Recurring revenue lending is an alternative form of senior debt financing that is particularly useful to growing companies dealing with the steep cost of customer acquisition.
“Companies can leverage a recurring revenue stream with debt which may lessen the amount of venture capital needed,” says Mark Breneman, senior vice president and business line manager at Bridge Bank. “By using this asset, they can lower dilution, gain liquidity and achieve positive cash flow more quickly.”
A growing number of companies with a subscription or SaaS (Software as a Service) model across many industries are looking at recurring revenue lines of credit to bolster their finances.
“Back in the day, technology companies sold equipment or software and billed on terms of net 30 days with just a small percentage of the sale coming from annual maintenance contracts that had recurring revenue,” Breneman says. “Now as we move to more of a subscription economy, the majority of a company’s revenue stream can be recurring because they are hosting and delivering software and technology to their clients through cloud-based subscription services.”
Smart Business spoke with Breneman about the Saas delivery model and how to know if would work for your company.
How does the recurring revenue model work?
When companies sell technology or software as a seat or a license, they typically require payment terms of net 30, meaning the payment is due in full 30 days after the time of purchase. A receivable is then created that banks can use to secure a working capital line of credit.
When companies deploy a SaaS model, the software applications are hosted and billed as a monthly or annual subscription fee. As an example, many companies are taking legacy software systems, moving them to the cloud and then charging a fee to host the application. Banks can then analyze the quality of the recurring revenue stream using several metrics including churn, customer acquisition costs and the lifetime value of a customer.
If recurring revenue is growing, churn is low and the lifetime value of the customer forecasts out to support customer acquisition costs. A bank can then apply a lending multiple to the monthly recurring revenue stream to support a line of credit.
Where should a company begin when looking at this model?
Start with your financial partner or your bank and see if they are comfortable with this type of lending. Do they provide these services? There are several banks and venture debt funds that are comfortable in this space. Talk to your banker, talk to your advisors and then find a bank or a financial partner that provides this type of financing and start the discussion there.
Going into this conversation, you should know your recurring revenue stream in detail.
Track your customer acquisition costs and the lifetime value of a customer, as well as your churn. Ideally the lifetime value of a customer should not be less than 3 times your customer acquisition costs.
What are some pain points in this process?
If you have a subscription revenue model or you’re a SaaS company, early successful companies will burn through a lot of money. That can be a healthy indicator early on, but it still may be harder to obtain financing from traditional sources.
If you’re adding customers very rapidly, even though it’s healthy, it causes cash burn. That’s why you need to seek out a bank or a fund that is really comfortable with this model and can help you through those tough spots.
How important is customer service?
It truly needs to be a long-term symbiotic relationship between the technology, software or service company and their clients. You’re not so much selling a product into a company and then servicing that product. You’re developing a partnership and a relationship. You have to win these clients.
But once you win, you have to continue to provide excellent customer service so they don’t leave you and take their highly coveted recurring revenue stream someplace else. ●
Insights Banking & Finance is brought to you by Bridge Bank