There are two types of capital available for founders. Venture capital is investment in a start-up in exchange for equity. The second type of capital is non-dilutive: alternative finance comprises a range of funding solutions, from providers to revenue-based financing.
Alternative finance is an attractive alternative to venture capital for founders who want to avoid diluting their equity.
But non-dilutive, or ‘alternative finance’ actually holds a large and growing subset of providers, from providers to revenue-based financing, so knowing which is best for your business isn’t as obvious as it might seem.
Additionally, knowing how to approach a provider, and which metrics they want to see when evaluating your business, are essential to successfully raising alternative finance. But founders typically don’t have access to as much information on approaching non-VC sources of funding. Many founders are being turned down purely based on misunderstanding the process, rather than their business being ineligible.
As the VC capital that’s been flowing into startups over the last few years slows down, now’s the time to ensure you’re armed with the right information before approaching a provider.
Identify which type of provider to approach
While there are many different varieties of alternative finance available to high growth businesses, knowing which one is best for you depends on your stage of growth and what you will be using the the funding for.
There are three things to consider when deciding which type of alternative finance provider to approach:
- What collateral can you offer?
- What structure would you be happy with?
- What is your risk profile?
If you’re an early stage company with low revenues, you normally wouldn’t have much to offer in terms of collateral. You’re also unlikely to opt for a highly structured loan which would mean signing up to restrictive covenants. The result is of course a high price. A representative example would be a 1% sign up fee, 9% fixed interest rate over 36 months plus warrants.
As you move into the growth stage, you can start offering collateral such as accounts receivable, or consider a more structured loan that requires you to sign up to covenants. Once you’re able to do this, you’ll be deemed lower risk and should expect a more reasonable price. You might expect 4% to 8%.
At a later stage when you’re breaking even or profitable, you can offer even more in collateral and you’ve also got more predictable revenue coming in, so you should expect to see LIBOR + 1% - 3%.
At Capchase, we help founders and CFOs grow their businesses faster and more predictably through non-dilutive, revenue-based capital. We provide financing by bringing future expected cash flows to the present day – thereby securing funding that is fast, flexible, and doesn’t dilute ownership. It’s ideal for SaaS and other recurring revenue businesses that are looking for growth funding to extend runway, finance customer acquisition costs or optimize for their next equity raise. Capchase funding is unsecured and non-dilutive – so no warrants.
How to pitch to alternative finance
Before approaching an alternative finance provider, you need to know what you’re trying to fund and how much you’ll be asking for.
Many founders make the mistake of pitching to alternative financethe same way they’d pitch to a VC. Although these providers and VCs are both in the business of providing capital to startups, they size up risks very differently, and you’ll need to tailor your pitch accordingly.
Before approaching a provider, make sure you know and are able to delve into detail on the following metrics:
- Revenue and growth
- Profit margins
- Unit economics
- Cash runway
It’s key to know your KPIs: LTV/CAC, CAC Payback, quarterly growth or ARR growth. Also know your unit economics, and how good or bad those are in relation to market norms. We created our SaaS Benchmarking Report, with financial data from 400+ start-ups, to give you an understanding of these trends and where your business lines up.
Although this might seem basic, it’s surprising how many companies pitch without knowing their KPIs. Not taking the time to prepare these KPIs ahead of a pitch will raise a red flag to providers, who could take it as a sign that you don’t have a full grip on your business’ performance.
Another thing you have to show is customer analysis - including who your key customers are, how much they pay, and when.
If you’re considering venture debt specifically, you’ll additionally need to show:
- The existing investors on your cap table, how much they’ve invested in your company, how strong they are and how well known they are.
- How likely you are to raise your next round.
- Your competitive advantage.
It’s likely venture debt providers will ask for due diligence calls with your existing investors, so make sure you’ve warned them to expect that.
How much to ask for
Understanding the difference between how to approach alternative finance versus a VC is also important when it comes to deciding how much to ask for.
Asking for 1 - 2 times as much debt as you’ve just raised in equity while you’re still at an early stage could raise another red flag for these providers. A more reasonable amount to ask for at an early stage is 1 times revenue. Or, if you’ve got decent equity backing, you could aim for a debt:equity ratio of roughly 1:2. As you grow, that can normalize to 50% of your revenues, or a 1:1 debt:equity ratio.
Also keep in mind that if you’re planning on raising further equity, you need to avoid a large debt hangover that incoming investors will have to pay off. That’s where a flexible solution like revenue-based financing will be most supportive. That’s because you’re able to inject just the right amount of capital – according to your business needs – at exactly the right time, on a monthly or quarterly basis, rather than a large lump sum upfront. So you can scale it up and down with your business’ growth, and only pay for what you use. By using this ‘pay as you grow’ structure, you won’t end up with a large debt hangover.
What to watch out for in alternative finance offers
Once you have one or more alternative finance offers, don’t assume you have to just accept them as they are - take the opportunity to negotiate the best terms you can. Not doing so could cost you millions in years to come.
Here’s what you need to take a closer look at once you’ve got an offer on the table:
Make sure you calculate the full cost of the facility, rather than focusing only on the headline rate. Some providers can make these look very attractive, but have higher set up or back end fees, higher warrant coverage, or a higher covenant threshold you need to meet.
Make sure any covenants you’re agreeing to are not restrictive. If you have a revenue plan, and you’ve given it to the provider, give them a best case and a base case. The provider will review your base case in their own model to decide how much they’re prepared to lend and what the thresholds should be for covenants for revenue and minimum cash. If you’ve submitted an over-optimistic forecast to a provider, you need to make sure you can actually meet the covenant thresholds and exceed them.
Some alternative finance providers are unsecured, some take a lien on cash only or accounts receivable only. Others take a fixed and floating charge over all assets - in a downside scenario, they’re effectively getting the keys to the business. Always avoid personal guarantees - there shouldn’t be a need for that in business lending in today’s market. Typically, you’d expect fully secured loans on larger facility sizes, but if you’re going for smaller sizes relative to your revenue, aim to get unsecured or secured only on cash or accounts receivable.
At the very least, you can expect to send your P&L, balance sheet and cashflow every month.
Reputable alternative finance providers will likely have standard terms that experienced lawyers will be familiar with. Legal conditions on loans tend to have harmonized over the years. It’s important to have a lawyer - either in-house or external - that understands revenue-based financing, venture debt or any other types of alternative finance that you’re considering.
You should not be expected to give up a board seat or any type of board oversight - so if this crops up in proposals, push back immediately.
Raising alternative finance during market uncertainty
Raising capital, whether it’s venture or alternative, will be more difficult and take longer in 2022 than it has in recent years. If you’re planning to do so, you’ll need to:
- Monitor your customers, cash and key KPIs monthly.
- Be realistic in planning your best and worst case scenarios.
- Communicate clearly and often to your existing investors and providers that you’re in talks with.
- Prepare earlier than you normally would for fundraising.
To further understand how you can protect your business during more difficult market conditions, read our CEO’s thoughts on navigating a down economy as a founder.