Think debt isn't worth your time because terms would be so covenant-laden, they would restrict how you deploy your capital?
It's a familiar story. Cash is the lifeblood of your tech business. And you know that debt is cheaper, takes less time to set up, and is less dilutive than equity.
But at the same time, you know if you can't provide satisfactory answers to a traditional lender, such as a bank's questions:
- What is your EBITDA ratio? And how well can it cover your debts?
- Is your cash flow sufficient to support operations and pay back my loan?
- Will liquidation of your assets pay back my loan?
It will issue covenant-laden terms that'll put a stranglehold on your growth.
So what's the answer?
Tech businesses can and should explore taking debt, and it's easier than you think. To take on debt without signing up to constrictive covenants, you just need to know where to look.
But before I show you how this works, let's go back to basics.
What is a debt covenant?
Debt covenants require a borrower to adhere to contractual rules in the form of specified actions or conditions in a loan agreement.
Typical debt covenants include:
Cash covenants: A request for a percentage of the outstanding loan balance to be kept in the company bank account.
EBITDA/forecast covenants: Here, a loan is agreed against a forecast. And the loan recipient or borrower is expected to deliver in line with the estimates, with usually a 10-20% variance.
What happens if you breach a debt covenant?
Tech companies invest heavily in Intellectual Property (IP), so when a lender becomes the senior creditor, in the event of a default, debt covenants pose a significant problem. Breaching covenants can result in punitive fees and most worryingly forced repayment of the entire sum.
So now you know what a debt covenant is, let me show you how you can avoid constrictive covenant-laden terms.
How can the tech sector avoid constrictive debt covenants?
When raising debt, you ideally want to talk to the alternative finance sector, in particular, private debt funds which can provide funding faster, with a higher level of flexibility and debt structures much more suited to your business model.
How can a private debt fund issue covenant light terms?
1. Certain private debt funds specialise in the tech sector
Most compellingly, specialist private debt funds understand the growth stages and risk profiles of software and SaaS companies, and when is the right time to scale for success.
Because of this understanding, they're more likely to believe in the proposition presented by pre-profit, loss-making tech businesses. Therefore they'll be comfortable in structuring covenant-light deals that satisfy growth ambitions.
2. Private debt funds look for proven 21st-century business models
Private debt funds see the value in and reward favorable terms to:
- Fast-growing companies backed by VC/PE money
- Pre-profit companies that can demonstrate a sound business model, growth plan, and a recurring revenue stream
3. Private debt funds ask different questions
In particular, you can expect a private debt fund to ask:
- What is the probability that this tech business has the ongoing ability to grow?
- Also, attract investors and transition into profit?
- Will the company's total value be sufficient to pay off my loan should investor support prove insufficient?
4. Private debt funds structure terms and prices differently
To compensate for the risk in funding pre-profit, cash-burning companies, private debt funds:
- Value and use IP as security
- May combine loans with warrants
- Ask for regular access to financials, external reporting, and compliance requirements
And if private debt funds do take covenants, they structure them to suit your business plan, revenue streams, and capital strategy.
What can tech companies use covenant-light debt finance for?
Typically, tech companies use covenant-light private debt finance, including venture debt to:
- Extend cash runways
- Bridge a funding gap
- Reach a milestone
- Fund an acquisition or other growth expenses
- Avoid a down-round
- Provide a financial cushion to protect you from inflection points
In conclusion
To secure covenant-light debt finance for your tech business, talk to the alternative finance sector. In particular to private debt funds.
Because, private debt funds:
- Specialise in the tech sector
- Understand your business model
- Ask the right questions
- Structure terms and pricing that’ll satisfy your growth ambitions
And finally,
If you'd like to discuss how your tech company can access covenant-light debt finance, drop me a line, and we'll set up a time to chat.
