Multi-year contract costs, why working capital can beat cash, and how to blend capital sources, from a lender who has underwritten $250M
Kevin Houston · Founderpath
Published September 1, 2022We’re big on learning from mistakes. We’ve seen (and made) quite a few ourselves.
Our head of Finance, Kevin Houston, shares the top 4 capital allocation mistakes SaaS founders make, and what you can do instead.
In 20 minutes you’ll learn:
- The hidden costs of overusing multi-year contracts
- Why Net working capital is actually better than cash
- How to use multiple sources of capital to build your balance sheet
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Kevin Houston explains capital-allocation mistakes SaaS founders can avoid by understanding contract economics, receivables, liabilities, investment returns, and working capital.
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“capital on your balance sheet as a SAS founder so let's get into that okay so lesson one the downside of the multi-year contract so uh this may resonate with some of you um the multi-year contract is basically you offer a discount for a multi-year relationship with a SAS customer collect all the cash up front uh but what it what it effectively does is it”
“basically of an automatic ndr metric built into your contract structure I think gross margins who who's felt the the pain of inflation over the last little bit you can actually you can actually handle an increasing cost of goods sold because you're collecting more cash over the term of those three years and you're not as susceptible to margin erosion so long story short the key takeaways here are the multi-year contract could”
“lesson three why Network capital is good for your health your balance sheet health so let's start with a story here so who here has heard of commercial paper it is a product used by public companies it's an unsecured debt product that rolls over every 30 days it's cheap it's flexible it's unsecured it's a great product”
“marketing channel and this month you get a dollar fifty back so this is an incredible metric you should use debt for this because it's predictable it's short term and know what use credit cards use short-term debt that's totally fine this is this is a great use of of debt uh it's predictable and if you use equity you're just making your investors rich as a Founder you should make yourself rich”
“you're not you it's not debt or Equity it's debt and equity um manage risk cross obviously try and try not to if anything go longer duration on your capital and shorter duration on your use of proceeds not the other way around and create buffer in your plan part of the value of your business is the option set that you have if you are so constrained because you've spent all your money that you don't have”
“Run finance and underwriting at Founderpath, joined as 1st finance hire”
“Multi-year contracts may help in early days but transition away from them as soon as possible”
“Total Commercial Paper Outstanding, USD Billions”
“Cash is tight and you are worried about next payroll”
“I showed you lessons I’ve learned underwriting $250m+ SaaS deals”
Video
4 Capital Allocation Mistakes Smart SaaS Founders Avoid - Slide Deck
Kevin House is the founder of Stealth Startup which is an intersections of SaaS, finance and growth. Previously he has been CFO of Thentia and Head of Finance for FounderPath. His interests have taken the forms of venture debt investor, CFO, advisor, and founder. Personally, he is a husband, father to two boys, and a fan of March Madness, the Toronto Raptors and sci-fi.
Adam Baker · Dealpad
Andre Cvijovic · Referrizer
Ari Salafia · Taxtaker
Armando Biondi · Breadcrumbs
Becca Kay · Dingus and Zazzy
Ben Carpel · Galleon
Each slide with a short explanation of what it shows. Open the slide text for its exact wording.
36 passages
Founder500 Sept 2022 Kevin Houston Head of Finance, Founderpath 4 Capital Allocation Mistakes Smart SaaS Founders Avoid … lessons I’ve learned from deploying $250m to SaaS founders over the past 5 years
Houston frames the talk with his experience building finance and underwriting at Founderpath. The slide cites $250 million underwritten across 190 SaaS companies over five years and more than $150 million raised from credit funds and banks.
My Quick Background Run finance and underwriting at Founderpath, joined as 1st finance hire Underwritten $250 million of SaaS debt to 190 SaaS companies over last 5 years Raised over $150 million from credit funds and banks
The talk covers multi-year contracts, delinquent receivables, net working capital, and matching capital sources to uses. Houston says these lessons come from underwriting more than $250m in SaaS deals.
Over the next 20 minutes I’m going to show you lessons I’ve learned underwriting $250m+ SaaS deals LESSONS 1-2 LESSON 3-4 Overuse multi-year contracts (and what’s better) Let Receivables Get Delinquent Ignore Net working capital (plus why it’s better than cash) Mismatching sources and uses of capital
This section examines why multi-year contracts can create problems for SaaS companies and what founders can do instead.
Lesson 1: The Downside of the Multi-Year Contract
A hardware and SaaS company introduces the first lesson through a comparison of cash on hand and cash flow. The illustration sets up how contract terms affect when cash arrives.
Story Time - Cash in Bank vs. Cash Flow Hardware + SaaS Company
The comparison asks which contract is better while holding average ACV at $50K. One scenario is a discounted three-year prepayment; the next tests annual contracts with upsells.
Which Contract is Better? Both contracts have average ACV of $50K
This build adds the annual-pay scenario: cash arrives at renewal points while monthly recurring revenue rises across the contract. It contrasts those periodic receipts with the upfront cash in the discounted three-year contract.
Which Contract is Better? Both contracts have average ACV of $50K
The table contrasts two contracts with the same $50,000 average ACV: Contract 1 takes a 10% discount for $135,000 in Year 1 cash flow, while Contract 2 collects $40,000, $50,000, and $60,000 over three years. The comparison asks founders to weigh immediate cash against total collections, MRR growth, net dollar retention, and gross margins.
Let’s compare these 2 contracts Comparison Contract 1 Contract 2 Average ACV $50,000 $50,000 Discount 10% N/A Year 1 CF $135,000 $40,000 Year 1 MRR $3,750 $3,333 Year 2 CF $0 $50,000 Year 2 MRR $3,750 $4,167 Year 3 CF $0 $60,000 Year 3 MRR $3,750 $5,000 Which contract is better for (✔): Contract 1 Contract 2 Cash flow day 1 Total cash collected MRR Growth Net Dollar Retention Gross Margins
The comparison marks Contract 1 as better for cash flow on day one, while Contract 2 is better for total cash collected, MRR growth, net dollar retention, and gross margins. Both contracts have a $50,000 average ACV.
Comparison Contract 1 Contract 2 Average ACV $50,000 $50,000 Discount 10% N/A Year 1 CF $135,000 $40,000 Year 1 MRR $3,750 $3,333 Year 2 CF $0 $50,000 Year 2 MRR $3,750 $4,167 Year 3 CF $0 $60,000 Year 3 MRR $3,750 $5,000 Which contract is better for (✔): Contract 1 Contract 2 Cash flow day 1 ✔ Total cash collected ✔ MRR Growth ✔ Net Dollar Retention ✔ Gross Margins ✔ Let’s compare these 2 contracts
The takeaways are to transition away from multi-year contracts as soon as practical, build automatic upsells into contracts to support net dollar retention, and use cash flow to generate cash profits.
Lesson 1 Key Takeaways Multi-year contracts may help in early days but transition away from them as soon as possible TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Building in automatic upselling through the contract itself is an Net Dollar Retention cheat code Cash flow is your most valuable asset, maximize it to generate true cash profits
This section focuses on delinquent receivables and how founders can respond before overdue customer balances weaken company performance.
Lesson 2: Bad Accounts Receivable and What to Do About It
The example company has $1,400,000 ARR, 53% year-over-year growth, a 14% cash flow margin, and a 67% Rule of 40. These figures establish the starting point for the receivables scenario.
Example Company Metrics Metric Value ARR $1,400,000 Y/Y Growth Rate 53% Cash Flow Margin 14% Rule of 40 67%
The aged receivables report highlights $205,000, or 60.29% of the total, in the 90+ days past-due column. Most of that overdue balance comes from Tesla at $115,000 and Peloton at $90,000.
Can You Really Count Customer Revenue Committed But Not Paid For 90+ Days?
The slide connects customer revenue unpaid for 90+ days to four company measures: ARR, growth rate, cash flow margin, and Rule of 40. It asks how these metrics change when committed revenue is not collected.
Which Happens to These Metrics: Starting Point (⇧ / ⇩) ARR $1.4M Growth Rate 53% Cash Flow Margin 14% Rule of 40 67% Can You Really Count Customer Revenue Committed But Not Paid For 90+ Days?
The answer build shows downward arrows for ARR, growth rate, cash flow margin, and Rule of 40 when customer revenue remains unpaid for 90+ days. The starting values remain $1.4M, 53%, 14%, and 67%, respectively.
Answers Which Happens to These Metrics: Starting Point (⇧ / ⇩) ARR $1.4M ⇩ Growth Rate 53% ⇩ Cash Flow Margin 14% ⇩ Rule of 40 67% ⇩
The takeaways are to monitor whether large customers can pay, create a close-and-collect culture on the sales team, and reach out proactively instead of waiting for payment.
Lesson 2 Key Takeaways Ensure customers ability to pay - stay on top of news for your largest customers TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Instill a Close and Collect culture on your sales team Be Proactive - don’t wait to reach out for payment
This section explains why net working capital can be a more useful view of financial health and runway than cash alone.
Lesson 3: Why Net Working Capital is Good for Your (Balance Sheet) Health
The chart tracks total commercial paper outstanding from 2003 to 2009, rising through 2007 before falling steeply around the ABCP crisis and Lehman’s Chapter 11 filing. It illustrates how funding conditions can change quickly.
Remember Lehman’s Commercial Paper Problem? Commercial Paper Demise Total Commercial Paper Outstanding, USD Billions
Net working capital equals current assets minus current liabilities. The slide includes cash and receivables under 90 days as assets, lists payables, accrued expenses, credit cards, and short-term debt as liabilities, and notes exclusions for some inventory, prepaid expenses, and deferred revenue.
What is Net Working Capital? Net Working Capital = Current Assets - Current Liabilities Current Assets Includes Current Liabilities Includes Cash Accounts Receivable (under 90 days) Inventory - I remove this unless it’s high margin Prepaid Expenses - I remove this as it doesn’t convert to cash Accounts Payables Accrued Expenses Credit Cards Short Term Debt Deferred Revenue - I remove this for high margin SaaS (65%+ Gross Margins)
The slide defines net working capital runway as net working capital divided by the last three-month average burn. It positions the calculation as a way to assess runway beyond the cash balance.
NWC Runway = Net Working Capital / Last 3 month average Burn What Can We Do With Net Working Capital? Calculate your runway Why not just use cash?
The side-by-side balance-sheet diagrams compare debt with less than 12 months of maturity against debt with more than 12 months. Short maturities weigh on current liabilities and can leave working capital negative, while longer-term liabilities preserve more working capital in the example.
Cash is not king. Net working capital is. Raising Debt With < 12 Month Maturity Raising Debt With > 12 Month Maturity Cash Working Capital Long Term Liabilities Current Liabilities Current Assets Current Assets Current Liabilities Long Term Liabilities (>12) Working Capital
The takeaways are to consider both cash and net working capital when assessing runway, be cautious with short-term debt used for growth, and review monthly balance-sheet trends.
Lesson 3 Key Takeaways Look at both cash and net working capital when thinking about your Runway TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Be careful with short term debts if you are planning to use the capital for growth Spend time with your balance sheet each month to see how accounts are trending
This section shows how the duration and purpose of a planned investment should shape the type and maturity of capital a company raises.
Lesson 4: Match Your Sources and Uses of Capital
A marketing program with a 1.5x return on ad spend is presented for a good-versus-bad debt decision. The example asks founders to consider whether expected returns and timing fit the borrowed capital.
Uses of Proceeds Good Use of Debt? Bad Use of Debt? Marketing Program with a Return On Ad Spend (ROAS) of 1.5x
The answer marks a marketing program with a 1.5x return on ad spend as a good use of debt and says short-term debt is a great option. The example links capital duration to a measurable marketing return.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? X Short term debt is a great option Marketing Program with a Return On Ad Spend (ROAS) of 1.5x
The scenario adds a company worried about making its next payroll while cash is tight. It tests whether short-term debt is suitable when a business needs cash to cover immediate operating needs.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option Marketing Program with a Return On Ad Spend (ROAS) of 1.5x
The answer marks short-term debt as a poor fit when cash is tight before payroll and recommends equity capital instead. The slide contrasts this emergency need with debt funding for a marketing program returning 1.5x ad spend.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here Marketing Program with a Return On Ad Spend (ROAS) of 1.5x
The example adds a sales representative with a six-month ramp who can reliably produce $500K ARR per year. The long lead time means the funding should last beyond the initial ramp period.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year
The answer marks long-term debt as a better fit for a sales hire with a six-month ramp and $500K ARR per year in expected production. It distinguishes that longer payback period from short-term marketing spend.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here X Long term debt would be better Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year
The scenario adds an engineer working on a complementary product alongside a sales hire with a six-month ramp. Both investments take time to produce results, so the slide asks founders to match them with durable capital.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here X Long term debt would be better Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year An Engineer hire to work on a new complementary product
The answer assigns a 48+ month horizon to an engineer building a complementary product, and also shows that horizon as the better fit for the sales hire. The slide contrasts these longer investments with short-term debt for immediate uses.
Uses of Proceeds Answers Good Use of Debt? Bad Use of Debt? Cash is tight and you are worried about next payroll X Short term debt is a great option X Equity capital is best here X Long term debt would be better Marketing Program with a Return On Ad Spend (ROAS) of 1.5x Hire a sales rep with a ramp time of 6 months that can reliably produce $500K ARR / year An Engineer hire to work on a new complementary product X 48+ month debt, equity, or profits best for this X 48+ month debt, equity, or profits best for this
The timeline pairs marketing spend with credit cards under 1 month, other go-to-market investments with short-term debt under 12 months, and product and engineering with long-term debt over 12 months or equity and retained earnings. It spans 0 to 60+ months and recommends combining capital sources to invest across the organization while managing risk.
A Mental Model for Capital Raising Credit Cards (<1 month) Marketing Spend Short Term Debt (<12 months) Other Go-To-Market (sales hires, SEO, etc.) Long Term Debt (>12 months) Equity / Retained Earnings* Product & Engineering Capital Product Duration Use of Proceeds Duration (months) As a SaaS founder, you should use a combination of capital sources so that you can invest across your organization and manage the risk of the products used. It depends on your use of proceeds: *Retained Earnings are net cash flows produced from current operations. 60+ 0 1 12 24 36 48 Duration (months)
The takeaways are to use multiple capital sources, manage risk through the match between sources and uses, and leave a buffer in the plan to preserve options.
Lesson 4 Key Takeaways You can use multiple sources of capital to build your balance sheet TAKEAWAY 1 TAKEAWAY 2 TAKEAWAY 3 Manage risk through your sources and uses of capital Create buffer in your plan to maximize optionality
The recap lists multi-year contracts, receivables, net working capital, and mismatched capital sources and uses as four mistakes to avoid. It says founders should mitigate risk, practice patience while bootstrapping, and run small experiments to control risk.
Key Takeaways 4 MISTAKES AVOID Founders top job is to mitigate risk Bootstrapping requires patience Double down on small experiments to control risk Multi-year contracts Receivables (watch out!) Net working capital Matching capital sources and uses
The closing recap revisits multi-year contracts, receivables, net working capital, and matching sources of capital to uses. These are the four underwriting lessons the talk set out to explain.
Over the last 20 minutes I showed you lessons I’ve learned underwriting $250m+ SaaS deals LESSONS 1-2 LESSON 3-4 Downside of multi-year contracts (and what’s better) What to watch for with your receivables Net working capital (and why it’s better than cash) Matching sources and uses of capital
Houston closes by thanking the audience after sharing his capital allocation lessons. The final card identifies him as Founderpath’s Head of Finance.
Sept 2022 Kevin Houston Head of Finance, Founderpath