VC Financing vs. Revenue Financing: What Works When w/ Capchase CEO + Head of Capital Markets & Risk

So I think I'll be stating the obvious when I say that fundraising is not fun. It's difficult, it's time consuming. The average founder requires around 30 meetings, if not more to get to a term sheet. And then think about all the time you spend in between preparing, following up and over the life cycle of a company. You know, that adds up to a lot of hours and a lot of effort. However, as we know, capital is necessary and especially for a SaaS company. Most SaaS companies require large investments upfront to develop, distribute, and the life cycle between the investment being deployed and the investment then yielding results is quite long. Think about acquisition, implementation, sales commissions, the payments and the customers starting to trickle in. And so the faster that the company grows, the more money it burns. Can we go to the next slide? No. Yeah. So if you add these two together, that it's time consuming, it's difficult, but you need capital and it also takes time to recoup the capital. You start thinking about, well, what's the best way for me to finance my company? So if we go to the next slide, the traditional means of financing that are available well, in the venture space, you have equity capital, quite selective, not available to all companies, as we know. VC funds in general have quite a selection bias towards companies that they view as being potential unicorns, which potentially leaves a large pool of companies out there that could be great. Businesses may not meet unicorn status, but still need the capital. And in terms of equity, in terms of cost, I mean, as we know, high cost of capital and then dilution is a big problem that founders face in this space. So if you have venture equity on one side, what is the other option currently available left to SaaS companies would be venture debt. So while it relatively speaking would be cheaper than venture equity, when you add in all the bells and whistles, such as warrants, such as the transaction costs, such as the flexibility that you give up in terms of covenants, in terms of operational constraints that get put on the business, you add all of this together, the cost is also relatively high, the flexibility is reduced, and so you're left with a set of options. From a venture perspective, for a SaaS company, that may not be ideal incomes, a alternative form of financing, revenue financing, or what we also sometimes internally at Captchase think of as revenue clipping, which has a much lower cost of capital in terms of it's closer to pure debt, but also is the most flexible in terms of the covenants, in terms of some of the constraints that I spoke of earlier with respect to venture Debt which are not really put on the company in that sense. What you have then is the best of equity, which is the flexibility as well as debt, which is availability, repeat value as well as a lower cost of capital. And if you think of it that way, then this form of financing or revenue financing would probably be a very good alternative to finance what we think of as the biggest sinks of VC money currently, which are customer acquisition working capital as well as M and A. So pulling that together you have a type of financing which is available, which improves on the constraints of equity as well as venture equity, venture debt.

Great. Yeah. So if we think about when to use what now, I mean we know the different pools of capital that SaaS companies can tap into now. We need to understand when to use them and the initial phases of a SaaS company. When there's all this upfront investment in technology, all these experiments trying to hit pre product market fit, there's not really much revenue and revenue comes in bumps, so it's not really predictable. You can't really count on it. And those stages companies have two choices, either to bootstrap, in which case this stage can take a long time or if possible, raise vc. VC funding. Ash mentioned not all companies are so attractive for VC investors. So if you can, that is the right time to raise VC money because there are no revenues coming through the door. But then as you hit product market fit and you hit growth stage and then there's more revenues piling up because all revenues in SaaS pile up as the revenues start to pile up. Not tapping into those revenues to grow now is a huge cost of opportunity. So think about a company, let's say $10 million in ARR, the run rate is 10 million. So you're going to get 10 million through the door in whatever shape or form, at least in the following 12 months. So not tapping to that future revenue to grow now is a huge cost opportunity. And if you just use VC money to fund all along the hockey stick curve, then they got the opportunity of not using the revenue, it starts to get higher and higher. So basically as I mentioned earlier, the average funding team owns only 15% of the company at exit. And this is dramatic given that from inception to exits the average time is between seven to 10 years. So dilution doesn't feel like a lot when you're raising money and again diluted 10, 20% running around. But if you add all that together in the end the average funding team just owns 15%. So the vision really hurts and it's really real. So then let's do a case study of what it means to raise just VC or to raise VC and revenue financing to understand the difference. So this is a real case study of a company with $3 million of AR burning around $150,000 a month and raising a series A to get to $15 million of ARR in 24 months. So to do so, the burn is going to increase from 150k to 500k. So in a mindset of I'm just going to raise VC funding to get from 3 to 15 million in 24 months. I need to cover 24 months of Runway, I'm going to be burning 500k a month. So then the series A will have to be around $12 million. Right? So 24 months times 500k per month in burn. So then at current the multiples, that could be at around $80 million of post money valuation. So raising $12 million in VC money at $80 million post money valuation would be around 15% dilution. The alternative is, let's say that the company now has $3 million in AR and they can use revenue financing to tap into up to 60% dollars. Sorry, up to 60% of the ARR into funding now. So that's for a $3 million ARR company is less than 2 million. So it's not extremely material in comparison to the Series a to the $12 million Series A. But then as a company grows from three today to eight 12 months from now to 1524 months from now, that part of revenue financing just gets higher and higher. And in the end it's almost $10 million. Right, which is almost as high as the round, as the full round. And then the company doesn't need 12 million upfront, it's just going to sit in the balance sheet for the following 24 months as it gets really depleted. So then the company went from raising $12 million of Series A to raising $6 million of Series A and then using revenue financing to fund the growth of the business as they went from 3 to 8 to 15 and so on. And then the dilution was half of what it would have been with raising just VC money for the round. And then this meant that the founder stake value was 6.5 million higher than it would have been if they had just raised VC money. So this is a case study of using revenue financing in combination of events around. So then, now, I mean, we know what capital is good for when we know when to use different source of capital. But then like how much should SaaS companies think of raising and the default here so far has been in the industry, has been raised as much as possible, as much as I can and keep that money in the balance sheet for a rainy day. But then what happens? What happens with all the unused capital? So if you haven't used capital on your balance sheet, it's just costing money, it's not being put to use and it's not generating returns. So then, especially if this is venture capital money or venture debt with an associated cost to it, it can get very expensive if it's not used. So then this idle cash presents a dilemma. On the one hand, there needs to be enough to reach the goals of the company in the future. But then if you have too much that's not being used and it's never going to get used, then it's just costing money and it's very, very, very expensive. So then let's see how the best of both worlds can be achieved. Right, so if we look at, well, this is what we like to call static funding versus programmatic funding. Static funding is that mindset of I'm going to get as much as I can upfront and then programmatic is I'm going to get just exactly what I need to get to those long term goals. So then discrete funding events, let's just for a moment take it back. Focus only on Visa funding. Right? Imagine that $3 million ARR company that we spoke about earlier, a discrete funding event would be just raising $12 million upfront, right? But then this $12 million pool is going to be spent 500k per month. So then those $12 million are really not needed now. Right? So what if the company could raise, instead of $12 million now, they could raise $6 million. So for 12 months and then $6 million again 12 months from now. So then they would raise $6 million at $3 million AR, and then $6 million 12 months from now at $8 million AR. Right? So they would raise in way better metrics, much higher valuation and thus way less dilution. So let's take it to extreme. Let's see how they could raise 500k every month to cover the burn, 500k in equity money every month to cover the burn. So then they will be raising with subsequently better metrics, subsequently higher valuation and less dilution all the time. 500k now is much more dilution than $500,000 with $50,000,000 of AR. Of course that's impossible. It's impossible to be raising money every single month or from equity from venture capital or from a bunch of debt. It just doesn't work, it doesn't make sense. It takes longer than a month to raise that money, right? But new technologies are making that possible. Being able to understand exactly how much capital is needed at every single month. And how they do this is by understanding very, very well the data of the SaaS companies, understanding the data in real time and how that changes and then prescribing the right amount that is needed at any time and how much is needed. This can follow different logics. It can be understanding all the cash inflows and outflows into a SaaS company and predicting cash gaps in the future and then prescribing the right amount to plug that cash cap. Or for example, following some logic like a lot of companies do, like, hey, I'm just going to use this revenue financing, this programmatic financing to cover at any given time all the customer acquisition costs and all the burn. This means that all the cash deployed is spent immediately, is deployed immediately to generate returns. So there's no, I mean there's a minimum amount of idle cash left in the bank and not generating returns. So let's do a case study of, well with that case study, sorry, of 250 companies, real companies, modeling the effect of doing discrete funding events using revenue financing versus a prescriptive funding plan, doing programmatic financing, tapping again into future revenue. So here the logic is. The study use case means deploying immediately all that's available in revenue financing. So in the case of the previous company, $3 million in ARR, let's say that the availability is $2 million. So the static funding means deploying upfront everything that's available, even if it's not going to be used immediately. And then the prescriptive funding plan means understanding every single metric what's going to happen over the following 12 months and then prescribing a plan so that only the right amount of capital is deployed in order to reach those long term goals. And then the roi, which is what we're solving for here, is how much revenue is caused by the deployment of capital over how much that capital costs, right? So then when we look at the discrete funding events, all the big lump of cash upfront, the ROI is between 1.5 to 3 times the cost of the capital, depending on the source and the type of revenue based financing or venture debt and so on. Again, this is because there's a lot of capital that's idle, just generating costs, costing money, but not generating returns. And then on the prescriptive funding plan is, hey, this is exactly what should be deployed at any given time in order to be deployed immediately and generate returns. Well, the ROI was much higher between 8 to 11 times depending on the profile of the company, the CAC and LTV metrics and so on. So then basically this means that every dollar that's put into a business is deployed automatically to generate returns and to avoid tapping into that precious VC money reserve that is extremely, extremely expensive. So basically, before we jump into the conclusions of the session, SaaS companies are recurring in nature. The revenue is recurring, the metrics change in real time. So then the growth strategy isn't absolutely fixed. So our question is why is financing so fixed until now? Big lumps of cash up front and why is funding not as recurring as the business itself? I'll hand it over to Ash for top takeaways and then we can jump into questions.

Thanks, Nikki. I think just to cap on the session and everything we've talked through, the high level takeaways would be that financing and the tools that should be available to you should be as dynamic as the businesses. SaaS companies, these are dynamic businesses, they grow fast, they have different profiles, and using just the existing cookie cutter type financing models that are out there may not be the ideal solution for these companies. And so financing for that should be as dynamic as the underlying business. Then of course, in terms of growth at all costs, is it worth it? That's a very big question that all founders will ask themselves is that you need to understand what the true costs of your funding sources are in order for you to make the best and the most informed choice. And so the cost isn't necessarily just the coupon that you have to pay or the high level IRR that you have promised. But there are a lot of hidden or soft costs that go into evaluating your options, such as the transaction costs that are around it, any constraints that are put on you operationally in terms of covenants and as one of the biggest ones would then of course be the dilution. How much of your company do you give away in the future for your funding need? Now we talked about how time consuming this process is and I think a lot of us on this, watching this right now are pretty familiar with this. Protect your time, protect your money. These are scarce source resources and ones that are best put to use in growing your company in the right way. Idle capital, of course costs a lot of money. Negative carry is a very big focus across many industries, including SaaS. And so we believe that it's about Finding the right financing structure for the right stage of your business.

Yeah. All right, so let's jump into questions. There have been a few coming through. So somebody has asked if the revenue financing offering works like pure debt or is there an equity component to it. The short answer is no, that it doesn't work as equity and it doesn't really work as debt either. It's like a current liability in the balance sheet, no equity involved. There shouldn't be any hidden fees involved. Just the typical discount of bringing something in the future to now. But yeah, no equity at all. The whole purpose of revenue financing is not keeping that equity precious and close to the founders of the business. Then this another question around how can founders prepare to speed up the funding process revenue financing? And the answer is that this is totally different from raising equity or raising debt where you need to prepare a lot of documentation, a lot of pre work into raising the round and the debt and so on in the new revenue financing businesses. And Captcha is just an example. That data is ingested through API. So it takes literally one minute to connect data. It requires zero technical skills. It is as easy as logging on on Facebook or in Gmail and then the data is ingested and processed and usually the answer comes within just like a few hours. Then this is my question. How applicable is the revenue financing to non SaaS E commerce models? So here there are different types of revenue financing types. One would be better suited for one time transactional events like let's say purchasing jeans from an e commerce store. That's one. There are a lot of e commerce businesses that are recurring in nature because they have subscriptions like BDC subscriptions for healthcare, for the $1 Shave Club and so on. So this type of recurring revenue financing model is just as applicable to e commerce businesses like that than to high tech predictable revenue SaaS companies. Then there's another one. How can funders be prepared for the due diligence and assessing term sheets when it comes to revenue financing? I think that term sheets is like a term that's been used recurrently in venture capital and venture debt. I think the new revenue financing providers they offer just very simple terms that are very easy to understand. So the key things to take into account would be the flexibility. What kind of security is actually being put towards the type of financing if at all. Like theoretically shouldn't be any. But there are cases where there are also the scalability as a company grows from let's say $3 million AR to $15 million a year. How much Is the availability of capital going to grow and what needs to be put in place to ensure that it grows? And then of course the cost, like what is this going to cost to the business and what type of additional revenue is it going to provide. So again, flexibility, scalability and cost to revenue or roi.

And I would just add to that also speed. Right. Because it's the whole concept of revenue financing is making raising this type of financing almost into a commodity type process where it's automatic, it's quick and it doesn't need to take up your time. The time that you would take to assess term sheets for venture debt and have bilateral customized arrangements. This is meant to be quick, it's meant to be data driven and it's meant to be a no brainer in a sense.

Yeah, maybe a couple of last questions. There's one asking are there minimum performance metrics that we need to see before funding? The assurance is that very little, just around six months of revenue generating history so that the systems can learn from what has happened in the past and what is going to be needed in the future and can extrapolate to get to that programmatic funding approach that reduces the financing cost for everybody. And then how quick is the funding process? I think Ash just touched onto this versus traditional VC raise. But if we looked at the first slide in the presentation, raising around can take up to 30 meetings to get one term sheet revenue financing. Given that it's API enabled and it learns from the data of the company and so on, it takes less than a minute to raise up to 60% of the ARR or to get like a prescriptive funding plan to grow the business. Yeah, I think that there are a few more questions but I think they have been answered through the presentation and through the Q and A and we're running out of time. So Kathleen, unless there's something else.

No, you guys have been great and I'm glad you guys got through them all and I appreciate you guys for being here. Miguel and Ash, thank you very much and I know everyone else did as well. If you guys have more questions, I'm sure there is a way that you can reach out to Miguel and Ash be social media or email and they can answer your questions there. Thank you guys for joining us. Thank you for having us. It was super fun. Awesome. Thank you guys. Thank you guys. Attendees of the next session throughout the day.