Financing Innovation: Key Considerations for Technology Firms Taking on Bank Debt

Less- or non-dilutive bank debt alternatives do exist for mid-market technology firms, but there are considerations that should be taken before pursuing them. John Hoesley, Head of Sterling’s Innovation Finance Group, breaks down what founders need to know.

CHOOSE YOUR BANK WISELY. Founders often work with larger, less-focused financial institutions, mainly because they’ve ‘always banked there.’ These founders often face a harsh reality: their day-to-day banks don’t actually understand their businesses or, worse, the unique and rapidly-evolving dynamics of the technology sector.

When assessing your banking partner, it is important to look at their lending habits objectively. Are they quick to issue loans only to have knee-jerk responses to the inevitable speed bumps in a firm’s path? Look for banks whose underwriting is mapped primarily to business risk (whether investors are involved or not), which affords a better understanding of firms’ unique management, model, and markets. Armed with that knowledge, these banks are better able to respond to changes impacting the firm and identify opportunities and anticipate challenges in the market as a whole.

MATCH SOLUTIONS TO WHERE YOU ARE TODAY. While there are rarely ‘one size fits all’ solutions, firms should look for banking partners offering credit solutions across all stages of business development:

• VENTURE DEBT. For early-stage firms, venture debt typically follows and supplements equity rounds by adding debt equal to 25-50% of the raise. The debt also may offer a 6-24 month “interest-only” period that allows firms to continue maximizing internal investment by deferring principal amortization.
• RECURRING REVENUE-BASED SOLUTIONS. For mid-stage technology firms with subscription or highly-repeatable revenue (such as SaaS companies), recurring revenue-based lines of credit provide acquisition financing and growth working capital to support business investment.
• ASSET-BASED LENDING. Mid-stage firms with service-intensive models may explore asset-based financing to support working capital requirements. With advance rates typically up to 90% of eligible accounts receivable and 50% of eligible inventory, firms can leverage existing asset bases to provide required working capital.
• LEVERAGED LENDING. Finally, late-stage firms with positive EBITDA may explore traditional leveraged solutions for organic investment, acquisitions, recapitalizations, and management or leveraged buyouts.

ASSUME NOTHING. The timing of bank debt availability is often misunderstood. Founders often assume bank debt is not available to firms with negative free cash flow, or absent significant asset bases or investor support. The truth is, by understanding the firm’s business model—and the fact that growth investments often consume cash but drive enterprise value—experienced technology lenders can often underwrite to firms with so-called “cash burn” profiles in cases where gross and net retention, LTV/CAC, and unit economics are strong.

Sterling’s Innovation Finance Group provides a full suite of lending and banking products to growing technology companies across all stages of development. To learn more, visit snb.com/innovation-finance.