As a founder, you’ll likely be faced with a choice between debt and equity financing at some point in your startup journey. You will have to decide whether you want to pay back a loan (debt) or give away a part of your company (equity). However, there are many scenarios where a combination of the two financing solutions—taking debt alongside equity—can be the right decision.
This short blog post describes three such scenarios and explains how debt can be used alongside equity to help you achieve your business objectives—while retaining more ownership and control of your business.
1. If the equity valuation does not meet your expectations
According to FE International, the average valuation multiples by technology business model are:
- SaaS: 4X-6X for businesses under $2M ARR
- SaaS: 1X-10X for businesses over $2M ARR
- eCommerce: 3.5X-6X
These valuations are generally for exits (i.e., a situation where someone is buying 100% of your business). Minority equity investors expect a discount on these valuations to increase their expected returns on their investment in an eventual exit. These discounted valuations often do not meet the expectations of the founders and current shareholders.
If your company is on the cusp of greatness but the numbers don’t yet reflect that greatness, the valuation offered by a VC will be disappointing.
Founders can exchange a lower percentage of their company for equity capital and supplement the rest of the required cash with debt. They can use this financing to grow their business and be in a much stronger negotiating position when the time comes to raise more equity-based capital.
Measured found itself in this scenario in 2019 and turned to TIMIA Capital for non-dilutive capital. CEO Trevor Testwuide said:
“TIMIA’s investment will give us more breathing room on our balance sheet and give us investment options down the line if we want to accelerate investment in our innovation and growth.”
2. If a large event or contract is imminent
If there are some big deals around the corner but you need more cash to get them over the line, your VC may try to take advantage of this, offering more money—and more dilution for the founder—in advance of this large event in order to achieve a greater return for themselves down the line.
This scenario is common for founders who operate businesses in verticals that have a long sales cycle. For example, healthcare sales cycles can be 9-12 months and government sales cycles can be 12-24 months. These verticals are slow moving due to their detailed procurement processes and high levels of contract due diligence. However, once you close a deal with them, the contracts can be large, lucrative, and long-term.
Your business will need enough cash runway to close these deal and VCs will be happy to provide equity capital when they know a big contract is on the horizon. If the VC is already on your board from a previous funding round, they will have perfect insight into your position and could possibly take advantage of the situation by offering you a valuation based on a multiple of current revenue versus future revenue.
One company turned to TIMIA Capital when it found itself in a similar scenario in 2019. It operated in an industry that was typically slow to change. The contracts were enterprise-level but the average sales cycle and implementation time was quite long. By using debt to bridge the sales-cycle gap, the company reduced dilution and held off on an equity round until it closed some enterprise contracts and was in a better position to negotiate more favorable terms.
3. If your VC loses interest in your company
When a venture capital investor first gets involved with your company, you are provided significant attention as the newest company in the portfolio—the future is bright.
When you’re a few years into the relationship with the VC and you haven’t hit all your milestones, the investor may lose interest or the individual that drove your investment may leave the firm. In either scenario, the chances of you securing more financing from them are slim. Worse, other VCs will be actively dissuaded from financing you when they realize your current VC has lost interest.
One portfolio turned to TIMIA Capital in this scenario a few years ago. In order to accelerate the pace of growth, the company needed more investment cash. Their original investors were unable to put in any more money and the company struggled to attract new investors for two reasons:
- MRR growth, while good, didn’t match the “triple, triple, double, double, double” rule of thumb that new VC investors are looking for.
- Growth investors are more comfortable with steady and stable growth. However, the company had not yet reached the magic revenue threshold that those investors work with.
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TIMIA Capital works with B2B SaaS and software-enabled
companies between $2 – $20 million ARR.
The only way the company could move forward was to get its MRR to a place where it could attract fresh investment to buy out the old shareholders. They took on $2 million in non-dilutive Revenue Financing from TIMIA Capital to help them grow revenue quickly. The company’s strategy worked and it managed to attract a new investor to buy out their old investors in just nine months.
Debt is a great solution for founders who find themselves saddled with tired investors given a debt provider’s perspective on the value of your company will be vastly different to that of a venture capital firm. The debt providers are not looking for the 20X return that a VC might look for. It can help you grow the business to a point where you can sell it at a price that will ensure the founders and early investors earn significant returns.
Founders don’t always have to decide between debt or equity. There are many scenarios where both can be adopted strategically to achieve the best possible outcome for the business. If you’re considering your growth capital options, get in touch with TIMIA Capital to see if our solutions could help you lower your overall cost of capital and secure you a better valuation down the line.Back to top