Tech Lending: Types of Debt for SaaS Providers
This article is the sixth in a series providing an overview of critical considerations for commercial lenders contemplating whether to finance a tech company and how such loans can be secured.
Software as a Service (SaaS) vendors provide services that are based on the access to and the functionality of software centrally hosted on external servers, rather than installed on the customer’s premises. While SaaS providers can seek financing through either equity or debt, debt may be preferred to avoid equity dilution and loss of control associated with financing sources like venture capital funds.
Debt options typically available to SaaS providers include factoring and a monthly recurring revenue line of credit.
1. Factoring is an arrangement by which current accounts receivable can be assigned to a professional lender at a discount. The lender evaluates the strength of the paying customer’s credit and lends against invoices. This allows the business to receive an influx of cash where invoices may take 60 or 90 days to be paid. However, many SaaS providers require customers to pay for subscriptions up front, rather than on credit, so accounts receivable may be minimal.
2. A monthly recurring revenue line of credit is a loan facility where the borrowing limit is based on the monthly recurring revenues of the borrower. This differs from traditional term loans whereby the borrower receives a lump sum on a defined schedule. It is also different from a typical line of credit where the collateral for the loan is based on accounts receivable or inventory.
Debt arrangements based on monthly recurring revenues are particularly attractive for SaaS providers, since these companies tend to use subscription-based business models that make recurring revenues especially predictable. Further, recurring revenues are often the provider’s most valuable asset since SaaS providers tend to have minimal accounts receivable and few tangible assets (e.g., inventory). Recurring revenue is also a very familiar asset to sophisticated lenders and is capable of being made subject to security.
Taking security in a SaaS provider involves at least a couple of considerations.
1. First, the cash-flow stream (i.e., recurring monthly revenues) must be secured. This can be done either by factoring or by a general security agreement and assignment of receivables under the Personal Property Security Act (PPSA).
2. The second issue is determining how to secure the intellectual property (IP) of the borrower. Depending on the type of IP and location of the borrower, security interests in IP may be registered provincially (e.g., through the PPSA), recorded federally with the Canadian Intellectual Property Office, or registered in another jurisdiction, such as in the United States with the U.S. Patent and Trademark Office. Each registration or recordal process presents its own unique requirements and affords the lender different protections.
An additional issue is whether the lender wishes to participate in the borrower’s upside. For example, the lender could get warrants in the borrower or invest in the borrower if the market capitalization rises.
SaaS vendors can be attractive borrowers to lenders, provided the type of financing makes sense on an operational level. It is crucial for lenders to consider the revenue streams, types of assets and business model of the SaaS provider to ensure the type of debt financing aligns with the business needs.