Subordinated Debt for SaaS Businesses

March 15, 2017 at 11:43 AM

Subordinated Debt for SaaS Businesses.pngWe have encountered a recent spike of interest in junior debt for SaaS businesses, and since we provide both senior and junior loans (although mostly senior), we thought we would share our perspective on the types of scenarios where subordinated debt makes the most sense.

1. Scale matters. Two lenders means two of everything (diligence, reporting, covenants, legal documentation, fees, lawyers) plus an inter-creditor agreement between the two lenders. Even with knowledgeable lenders at both levels, there are just lots of people and agreements, even if one is already in place. This can all be fine if you are borrowing more than $3 million in junior debt, but below that scale, it really starts to add a lot of cost-per-dollar borrowed both in transaction costs and ongoing reporting costs.

2. Pay attention to total interest expense, not just rate. Junior debt is almost always a fully funded term loan. That’s fine, and it’s obviously nice to have the security of the money in the bank, but it means you will pay considerably more in interest expense than you would under a line of credit where you can draw the money down as you need it. In the final analysis, what you want to try to figure out is the dollar cost per month of runway, and a term loan is an inefficient structure to do that.

3. On the plus side, junior debt is typically funded quickly, and can fill a real gap. For a $10 million or larger SaaS business that might need a $3 to $5 million cushion in order to transition to break even or bridge to a next round, subordinated debt can be a good fit. It’s difficult/awkward to raise outside equity at that size, and doing an internal round might have other complications.

4. While the subordinated debt may have no covenants of its own, it is almost always “cross defaulted” to the senior loan agreement which may be a monthly recurring revenue (MRR) or accounts receivable (AR) line-of-credit. That makes the covenants you have with your senior lender even more important.

SaaS businesses have more options than ever for debt financing, so choosing the right partner and structure is getting more complicated. We hope the points above will educate borrowers to ask good questions and find the right structure for their needs.

Todd Gardner
Founder and Managing Director, SaaS Capital

Tags: saas financials saas financing saas fundamentals saas metrics saas capital
Category: Financials

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