Credit Lines for Software-as-a-Service Startups

Now that Software-as-a-Service (SaaS) is mainstream and seemingly billion dollar acquisitions occur on a monthly basis (see Responsys to be acquired by Oracle for $1.5 billion from last week), it’s important to discuss the line of credit options available for these types of businesses. See, most entrepreneurs won’t qualify for a line of credit unless they have personal assets to guarantee the loan (e.g. if you want to borrow $100,000 be prepared to have $80,000 in deposits, real estate, etc. to put up as collateral). SaaS, due to recurring revenue, high gross margin, and the predictable nature of the model makes for a unique business that’s well suited to loaning money based on recurring revenue (even absent free cash flow).

Here are a few thoughts on credit lines for SaaS startups:

• Credit lines are often based on a multiple of monthly recurring revenue (e.g. 3x) and annualized renewal rate (e.g. 80%) — an example is doing $500k/month in recurring revenue ($6 million annual run rate) with an 80% renewal rate results in a line of credit of $1.5 million * .8 = $1.2 million
• Covenants are always required, typically around customer renewal rates (e.g. 70%+ annually), growth rates (20%+ annually), gross margins (70%+), and cash collected over the past 90 days (70% of the line of credit)
• Banks and other lenders want some level of scale to do a deal (e.g. must qualify for at least a $500,000 line of credit as they don’t want to do smaller lines due to the lender’s business model)
• Square 1 Bank and Silicon Valley Bank both have great programs for SaaS companies
• Firms like SaaS Capital are emerging that offer smaller lines of credit as well as lines that aren’t as restricted as banks (but have a correspondingly higher interest rate)

Pardot was a major beneficiary of a credit line from Silicon Valley Bank and it allowed us to significantly invest ahead of growth. Once a SaaS startup achieves enough scale to qualify for a line of credit, it’s one of the best ways to finance the business.

What else? What are some other thoughts on credit lines for Software-as-a-Service startups?