3 myths about debt funding and why they are false

Mar 1, 2024

The SaaS world used to be all about equity. Venture capitalists showered young SaaS companies with funds, valuations soared, and debt financing seemed like a dusty option.

But the tide is turning. With stricter VC scrutiny, plummeting funding rounds, and a renewed focus on profitability, many startups are discovering the power of debt. Yet, myths and misconceptions are still buzzing around. Let’s take a closer look at the top 3 debt myths – and why they are false.

Myth 1: Debt is expensive, equity is inexpensive

This misconception makes many SaaS founders shy away from debt. They imagine high interest rates while picturing equity as free money. Truth is, both funding options come with capital costs, just in different forms.

Do the math with equity

While you don’t pay immediate interest with equity, you sell a piece of your SaaS company. Each share sold dilutes your ownership and future profits when exiting. The bill may not come for a few years, but when it does, many SaaS founders are surprised to find out how little they actually earn from an exit.

Additionally, dilution means less control of your SaaS company, impacting your ownership. VCs often demand control over strategic decisions and a seat at the table.

Cost of capital with debt is clear

With debt, the cost is upfront and clear: interest. You know what you’re paying and when. This transparency allows for better financial planning and avoids unpleasant surprises down the road. Plus, you maintain complete control over your company’s direction.

Don’t assume debt is automatically more expensive. Non-dilutive funding and strategic freedom offered by debt can outweigh the repayments. Carefully analyzing your situation and potential returns is crucial.

Myth 2: Debt is tricky, equity is easy

The simplicity of pitching your idea and receiving a check in exchange for shares makes equity seem easier. It can take a couple of months, but in the end, you have a large sum in your bank account – and there is no need to pay it back directly. Capital efficiency and quick capital deployment are not your main priority.

Debt requires planning

While navigating financial structures might seem daunting compared to the straightforward equity pitch, debt financing and taking on loans isn’t rocket science. The key is planning ahead.

You must identify investments with predictable returns, like marketing campaigns or events. Projects with a calculable ROI make sense to finance with debt. This requires thoughtful analysis, but it’s an achievable task.

Using debt effectively demands discipline. You need to track your finances diligently and use the capital efficiently. This fosters a culture of cost-consciousness and strategic decision-making, but ultimately puts you in a stronger competitive position.

Myth 3: Bigger is better

The charm of a huge funding amount, providing a seemingly endless runway, can be tempting. However, this “more is more” approach can be disastrous.

Remember, bigger debt means bigger interest payments. These costs eat into your cash flow, impacting your ability to operate and grow. Think of it as a heavy backpack – initially, it offers security, but soon becomes a drag on your progress.

Raise more than you need is rarely smart

Overfunding with equity might seem harmless, as you simply sell more shares. However, this increases dilution, potentially leaving you with a minority stake in your own company. Additionally, if you overvalued your company during funding, future down rounds could be brutal.

Instead of chasing the biggest possible number, focus on taking on only the funding amounts you need and can utilize effectively. It applies to equity and debt. With that in mind, you ensure manageable costs and can fuel your strategic growth – without the burdens of overfunding.

Debt can be an untapped ally

Debt financing isn’t a monster to fear. It’s a powerful tool waiting to be harnessed. It diversifies your funding sources, reduces dependence on volatile VC markets, and grants you greater control.

A multitude of companies have already discovered debt financing as an ally and added it to their capital stack. For example, Cloud86, which uses debt to scale their web hosting business and fuel their growth. Or Stories, which refinances its operational and capital expenses.

In today’s challenging funding landscape, the ability of debt to bridge the gap, fuel profitable growth, and minimize dilution makes it an invaluable ally for any ambitious startup.

Other articles:

Alternative debt funding vs. traditional debt funding: All you need to know

Navigating startup funding: Which financing instrument is relevant at each stage?

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