What is recurring revenue financing?
‘Recurring revenue’ refers to the portion of a business’s revenue that is most predictable, stable, and likely to continue. Typically recurring revenue is either services revenue or revenue that clients pay for software as a service (SaaS). SaaS companies have historically required significant up-front cash to build and deliver the solution while the revenue is generated on a monthly or annual basis in the future. The need for cash can place significant constraints on growth. Once businesses demonstrate their ability to predictably receive revenue at a steady pace, this reliability can pay off in the form of debt financing rather than equity.
If you have your ear to the ground you have probably heard a lot about the concept of recurring revenue financing lately. As the credit market heats up, there is no shortage of diverse financing options – alternative lenders and traditional banks provide consumers with an abundance of choices. The challenge for business owners is wading through all these options to find the right lender for their company, one that has cultivated a deep understanding of the industry it serves through the ups and downs of economic cycles. Since recurring revenue financing is not available through traditional banking services to most SME SaaS companies, alternative lenders in niche markets will be the providers to seek out when considering this option.
Numbers vary across recurring revenue financing providers, but in general, eligible companies maintain historical renewal rates of around 75% or higher. Keep reading for some of the key details you should know when considering this type of financing structure.
Who is right for recurring revenue financing?
Businesses that stand to benefit the most from recurring revenue financing are companies in a period of rapid growth, generating high monthly recurring revenues. Some of the most appropriate high margin, high growth businesses for this financing structure will be Software as a Service (SaaS) companies and others in the tech world. Recurring revenue financing can be especially useful because traditional bank loans are often hard to come by for companies like these due to a lack of collateral. Some of the other potential pros of the recurring revenue structure include higher advance rates based on MRR (4x to 8x), automatic increases in available credit as revenue grows, availability of longer-term sources of capital without diluting shareholders, the convenience of access to capital as you need it, and the fact that balance sheet covenants are relatively rare compared to traditional bank lines. All this makes recurring revenue an attractive and viable option for high-revenue growth companies looking to finance their growth without thinning out current shareholders.
While fast-growing companies working with high margins like many SaaS businesses are potentially good fits for recurring revenue financing, it works a little differently for smaller brick-and-mortar businesses. For bigger players, recurring revenue can be a great alternative to equity financing. For the smaller guys, this structure would work more like a merchant cash advance. If smaller companies maintain a steady stream of monthly recurring revenue, then revenue-based financing can still be a good option. By far the biggest benefits are felt in terms of scalability. With long-term increases in growth capital, businesses can focus on expanding in areas such as product development, new hiring, sales initiatives, marketing campaigns, and much more. So for companies that are maybe too small to be an ideal fit for venture capitalists, if they have steady and predictable revenue streams with room to grow sustainably, then recurrent revenue financing models can be appropriate lending alternatives.
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