Five Myths of Debt Financing for Software Startups
Stay up to date
Stay up to date
Navigating the range of funding options available to growth-stage B2B SaaS companies can be overwhelming. In our experience, the key is to optimize your capitalization structure with a combination of equity and debt.
You may have heard the prevailing “wisdom” championing equity fundraising for SaaS startups, but dilution-wary companies are increasingly seeing the benefits of alternative funding sources, like growth debt (as opposed to venture debt or bank debt). In fact, 98% of public SaaS companies use debt financing, with an average debt to enterprise value of 18.8%.1
Companies we speak to sometimes raise concerns about debt financing and negative connotations they’ve heard about debt in the past. Below, we seek to break down five common myths about debt financing for growth-stage software startups.
1. Myth: It’s a bad idea to use leverage to fuel a growing business when equity valuations are declining
REALITY: Raising equity that is priced lower than your current valuation is inherently dilutive—and may come with features (such as multiple liquidation preferences) that are punitive to employees and founders. When equity valuations are declining, debt can be a useful tool to sustain growth, can generate a higher return-on-equity and may prevent the need for a company to raise additional equity before a liquidity event.
2. Myth: Lenders will take your company if you don’t perform
REALITY: This is the proverbial “boogeyman” of debt financing. In reality, no lender makes an investment with the intention of owning a company. More often, if equity investors are unable to support a company, the lender can reset the company’s capital structure, enabling management to earn a larger pay-out than if they had closed the company’s doors.
3. Myth: Lenders will provide you capital when you don’t need it—but not when you do
REALITY: This is why it’s crucial to pick the right partner for your debt financing needs. Some lenders are focused on lending against enterprise value. Others, like bank lenders, aim to offset their debt balance with your cash. The right lender will partner with you to assess your financing options and help identify the best solution for your business—not fit you into their playbook.
4. Myth: Debt should only be used as an “insurance policy”
REALITY: It’s no secret that debt provided by a partnership-oriented lender can enhance returns better than equity alone. After all, leverage is a key driver of the returns generated by private equity-backed deals. Debt financing in lieu of, or in addition to, equity is a useful tool to yield a greater return-on-equity in a liquidity event, even for the fastest-growing businesses.
5. Myth: Lender covenants restrict a company’s ability to operate
REALITY: Not all lenders are created equal. It depends on the covenants and the lenders. While some lenders may look to cover their loan principal with your cash, a true lending partner will look to ensure a borrower keeps a reasonable amount of capital in place to allow time to plan for its next capital raise or exit event.
As you determine your capital needs, be sure to work with a partner who will help you assess your financing options and has the expertise and experience to offer a wide range of funding solutions. If you’re interested in learning more about partnering with Golub Growth, please reach out here.
1. According to the Golub Capital Public SaaS Tracker (“GC Public SaaS Tracker”), which comprises publicly traded SaaS companies that are listed on the NYSE and Nasdaq. Golub Capital defines Software as a Service (SaaS) companies as software companies that show a year-to-date (YTD) share of revenue above 51% being sourced from subscriptions and subscription-related services. Such companies are added to the tracker in the quarter of their initial public offering and are removed when they are no longer publicly traded, when subscription-based software is no longer their primary product or primary source of YTD revenue or when information on their revenue sourcing is not available or reliable due to extraneous circumstances (inability of company to file, etc.). The GC Public SaaS Tracker is updated on a quarterly basis and is not actively managed or available for direct investment. The GC Public SaaS Tracker and companies therein are provided for informational purposes only and are not intended as investment advice or recommendations of any kind. The GC Public SaaS Tracker should not be relied upon in making any investment or business decisions. All data included is public information.