For startups, equity has long been the primary mechanism for accessing cash. Whether in a friends-and-family round to get things off the ground or a Series B to accelerate growth, founders trade equity shares for cash that can fuel the business over the coming months or years.
The need to finance a startup using equity arose out of necessity. After all, traditional banks are only interested in financing traditional business models. The risk profile of startups doesn’t fit with banks’ lending practices, and so trading equity for investor cash became the standard way to raise both early-stage funds and growth capital.
But equity financing is expensive. With founders selling 10-20% of their company during each fundraising round, it’s easy to end up in an unenviable position where the vast majority of upside has leaked away from founders and employees.
Luckily, due to the increased prominence of SaaS business models, the funding environment has changed in ways that can benefit both founders and investors. Notably, there’s a new, non-dilutive option for your financial stack: debt.
Adding a new financing option is important because today’s challenging macroeconomic environment is once again proving that cash is king. Businesses that optimise their cash reserves and free cash flow can survive rocky times; cash-strapped businesses will find themselves in some very uncomfortable situations.
Of course, there are still many areas where startup funding should remain equity-based, namely the riskiest aspects of venture building: the search for product-market fit, international expansion, R&D…
But there are other, more predictable aspects where debt financing makes perfect sense. In this article we’ll zoom in on one of these: How debt can help optimise your CAC and fund your CAC payback period.
CAC has always been high on a founder’s list of priorities, a mainstay in Series A and B pitches trying to demonstrate to investors that they’re building a viable business. By comparing CAC and LTV, founders would show investors that they’ll be able to use their money wisely.
But using equity financing to fund your CAC ends up being expensive – very expensive. At a certain point of company maturity, these costs are far from being risky; they are instead well-identified and predictable. So why should they be financed using risk capital?
Here’s a Scenario:
- XYZ Ltd is a SaaS business with a Gross Margin of 70% and Annual Churn of 3%
- Customer A will bring in $12 over the next 12 months
- It costs $8 to acquire Customer A;
- Taking into account churn & margin, Customer A will then turn cash flow positive in month 11
- However, XYZ does not want to allocate all of its capital into customer acquisition and would prefer to spread the costs over the year, freeing up capital for other parts of the business
- Instead, XYZ decides to finance CAC and spread the cost over 12 months (beyond the CAC payback period)
- Utilising debt allows the business to have greater free cash flow, and allows the business greater liquidity for other activities
Obviously, your company’s numbers will differ. But if you have a business with this kind of predictability, it only makes sense to use debt financing – which is temporary – rather than equity financing – which is permanent – to fund your CAC.
The Uncapped loan system was designed precisely to fit this type of situation. With transparent terms, flexible repayment scheduling and no collateral required, it provides the cash you need to increase your growth rate.
Operationally speaking, there are several reasons why it makes sense to use debt to optimise your CAC and benefit from more free cash flow:
- You can spread your CAC costs across a given period, with a clear view of exactly how much you’ll pay back and when.
- Having the cash in your account creates internal liquidity rather than being dependent on the arrival of outside funds.
- By reducing the upfront burden linked to your CAC, you free up cash to make more investments in areas that make sense – for example by increasing the size of the sales team and benefiting from the extra deals they’re able to close.
These operational benefits are accompanied by some big-picture advantages that we’ve seen illustrated by some of Uncapped’s happy customers.
By using debt well, the value of your equity is maximised. With non-dilutive debt helping to boost customer acquisition, your company will be in the strongest position possible when you next decide that the right moment has come to raise money.
Look at the example of Marshmallow, where they were able to grow revenues by 56% in just two months by using an Uncapped loan for customer acquisition. Those higher revenue numbers had an outsized impact when they next went to talk to VCs. They ended up with a new valuation that was several multiples higher than where they were a few months before.
And remember that since equity is forever, any given amount of “saved” equity isn’t just a big deal during your next fundraising round. When looking forward to an acquisition or IPO years down the road, being able to keep an extra 5-10% in your pocket now can turn into a truly exponential return.
It provides additional runway and thus gives you more options. Fundraising isn’t just about your company. It’s also a question of industry context, macroeconomic trends, VC needs, and more. The last thing a founder wants is to be in a position where they need to raise money now. If they get lucky, that “now” will be a good moment to raise; and let’s face it, during the bull run of the past decade, there were a lot of good moments to raise.
But the context has now shifted. Today founders are faced with rising interest rates, a pivot from growth to consolidation that’s happening even in many of the world’s largest tech firms, economic uncertainties linked to shifts in globalisation, and much more. There are a multitude of headwinds, and you need to make sure that you’re in a very strong position when looking for equity financing.
To see how debt can help strengthen your negotiating position, check out the Noah story. By using debt wisely Noah’s founders went from struggling to raise to being oversubscribed. They used their Uncapped loan to both expand their runway and boost performance, growing year-on-year revenues by 127% and putting the company in a great position both financially and in the eyes of investors. It’s an example that shows how debt financing can be a way to increase your cash reserves and escape the whims of volatile equity markets.
The bottom line is that having more funding options is a giant step forward for ambitious founders looking to optimise every aspect of their business. Accessing debt isn’t about replacing equity financing; it’s about using the right kind of money for the right kind of activity.
Equity has its place: it’s high-risk, high-reward strategic funding.
Debt has its place: it’s low-risk, well-forecasted tactical funding.
So moving forward, let equity serve as the rocket fuel that will be added at key moments to send your machine to the next level. And let debt serve as the oil that keeps your sales and marketing engine humming, improving the business on a daily basis so that you end up sitting in a bigger, better rocket.