July 28, 2022
Building a resilient capital stack in a turbulent market
Say you run a startup that’s found traction and you want to keep growing. As the founder, CEO, or CFO of the company, you’ve probably spent some time thinking about the best way to finance your growth goals:
“Should we try to raise another equity round?”
“What are my chances of securing Series A (B or C) financing?”
“What if we took on some venture debt?”
But things aren’t quite like you thought they’d be when you started your last round of planning. Due to a host of factors, markets all over the world are in a state of flux, leaving business and startup financing in limbo too. So what should you do?
First, take a breath. Then, take a look at the current economic climate for companies looking to secure financing—and consider how you can get strategic about building a resilient capital stack while taking the particulars of your business into account.
The current startup financing environment
Founders and CFOs of equity-track businesses looking for the next round of venture capital have all heard the rumblings: Access to VC for post-seed-stage companies is tightening as many investors are limiting their deployment of cash in a wait-and-see manner. Put simply, for many companies, raising a round today is tougher than it was yesterday—and if you can land a deal, it may not be a great one.
If you didn’t already have contingency plans in place to access cash if venture funding doesn’t come through, then you’re probably among the founders and CFOs trying to think through alternative forms of financing.
Many folks are thinking about how to extend their runway, become cash flow break-even, and make the current money they have last without knowing when they’ll have access to more. Some are figuring out how to have a successful conversation at the more-challenging negotiating table. And just about everyone is thinking about their options for accessing capital while we see how the markets shake out.
How your capital stack can help you weather the storm
Founders and CFOs can get ahead of the challenges presented by a difficult equity market (and general economic question marks) by being especially strategic about how they finance the company, whether they’re aiming for growth, cementing stability, or balancing both.
And one way to do that is by taking a fresh look at all your financing options, starting with the company’s current capital stack—and exploring what you need to round it out and optimize for resilience.
What is the capital stack?
The capital stack is the combination of equity, debt, and other funding and capitalization methods used to finance a company’s overall operations and growth. Your capital stack can include traditional financing methods like angel and seed round investments, your Series A and beyond, bank loans, venture debt, and revenue-based lending (also known as revenue-based financing or RBF). It can also include alternative financing methods, like recurring revenue financing from Pipe.
Why think of your financing as a capital stack? Because businesses in different industries and at different stages of their lifecycle may need various capital strategies to reach their goals.
Cost and risk of different capital options
Each type of capital plays a different role in the capital stack. Equity capital arises from ownership shares in a company and claims to its future cash flows and profits, and is often used for major investments with a longer-term ROI, like R&D. Debt comes in the form of bond issues or loans (whether venture debt, startup loans, or beyond), and can help you finance operations and initiatives without dilution, as long as you have the predictable cash flow to reliably service the loan payments. Uniquely, recurring revenue financing through Pipe's trading platform lets you fund growth and operational needs by treating your recurring revenue as a tradable asset so you can access dilution-free capital. (More on that to come.)
So how does repayment work? Returns on investment are repaid starting at the bottom of the stack. The higher up the in stack the investor or lender, the bigger risk they incur—and typically the more costly their capital.
Equity is always at the top of the stack—the pay back is slower, but the cost to your company can ultimately higher if the value of your company grows. While equity investors hope to get a big return from successful investments, they often wait years to see that value materialize—and if the company fails, they won’t be paid back at all. Big risks, but big potential rewards for them—and big capital infusions, but big potential equity loss for you.
Below that layer, debt-holders like banks are more certain of repayment, and often take a slightly smaller reward for their lower risk level, typically in the form of interest and fees.
Traditional financiers—think: lenders and investors—generally want to see where they fit in to your capital stack to see where they are in your hierarchy of funding. This helps them calculate their potential return on investment versus level of risk—and may impact your cost of capital.
What founders should consider when financing a business
A big part of your job as a founder or CFO is to determine the best capital stack for your goals. What that means will vary, but often it translates to figuring out how to minimize the equity you give away—and the restrictions you take on—while still enabling growth and maximizing profits.
For many companies, selling some equity is the usual course of action to take at certain times during the business’s journey. For other companies, equity is off the table, for whatever reason—and for those folks, taking on debt has traditionally been the move. But during an economic downturn, both equity and debt can come with less favorable terms—including things like higher interest rates on business loans, more restrictive covenants, and less cash on the table in a funding round.
In a tricky market, consider what capital decisions will enable your goals today—and set you up for financing success tomorrow, or whenever the markets next shift. Some key things to keep in mind are:
Speed: Can you get the capital you need when you need it?
The predictability of your access to capital: Can you count on it, or could the funds get pulled?
How you can extend your runway and shore up your cash position
And how repayment terms will impact you and the business today and down the line
Recurring revenue financing can change the game
Not to be confused with revenue-based lending, which is ultimately a loan based on your revenue streams, recurring revenue financing treats your revenue as a tradable asset that you sell to investors.
If your company generates income from recurring revenue streams, then recurring revenue financing (or RRF) could provide a great opportunity for you to access the capital you need without giving up ownership shares or taking on traditional, restrictive debt.
Algorithms perform due diligence almost instantly, so companies can stay agile and access capital in hours instead of weeks or months. RRF can also be a strategic way to capitalize your business when other options aren’t as accessible—or as favorable—to your scenario as they might be at other times… perfect for times like these.
How Pipe’s recurring revenue financing works
Pipe is the world’s first trading platform for recurring revenue. Through Pipe’s trading platform, you can effectively turn your MRR into ARR by pulling forward a portion of your booked revenue—cash you can then use to fund your daily operations and growth goals.
How does it work? Institutional investors bid on your anonymized revenue streams to buy them like an asset. They don’t buy equity, which preserves your control over your company, nor the underlying customer contract, which means there’s no disruption to your customers’ experience. Instead, they give you up-front capital today at a slight discount in exchange for the right to the cash from those revenues as they come in. This gives you flexible access to capital at a low cost and gives investors stable, fixed-income–like returns.
Once you sign up to trade on the Pipe platform and connect your accounts you can receive a trading limit (how much capital you can access at a given point in time) and bid price (that’s how much capital you can access right away and at what price). Receiving a trading limit and bid price is not an obligation to trade, and these numbers will be automatically updated each month based on your business’s performance, so you can always see what’s available to you.
Where Pipe fits in
Your capital stack doesn’t have to be an either/or decision—traditional and alternative financing, equity plus recurring revenue financing plus venture debt… Today there are more options than ever. When the markets and economy are rocky like they are now, optimizing your capital stack for resilience may mean diversifying to ensure you have options even if one type of capital dries up.
Some pre-revenue and very-early-stage companies self-fund or bootstrap, but many are more likely to be heavily reliant on equity, since they don’t yet have predictable cash flow to pay back other financing. Once a company has revenue coming in, business loans and venture debt are often used between equity rounds to extend runway and finance growth without further dilution.
For companies with recurring revenue, Pipe is an alternative to loans and venture debt, allowing you to grow your business while holding on to as much equity as you’d like. By leveraging the predictable nature of recurring revenue contracts, Pipe gives you access to capital from institutional investors without the warrants and restrictive covenants that can come with traditional debt. (Keep in mind that those warrants and covenants aren’t just fine print—they can have real impacts on your business. It’s especially important during times of economic and industry uncertainty to understand their impact, and when they might kick in.)
And a note: unlike venture debt, which is only available to venture-backed companies, Pipe is available to venture-backed, debt-funded, and bootstrapped companies alike. That means it can work alongside equity or even replace it as your financing source, depending on what you deem best for your business.
The right capital at the right time
With all your options in front of you, you can assess and choose the right source (or sources) of financing at the right time. Whether that means optimizing for something ideal for your stage of business growth, a stack prepared for the current economic environment, or ideally both—having a strategic approach and knowing what you’re working with can help you build a capital stack for the ages.
Disclaimer: Pipe and its affiliates don't provide financial, tax, legal, or accounting advice. What you're reading has been prepared for knowledge-sharing and informational purposes only. Please consult your financial and legal advisors to determine what transactions and decisions are right for you and your business.