Debt Financing and Credit Facilities: Leverage Without Dilution
Master debt financing. Access credit, understand terms, manage debt responsibly.
Key Takeaways
- Debt vs equity: Debt = borrowed money (repay with interest, no dilution), Equity = investor ownership (dilutes founders, no repayment). Debt best for: Predictable revenue (SaaS ideal), near breakeven (leverage profit), extending runway. Equity best for: Pre-revenue, rapid growth, need investor expertise. Typical structure: Venture debt (£500K-£2M) + equity round (Series A/B). Cost: 10-14% interest (vs 30% equity dilution). Benefit: Extend runway 12-18 months, bridge to next round, less founder dilution.
- Types of debt: Revenue-based financing (repay % of revenue), term loans (fixed monthly payment), venture debt (secured by investor commitment), lines of credit (borrow as needed). Revenue-based best for: Predictable SaaS (repay 3-8% revenue until 1.5x borrowed). Term loans best for: Strong financials, can service debt. Venture debt best for: Backing up equity raise (£2M equity = £500K-1M venture debt). Cost: RBF 6-10% annualized equivalent, term loans 10-14% APR, venture debt 12-15%.
- Debt planning: Calculate capacity (can we service payments?), repayment timeline (monthly payments vs milestone-based), triggers (covenants, defaults). Example: £10M ARR SaaS with 70% gross margin = £7M gross profit. £500K venture debt at 12% = £60K annual interest (less than 1% of profit, manageable). Risk: Over-leverage (too much debt, hard to service), growth slowdown (payments become burden), default (if revenue drops). Strategy: Conservative (only when near breakeven), monitored (track debt-to-revenue ratio).
Understanding Debt Financing for SaaS
Accessing capital without equity dilution. **Types of debt financing** Revenue-based financing (RBF): - Structure: Lend £500K, repay until £750K (1.5x) is returned - Payment: Monthly % of revenue (3-8% typical) - Advantage: No fixed payment, scales with business - Cost: 6-10% annual equivalent interest - Example: £100K/month revenue, 5% RBF, £5K/month payment - Duration: Until 1.5x repaid (could be 18-36 months) Venture debt: - Structure: Traditional loan with fixed payment - Amount: Usually £250K-£2M - Tied to: Next equity round (investors guarantee) - Cost: 12-15% APR - Example: £500K venture debt, 24-month term, ~£23K/month payment - Advantage: Backs up equity round (lender comfortable because equity coming) Term loans: - Structure: Bank loan, fixed payment, fixed term - Amount: £100K-£1M (depends on creditworthiness) - Cost: 10-14% APR - Term: 3-5 years typical - Qualification: Require strong financials, asset backing - Best for: Growth-stage SaaS with predictable revenue Lines of credit: - Structure: Access up to limit, draw as needed - Cost: Interest on borrowed amount only - Advantage: Flexibility (use when need) - Example: £500K line of credit, only draw £200K, pay interest on £200K **Debt capacity assessment** Can you service debt payments? Formula: (EBITDA or gross profit) / Debt service = Debt service ratio - Healthy ratio: >1.5x (profit 1.5x larger than debt payments) - Example: £10M revenue SaaS, 70% gross margin = £7M gross profit - £500K venture debt, 12% APR = £60K/year interest (~5K/month) - Debt service ratio: £7M / £60K = 116x (very healthy) Scenario analysis: | Stage | Revenue | Gross Margin | Gross Profit | Max Debt | Annual Interest | Burden | |---|---|---|---|---|---|---| | Early (£1M) | £1M | 60% | £600K | £200K | £24K (4%) | Manageable | | Growth (£5M) | £5M | 70% | £3.5M | £1M | £120K (3%) | Comfortable | | Scale (£20M) | £20M | 75% | £15M | £3M | £360K (2%) | Easy | **Debt vs equity decision framework** Choose debt if: - Predictable revenue (SaaS fits) - Near profitability (can service payments) - Don't need investor expertise - Want to minimize dilution - Have 12+ months runway Choose equity if: - Unpredictable revenue (pre-product) - Burning heavily (can't service debt) - Need investor board seat, network - Raising for growth (equity has better terms) - Want to hire investors as advisors Combination (most common for growth-stage): - Series B: £5M equity + £1M venture debt - Use equity for product, team, growth - Use debt to extend runway, bridge expenses Example comparison: | Metric | Equity Only | Debt + Equity | Difference | |---|---|---|---| | Capital raised | £5M equity | £5M equity + £1M debt | +£1M runway | | Founder dilution | 25% | 20% (estimated) | -5% less dilution | | Annual cost | £0 (no payments) | £150K (debt service) | Manageable from profit | | Control | Diluted 25% | Less diluted (20%) | Retained more equity | **Debt terms and covenants** Key terms: - Principal: Amount borrowed (£500K) - Interest rate: 12% APR (example) - Term: 24 months (example) - Monthly payment: ~£23K (principal + interest) - Maturity date: When loan fully repaid Covenants (conditions lender enforces): - Minimum revenue (must maintain) - Maximum burn rate (can't exceed) - Debt-to-revenue ratio (must stay below) - Financial reporting (monthly financials) - Collateral (what secures loan) Default triggers: - Miss payment (usually 30 days grace) - Revenue drops below covenant - Debt-to-revenue ratio exceeds limit - Violate covenants - Consequence: Lender can demand immediate repayment **Debt management best practices** Timing: - Raise before desperate (not when runway = 3 months) - Ideal: 12+ months runway remaining - Earlier = better terms (lower interest, larger amounts) Amount: - Conservative: 2-3x annual cash burn (safe repayment) - Moderate: 4-6x annual burn (stretching comfort) - Aggressive: 8-12x annual burn (risky, may not qualify) - Example: £50K/month burn = £600K/year = borrow £2-3M maximum Monitoring: - Monthly: Track debt-to-revenue ratio - Track: Are payments manageable? - Assess: How's business tracking vs covenant requirements? - Plan: Will you hit milestones (revenue targets) to justify debt? When to refinance: - Interest rate drops (refinance at lower rate) - Revenue increases (qualify for larger facility) - Approaching maturity (extend before due) - Problems arising (talk to lender early, don't hide)