A summary of some questions and answers about debt for tech startups from a recent Ask Me Anything webinar with TIMIA president Monique Morden.
In our latest webinar for tech entrepreneurs, TIMIA’s Mark Bakker welcomed our new president, Monique Morden, to co-host an Ask Me Anything session with attendees.
We’ve summarized some of the key points in this short post. Alternatively, you can watch the full webinar here.
Here are some of the top learnings:
- VC fundraising is difficult in the current climate
- Venture debt is a viable alternative, especially for mid-sized startups
- Consult an accountant, contract CFO, or proficient VP of Finance for help, secure multiple term sheets, and compare the differences to find the best deal for your specific needs and circumstances
- Watch out for tricky terms that can come back to bite you later
- Be careful with short-term loans — they’re not healthy for many SaaS businesses
What is the recommendation for startups given the reality of the tech economy today?
The fundraising landscape has been challenging for the past six to nine months. With venture capital drying up, the situation will force companies to tighten their belts and get their financial houses in order. High performers are still getting support from their investors, but underperforming startups face financing challenges and may reach the end of their runway
Venture debt could be a viable alternative to venture capital, especially for mid-sized startups that want to avoid flat or down financing rounds. Overall, we advise startups to strategize carefully to weather the current economic conditions while still hitting their business milestones. We also emphasize the importance of balancing optimism and reality in today’s environment.
How does the Software as a Service (SaaS) model impact founders and financing?
SaaS can be a challenging model for founders in the early years because it puts the financial burden on them instead of the customer.
Instead of customers paying 100% upfront as they did in traditional software models, SaaS customers often pay monthly or annually. This means the SaaS company has to finance the customer’s lifetime value, making services like ours beneficial for providing additional runway to access that value.
What advice would you give to a company seeking investment?
Companies should seek expert advice during a capital raise to understand their options better. Whether through an accountant, contract CFO, or proficient VP of Finance, it’s essential to get help, secure multiple term sheets, and compare the differences to find the best deal for their specific needs and circumstances.
What should founders look out for on investment term sheets?
Investors often want a piece of equity, a board seat, a personal guarantee, liquidation preferences, a specific financing structure (such as term loans instead of revenue-based financing), and various other terms or hidden fees.
A personal guarantee is particularly problematic as it means the founders’ personal finances are at stake if the business cannot repay the loan. Therefore, we advise founders to avoid taking a loan with a personal guarantee, as lenders should be satisfied with a business guarantee.
A board seat is a position on a company’s board of directors. We advise startups to be careful when giving away a board seat, especially to a lender. This is because it gives the lender significant control over the business.
Liquidation preferences determine who gets paid first when a company is sold or liquidated. We advise businesses to be cautious of liquidation preferences greater than 1x, as this could disadvantage the founders and early investors in the long term.
Questions About TIMIA
What type of companies do you invest in?
We mainly invest in technology companies, with a majority being in B2B SaaS. These could include companies with combinations of hardware and software, software with services, or even some without software but with recurring revenue.
We generally invest in companies selling to the SMB space, mid-market, or enterprise. We like sectors like finance and administrative tech, cloud and security tech, and healthcare tech. We don’t invest much in eCommerce companies, direct-to-consumer businesses, or services unless they’re high margin with a tech-enabled platform.
How can an entrepreneur apply for funding from TIMIA?
You can reach out by email, LinkedIn, or via the “Get Funded” button on the TIMIA Capital website. The team at TIMIA strives to make the application process as quick and efficient as possible.
How should a business present its financials when applying for a loan from TIMIA?
We prefer to see a realistic view of a business’s historical performance and first-year budget. In addition, we want to know that the business’s forecasts are reasonable and achievable and that the company has a handle on managing its burn rate.
How does your approach differ from venture capitalists regarding companies with services revenue?
We typically segment the different parts of revenue and recognize the benefits of each. Unlike venture capitalists who might penalize you for having services revenue, we appreciate it. Services revenue demonstrates that you’ve been resourceful and maintained cash flow while developing your product — we see this as a sign that you can manage your burn.
Where does TIMIA fit in the investment stack?
Our investment target is companies with between $2 and $20 million in annual recurring revenue (ARR). Several capital providers exist both below and above this range.
For companies under $2 million in revenue, providers like Pipe, CapChase, FounderPath, Arc, and others may be a better fit. For those above our range, options include structured equity, private equity, growth equity, traditional venture capital, regional players, and family offices. We maintain relationships with all of these players to help our portfolio companies progress to their next stage.
What happens if a company isn’t a fit for TIMIA but has potential in the future?
If you don’t qualify now, we provide you with feedback on what you need to do to qualify, metrics you need to improve, etc.
Also, if a company isn’t a fit for us due to being below our revenue threshold or requiring a larger facility, we leverage our extensive network of partners to connect them to appropriate resources. This could include grants or partners focused on their sector. The aim is to find a way for each company to get what they need.
We also like to stay in touch with companies as they will often they will qualify down the road.
Looking for non-dilutive capital?
TIMIA Capital works with B2B SaaS and software-enabled
companies between $2 – $20 million ARR.
Questions About Types of Debt
How does venture debt work?
Venture debt is a type of loan that requires a sponsor, typically an equity investor from a reputable venture capital firm. Once a startup secures equity investment, they can go to a bank and secure a line of credit — or venture debt — sometimes up to 2x their annual recurring revenue, guaranteed by their venture capitalist. This is an attractive financing option because it usually offers a lower interest rate than typical business loans.
However, we feel that the term venture debt should be extended to incorporate all types of debt available to founders, including term loans, regardless if a startup has sponsor-backed capital or not.
What are the advantages and disadvantages of short-term loans or merchant cash advances?
While short-term loans can seem attractive due to their flexibility and seemingly low cost, it’s crucial to understand the true cost of capital. When calculated, the annual interest rate can be over 50%, and the loans usually have to be repaid quickly (between 6 and 18 months) with aggressive repayments.
These loans can be a valid approach in certain circumstances, but for companies constantly resorting to them, a term loan might be more advantageous.
How do senior debt and junior/subordinated debt differ?
Senior debt typically comes from larger banks, has attractive interest rates, and holds the first position in the case of a company’s liquidation, meaning they get their money back first.
Junior/subordinated debt sits below senior debt, costs more due to higher risk, and may not require first position, meaning it can be layered with senior debt to potentially lower the overall cost of capital.
What is the cost of equity capital?
The cost of equity capital in a venture capital round can be calculated as an effective rate of return. Venture capitalists are typically looking for an annual rate of return of 25-45% to pay their investors.
While raising equity might initially seem like a victory for founders, they often end up with a smaller share of the company’s value due to the preferences of preferred stockholders at the time of an exit.
Is it ever okay to take equity-based capital?
We believe that equity-based capital is useful and necessary at certain times and in certain opportunities. But if your go-to-market strategy, initiative, or sales team is running well, you don’t necessarily need equity capital. Instead, you might need a different type of capital for a different period of time so you can grow your valuation and maximize your outcome.