Today’s SaaS entrepreneurs have extensive options for securing debt capital to extend runway, fund working capital, and help achieve almost any business goal.
Prominent SaaS financing solutions feature a straightforward application process, fast funding, flexible repayment terms, and, most important, zero equity dilution.
Short-term financing (12 months or less), which includes merchant cash advances (MCA) and merchant financing, often attracts startup founders looking for lower capital costs and quick access to cash — but those benefits can fade quickly if the loan terms don’t line up with what the business needs.
How do you know whether a short-term business loan can help your SaaS business grow without adding unnecessary risk and costs? Start by asking three crucial questions, then carefully weigh the pros and cons.
QUESTION 1: What am I using the loan for?
Just as you’d choose a travel credit card that best suits your financial situation and travel needs, you want to choose financing that optimally fits your business strategy. Short-term business loans are advantageous in certain situations, but much less so in others. Before you even consider short-term financing for your startup, make sure it’s the right type of debt financing for your intended purpose.
If you plan to invest debt capital in ways that deliver immediate results for the business, then short-term financing can be a good fit. Other investments that take longer to germinate into revenue growth — such as product development, strategic hires, and market expansion — should be funded with a longer-term financing solution.
Short-term loans are most effective when capital is quickly sourced, quickly invested, and quickly repaid. We’ll dive deeper in a moment, but let’s look at some use cases.
When can short-term financing be a good option for SaaS startups?
You need a quick injection of cash to cover operating expenses or unexpected costs.
Funding the purchase of product inventory that can be fully sold within 120 days.
Investing in marketing programs that will generate viable sales opportunities that can be closed within 90 days.
Funding near-term product improvements that will drive expansion revenue from existing customers and improve customer retention.
QUESTION 2: Do I have enough cash flow to pay for financing costs while still funding business operations?
Fast financing can seem like a good deal, but be sure you can support the capital’s carrying costs. Short-term business loans may have a lower total cost than long-term loans if all goes well, but they are also riskier for a growing SaaS business.
If you don’t fully understand how repayments will affect your future cash flow, you’ll probably end up in a bind without enough cash to service the debt or pay other operational expenses — and that can be extremely costly, wiping out any financial benefits you expected to gain.
How changes in working capital affect your SaaS startup’s cash flow
When working capital is thoughtfully invested, it can have a flywheel effect and generate more cash flow. You have enough cushion not only to pay back your debt and keep up with monthly expenses, but also to re-invest revenue produced from the borrowed money.
Conversely, if expenses outpace monthly income while you’re paying back the borrowed money, it can create a ripple effect that squeezes your business financially. At some point you’ll either have to cut costs or raise additional money. With less cash on hand, raising capital can be challenging, regardless of whether you seek to raise equity or debt.
A miscalculation here can quickly spiral out of control — a surprisingly common occurrence. SaaS entrepreneurs benefit most by augmenting their working capital with financing that provides flexibility and breathing room.
Short-term financing, except for a few specific use cases, is more likely to deplete your working capital and disrupt your cash flow as you pay back the loan.
That brings us to the final and perhaps the most important question, which will help you crunch your own numbers and make a well-informed decision about what’s best for your business.
QUESTION 3: When do I anticipate a return on my investment?
This is a two-parter: How quickly can you invest the cash in the business, and how long will it take for that investment to start generating a return?
Part 1 – Time to invest the money
Before taking on short-term debt, consider how quickly you can put that money to work — the faster you can invest it, the better off you’ll be. Sitting on borrowed money for even a few weeks will sap your cash on hand, which can strain your finances and could send you into a costly debt spiral.
EXAMPLE
Let’s say it’s time to hire another salesperson to expand your customer base and drive more revenue. You have several solid candidates in your pipeline — but you don’t have the cash to hire one today. You decide to borrow $150,000 from a short-term lender. Two weeks later, your top candidate accepts the offer and agrees to start in four weeks.
Congrats! You’ve hired a fantastic salesperson. They begin onboarding six weeks after you secured funding to hire them; already, you’re starting to feel the strain on your startup’s finances.
In this example, you’ve borrowed $150,000 with a 1.1 repayment cap for 12 months. You’ll pay back a total of $165,000 ($150,000 x 1.1), which makes your monthly payment $13,750.
Your new salesperson hasn’t even started yet and you’ve already paid $13,750 on that investment. By the time you make your second payment (-$27,500), the new hire is two weeks into the job and still getting up to speed — but not yet creating revenue. By the time your third payment is due (-$41,250), you’re also paying your new hire’s salary.
If you’re running a B2B SaaS startup with a longer sales cycle, most likely you’re not seeing a bump in revenue yet, and your cash is burning up.
Instead of actually investing that $150,000 in your business to grow, you end up paying back the short-term loan plus interest with the money you just borrowed and reducing your cash flow.
Depending on how long it takes to start seeing a return on that capital investment — in this case, your new salesperson — your cash flow could slow to a trickle or become negative.
Part 2 – Time to ROI
For short-term financing to work, you must invest the capital quickly and see a rapid return on that investment, so you can repay the loan without decreasing cash flow.
EXAMPLE
Let’s revisit the hiring example. New sales hires for B2B SaaS companies typically require 3 to 6 months before they generate sales that help cash flow. If your new salesperson's salary is $120,000 a year, you now have an additional monthly expense of $10,000.
Below, we show you how a delay in achieving a return can drain your working capital accounts.
Here we assume your company is breaking even, making $40,000 a month, and you believe a new salesperson can grow your sales by 30% by the end of month 6. As mentioned in the previous example, the salesperson started 6 weeks after the capital was obtained.
Payment Period (Month) | Current Monthly Income | Operating Expenses | Salesperson Salary Expenses | Short-Term Capital | Total Monthly Expenses | Monthly Cash Flow | Working Capital Available |
0 | $150,000 | ||||||
1 | $40,000 | ($40,000) | ($13,750) | ($53,750) | ($13,750) | $136,250 | |
2 | $40,000 | ($40,000) | ($5,000) | ($13,750) | ($58,750) | ($18,750) | $117,500 |
3 | $40,000 | ($40,000) | ($10,000) | ($13,750) | ($63,750) | ($23,750) | $93,750 |
4 | $40,000 | ($40,000) | ($10,000) | ($13,750) | ($63,750) | ($23,750) | $70,000 |
5 | $40,000 | ($40,000) | ($10,000) | ($13,750) | ($63,750) | ($23,750) | $46,250 |
6 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | $22,500 |
7 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | ($1,250) |
8 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | ($25,000) |
9 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | ($48,750) |
10 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | ($72,500) |
11 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | ($96,250) |
12 | $52,000 | ($52,000) | ($10,000) | ($13,750) | ($75,750) | ($23,750) | ($120,000) |
The ROI delay shortens the life of your working capital. By month 7, your available cash is depleted because it’s paying both short-term capital costs and the additional salary expense.
Many entrepreneurs in this situation take another short-term loan, repeating the cycle and paying far more than they had expected and significantly more than they would have paid with a longer-term loan or a more suitable debt solution. Ultimately, they end up in worse shape than when they started.
If you’re already in this position, Lighter Capital could help you restructure bad debt and improve cash flow. Complete our short online application to get an assessment.
Weighing the pros and cons of short-term business loans
Entrepreneurs seeking to make the best financial decisions should assess the positive and negative impacts that capital from any source could have on the startup’s enterprise value, in both the near and long terms.
With any debt financing option, it’s smart to shop around, minimize your cost of capital, and take time to vet potential lenders. Plenty of lenders don’t care whether your startup is struggling or will be out of business in a year if they can grab a big chunk of your cash almost as quickly as they gave it to you. Though the perceptible cost of capital is important to consider, your true cost of capital can be quite different if the loan facility doesn’t align with your business strategy.
So, think like a CFO, and make sure any debt capital you consider is structured to help your business grow.
Now that you understand the hidden costs that might be lurking in a short-term business loan, here’s a summary of the pros and cons:
Short-term loan advantages
Quick access to capital: Access funds quickly to address immediate needs or opportunities.
Lower interest costs: Though interest rates may be higher compared with long-term loans, the total interest cost is typically lower because of the shorter repayment period.
Manage working capital: You can cover unexpected costs or revenue disruptions that cause cash flow gaps, if you can’t get a business line of credit.
Flexibility: Some short-term loans offer flexibility in the repayment terms, but pay close attention to the fine print — interest might compound daily and send your costs soaring if you’re slow to repay.
Build credit history: Successfully paying off a loan will help build your startup’s credit history, which can improve your options and lower your future financing costs.
Short-term loan disadvantages
Higher interest rates: Depending on the terms and conditions, higher interest rates, even over a shorter period, could increase your total cost of capital.
Lower loan amounts: You won’t be able to borrow as much as you can with a longer-term loan, which might not meet your startup’s capital requirements.
Cash flow stress: Higher monthly payments can burn up your cash before you start seeing a return on your capital investment. It’s important to ensure you’re not using short-term financing for long-term investments.
Risk of a debt spiral: If repaying your loan burns up your cash faster than you expected, you could get caught in a costly debt trap.
Early repayment penalties: Some short-term loans have penalties for early repayment, which limits your flexibility and prevents you from saving on interest costs.
All capital sources have pros and cons. Before you decide whether a short-term business loan is right for your startup, consider how you intend to use the money, your projected cash flow, as well as your ability to meet the repayment terms while funding business operations.
Get non-dilutive financing that fits your startup
Lighter Capital has been helping tech startups grow for more than a decade. We get to know you and your business to find the right financing solution that can support your unique needs and goals. Connect with our investment team by applying online.