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For Executives, Entrepreneurs, and other Digerati who need to know about SaaS and Web 2.0.

Finance SaaS With Debt?

Posted by Bob Warfield on May 27, 2007

I recently read this Phil Wainewright post about financing SaaS companies with debt, and the more I think about it and the more folks I talk to about it, the more interesting a story it seems.

It’s become generally accepted that SaaS can be more capital intensive then perpetual models.  This stems from several issues:

–  SaaS requires more software than perpetual–multi-tenancy, IT “glue” code, and a host of other things that the perpetual guys don’t need to worry about.  It’s true there is savings from single platform and everyone on the same release, but those savings come later, while the extra functionality is needed up front.

– Speaking of SaaS advantages coming later–revenue is recognized later, creating a lag in profitability.  This is often made up for by cash up front, but it doesn’t wholly substitute.

– Lastly, SaaS is offering a considerable service component at much lower margins to the software itself.

Given this hunger for capital to grow, it’s always interesting to see where new sources can come from.  Now there’s a firm called SaaS Capital that wants to help out with debt.

Traditionally the capital has been raised through successive equity rounds, at the cost of much dilution for existing shareholders.  SaaS Capital is saying they’ll loan the money for interest.  They’re looking for companies in the $4M to $40M revenue range with a proven track record of renewals from their customers.  In today’s world of low interest rates, that’s an interesting proposition.

What’s even more interesting to consider is the tremendous vote of confidence this implies for the SaaS business model.  Their ability to profit from loans is inherently less than an equity investment.  What that means is they have to reduce the risk they’re taking relative to equity investors, and that implies they think SaaS is much lower risk than other ventures still on the equity model.

Or, as one VC interviewed by Wainewright put it:

“The nice thing about the SaaS business is, if the customers are getting some value out of it, then even if the business [management] messes up, the customers are not going to go away,” he said. “There’s still value in the business and you can take it over and just run it for cash.”

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