The equity-debt balance: the shift toward debt

Afshan Qureshi
Afshan Qureshi
Content Marketing Manager
Posted on
February 25, 2022
min read
The equity-debt balance: the shift toward debt

Recently, Miguel sat down with Blair Silverberg, CEO of Hum Capital, and Benjamin Wu, CEO of Brex Asset Management, to have a conversation about how equity alternatives are gaining traction. In this conversation, they discussed equity, debt, and the new shift in the fundraising paradigm that is increasingly tipping in the favor of debt financing over equity dilution.

Growth is rarely linear -- flexibility is key

Equity fundraising assumes that growth happens in a linear manner and designates certain thresholds for different rounds of funding. But not all companies grow in a way that neatly matches those thresholds, and that’s where alternative financing can offer greater flexibility.

As Blair pointed out, “there’s a huge difference between how normal companies historically finance themselves,” and how venture-backed companies receive working capital.

Capchase works with SaaS companies with recurring revenues and uses that ARR to calculate funding. “By reinvesting into growth, they can then turn those dollars of cash into further ARR and grow super fast without tapping into VC money,” Miguel explained. “They can add months of runway to their business and delay or avoid funding rounds altogether.”

What are you really paying for equity?

As valuations are coming down, equity is becoming more expensive, and that means that companies are considering other options.

As Miguel explained, “people traditionally think of equity as not something you have to pay interest on.” But when you consider the actual returns for the company, it can sometimes make more sense to pay a little bit of interest and grow faster as a result.

A key factor is educating businesses about the other structural solutions available. There are more factors to consider like the term, the interest rate, the rule for liquidation preferences, and so on. But once companies get used to discussing these different terms and see the benefits attached to equity alternatives, these may be the best funding options.

And as Blair pointed out, metrics are a critical part of unlocking debt financing. “It’s really important that you use your data well to tell your story.” As companies start using SaaS systems that document large quantities of data, having the evidence to back up your story becomes much easier.

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Why you should consider the ‘all-in’ cost of capital

One thing businesses rarely consider as they look at funding options is the ‘all-in’ cost of funding, as Blair puts it. Capchase works hard on the approach that growth doesn’t just need cash, it needs, “the right amount of money at the right time,” explains Miguel, often for one specific action– for example, for user acquisition.

Programmatic financing is what Capchase calls this, and for companies who can’t or don’t want to use venture capital funding and the dilution that entails, it can make growth skyrocket. “We’ve seen companies going from $70k to $7M ARR in six months, or $200k to $30M in 18 months. It’s transformational.”

Miguel explains that the advantage of developing a vertical for a specific industry, like recurring revenue SaaS businesses, is that a lender can clearly understand the risk profile within it and make much safer underwriting decisions, regardless of the market at any given time. Compare this with traditional underwriting that covers a wide range of industries and business models. When there are very few common indicators of what makes a company safe and the market means lending is risky, very few companies receive funding. “We have such a deep understanding of the revenue software and the expense software and so lending in this field becomes very safe for us.”

Blending equity and debt financing

As with all things in business, there’s nuance in how to use funding. And there’s rarely one right approach for every business, or for every stage of business. When businesses first start and don’t have revenue or cash, equity may be an essential first step. It can be incredibly useful when you’re looking to generate highly scaled returns in a few years. But as Miguel says, “for items that are predictable like ARR, that are scalable and metric-driven, then it might be better to look for a faster, and possibly cheaper, way to achieve growth.”

Lenders are all very different and take very different approaches, and Ben agreed that, “the onus will be on lenders to really get into a company, understand it, believe in its management and understand the opportunity, as opposed to just backing the investor base.”

And for the business, as Blair pointed out, “it really depends on the growth trajectory.” If your lender is going to be a major partner in the way capital works in your business, then it’s important to ask questions about where they get the capital and how easy it will be to fund things in the future.

Future of capital financing

For those at the cutting edge of alternative financing, how do Miguel, Blair, and Ben see the equity/debt balance moving in the next few years?

“I believe financing will be embedded into very specific actions,” says Miguel. There will be acquisition financing to acquire companies, user growth or expense financing, and that means you’ll get the financing at the right time, for the right length and the right price. It will be a massive shift.”

“Senior management will become more fluid with their understanding of the different types of capital out there,” says Ben.

And Blair sees the emergence and use of Saas as having the biggest impact. “Essentially, around 75% of companies right now are running on systems that spit out a bunch of data,” that can be used to support funding decisions.

Capchase is already using that benefit to speed up the financing process, explains Miguel. “We just sync systems and extract the data we need - it can be processed in hours as opposed to weeks or months, so we can make financing decisions incredibly quickly.”

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