable margin to ensure there is enough operating runway to effectively raise another round of capital or to expand the current financing.
Tip From Our Team
A common bank debt covenant is the “Adjusted Quick Ratio,” which ensures a borrower has enough unrestricted cash and accounts receivables to cover current liabilities. Essentially, when the remaining term on your revolver or term loan is less than 12 months, at no point can you have a loan balance greater than your current assets.
Process
Process
Due Diligence (pre-term sheet stage)
Very much in line with an equity investment process, lenders will request a short list of materials to review, which may include: a full set of historical and projected financial statements, historical net and gross dollar retention analyses, audited financial statements, capitalization table, ARR by customer, etc.
Due Diligence (post-term sheet stage)
This is a confirmatory process that may involve a management meeting, customer calls, third-party work, etc.
Closing Timeline
The time it takes to complete the due diligence and legal documentation, which is typically 30-45 days.
Tip From Our Team
There are a handful of lenders who promise funding within a few days to a week of signing a term sheet. We have seen a number of these types of lenders come and go over the years. Do you really want to allow an investor who doesn’t understand your business to sit at the top of your capital structure? As the age-old adage states, “if it sounds too good to be true, it is a fly-by-night lender.”