It is thrilling to scale a SaaS startup, but raising funds for the next big step without forfeiting ownership is not easy. This is where venture debt comes in—a practical loan option made to support the growth of startups while at the same time maintaining equity.
Though venture debt provides several benefits, the possible inclusion of complicated terms will affect your cash flow, growth plans, and, ultimately, the ownership of the business. The term sheet is a fundamental document in these venture debt agreements, and it includes significant elements such as the loan purpose, interest rates, repayment terms, fees, covenants, and warrants. It helps make sure you and the lender are on the same page about the financing structure. Be sure to go over it with your legal team, the lender, and other key people to make sure it matches your company’s goals and sets the stage for a successful funding partnership.
Having a clear understanding of these six terms is a must if you want to move forward with venture debt as well as position your business for success. In this article, we will dissect each of these terms and guide you through your decision-making process by matching them with your growth objectives.
Six Important SaaS funding terms to know
In the SaaS funding world, being informed about the appropriate terms in venture debt agreements has a huge impact. Here are six major funding terms with examples that are essential for SaaS entrepreneurs to grasp in order to attract investors and scale up their businesses.
Purpose
The venture debt proceeds are typically designated in a term document for a specific purpose. This may consist of hiring new personnel, establishing new systems, funding sales projects, or incurring other general expenses. The lender’s exact reason for prohibiting the use of the money will be outlined in this section.
Example:
Scenario: CloudPioneers Inc has set the goal to grow the business and, therefore, needs more capital to do so.
They plan to use the venture debt for:
- Recruiting more employees to sustain the growth rate.
- Deploying a CRM system to provide better customer service.
- Allocating money to an advertising campaign to gain a larger share of the market.
The lender stated that the funds are to be spent on company operational costs exclusively and not on office refurbishments.
Interest Rate
This is a relatively straightforward concept. It will depend on the creditworthiness of your business, the principal amount you need, the kind of loan you seek, and the associated interest rate risk factors, among others. Venture debt financiers will understand this, especially if they have collaborated with you in the past, enabling them to grasp the prevailing interest rates. However, getting more information about interest rates and other factors will help those who aren’t familiar with this type of funding.
Example:
Scenario: DataLinkX Corp is looking for a $1 million loan for the purpose of creating their new software platform. The interest rate will vary with their credit rating:
- If their credit is good, they are likely to receive a rate of about 8% to 12%.
- However, if their credit is below average, the rate may skyrocket to 15% or more.
The lender will decide the final interest rate after conducting a thorough analysis of the borrower’s financial status and the steady flow of their income.
Repayment Term
Before finalizing the agreement with the lender, it is important to comprehend the repayment term because the term document will provide an initial repayment schedule, such as that for a standard installment loan. Nevertheless, there are numerous other forms of debt financing you may utilize, including step-up financing or interest-only arrangements. The repayment schedule is different for these two options than the traditional loan, where both interest and principal are paid regularly.
Example:
Scenario: The loan that FlexiSyncX acquired for the purpose of updating the existing software must be paid back in two ways:
- Standard Repayment: They will have to pay $20,000 monthly for the next 5 years; this amount includes both the loan and interest.
- Interest-Only Option: In the first year, they will only pay the interest. This will give them more money to reinvest in the business’s growth before debt repayment in the second year kicks in.
This setup is meant to help with the cash flow needs of a SaaS business.
Fees
Know if there are any fees associated with the term, as it has the potential to significantly alter the overall financial picture if you were to repay early. Each lender varies, but some of the fees you may encounter include setup or advance fees, which are charged either when you pay a fixed fee, a portion of the loan amount upfront, or when new portions of capital are offered. Also, an early repayment fee may apply if you seek to repay the loan before its term is completed or before meeting any conditions.
Example:
Scenario: CoreShift Enterprises has taken out a loan with the following early repayment terms:
- Early Repayment Charge: If the loan is paid off before the term ends, a 2% early repayment fee will apply.
- Setup Fee: There is a $15,000 fee for processing the loan.
These terms take care of the costs that are related to early repayment and loan processing.
Covenants
Aside from the essential financial SaaS funding terms that you need to understand, it is also important to know the performance-based obligations. These are stated as covenants. It helps to explain it with examples, such as setting certain monthly targets of acquiring new customers or achieving a specific level of recurring revenue.
The lender’s objective is to reduce their risk and establish a baseline of performance that they anticipate you will achieve. The covenant is considered “tripped” if these obligations are unmet. SaaS lenders usually try their best to help you get back on track, but they can take different actions if things get worse.
Example:
Scenario: Veltrix Labs has entered into a covenant that imposes the following mandatory requirements:
- Customer Acquisition Goals: The company must attract at least 100 new customers per month, exceeding the set goals.
- Revenue Target: The company must maintain a revenue flow of $500,000 per quarter.
If these expectations are not met, the lender will intervene and take action to reduce the risk.
Warrants
Warrants are a form of incentive frequently provided by a SaaS company (or mandated by a lender) to finalize the funding agreement. A warrant is a financial mechanism in which the SaaS company grants the lender the right to purchase a portion of its stock at a specific price up to a specific point, typically at a reduced price.
The lender can exercise the warrant and acquire an ownership interest in the business within the terms specified in the warrant agreement, which outlines the conditions and timeframe for exercising the warrant.
Example:
Scenario: Wavora Technologies has included a warrant in its loan agreement with the following terms:
- Warrant Option: The lender has the right to buy 10,000 company shares at $5 per share within the next 5 years, even if the stock price increases to $20 per share.
This provision gives the lender the right to take advantage of the company’s growth potential.
These terms are foundational for any SaaS entrepreneur or investor looking to navigate funding rounds and make financial decisions in the SaaS market. Be sure to discuss these components with the lending institution’s personnel first to ensure clear communication and avoid problems when designing your business model.
Need Capital to Expand?
If you are a SaaS founder who wants to expand your business, needs extra working capital, wants better control over your cash flow, or sometimes needs to fill the gap between funding rounds, venture debt might be your best option.
When you have a suitable contract, you will be able to develop and enhance your business and make sure that your goals are achieved.
SaaS founders can also get support from Cheqly, a neo bank that offers business accounts, payment services, and financial tools to help them manage money, handle payments, and grow their business.
Ready to take your SaaS business to the next level? Discover if you qualify for venture debt financing today!