Harry Hurst is co-founder and co-CEO of Pipe, a platform for companies to trade their recurring revenue streams for growth capital. Views are the author's own.
When executives are ready to scale their companies, a lack of liquidity is typically one of the roadblocks they face. It can take significant liquid capital to make key hires, build infrastructure or gain traction in new markets. Often it takes time to see the returns from those investments.
To fuel growth, many companies turn to equity financing, loans or venture debt. But taking on restrictive debt and dilution isn’t always the best approach. This is why alternative financing solutions are getting more attention recently. With subscription and recurring-revenue models becoming more popular across most every market, companies are looking for financing solutions that are more compatible with their needs. Increasingly, they’re finding ways to use their revenue to finance their growth.
Here are three ways recurring revenue can fund growth for fast-scaling companies:
The slow and steady approach
This is the most obvious approach, so let’s get it out of the way. If a company needs funds to scale, they can always self-finance using the revenue as it comes in. The trouble is, the timing and speed of when that revenue is realized can be less than ideal.
SaaS companies are a good example here. While they may charge, say, $480 per year for a subscription, that revenue trickles in at $40 per month. When you need to grow quickly, you can’t always wait.
Many companies try to bring in the revenue faster by a) only offering annual rates (and potentially losing customers who don’t want to or can’t afford to pay all at once) or b) offering steep discounts to customers who pay annually (impacting top-line revenue and profitability).
Companies with a decent amount of revenue but not a lot of assets are often drawn to revenue-based lending. Revenue-based (or royalty-based) lending is fundamentally the same as it’s been since the early 90s. Companies use their revenue rather than assets to obtain a loan, repaying that loan by sharing a percentage of revenue with the lender.
RBF has gotten a facelift recently as newer lenders are making it easier to obtain loans online. But for recurring revenue companies trying to avoid loan restrictions and equity financing, RBF may not always be the right alternative.
RBF is still a loan, and it’s important to understand how the repayment structure works to ensure it’s aligned with the goals of the business. With payments calculated as a percentage of revenue, your payments grow as you scale. This can divert cash flow and cause your profit margins to be thinner during your scaling phase. If your revenues are predictable, but not recurring, RBF may still be a good option when needing access to growth capital. For instance, e-commerce companies may have significant revenue that isn’t recurring and RBF may provide the most affordable capital for scaling their operations.
Recurring revenue as an asset class
As recurring-revenue business models become a ubiquitous part of our economy, these revenue streams need to be treated differently. In markets ranging from SaaS and direct-to-consumer subscriptions to property management and professional services (like recurring monthly accounting services), recurring revenue has become the de facto model. The value of these contracted revenue streams is finally being recognized as an asset in its own right.
With the rise of recurring revenue as an asset class comes investors who are excited to purchase those assets. On the Pipe trading platform, for example, institutional investors buy recurring-revenue streams to diversify their portfolios and manage their risk.
Investors buy the revenue streams at a discounted rate—similar to a fixed-income product like a bond—based on the risk level of the underlying revenue and customers. Unlike equity investors, these investors are buying only the underlying revenue, not a portion of the company. There’s no dilution and no impact on company control. This allows companies to grow on their own terms.
It’s a powerful shift in the landscape because founders and business owners no longer have to rely solely on lenders and venture capitalists to finance their growth, negotiating the interests of both parties. Instead, they can harness the power of their own revenue to scale faster without making compromises.
The right financing at the right time
While there’s more than one way to finance growth with your revenue, they’re not all the right choice for every situation.
Scaling slowly, as your revenue comes in, is one way to keep your cost of capital minimal, but you need to consider the opportunity cost as well. Waiting to scale can actually be very expensive if it keeps you from taking action when you need to. Speeding up revenue by offering discounts for up-front payments can be even more so. However, if you’re investing in your company without having a clear timeline on returns (long-range R&D for example) this may make more sense for you than external financing.
RBF provides one option for those looking to avoid dilution and who may not have the assets or history to obtain traditional debt. For businesses with steady non-recurring revenue—like e-commerce, for example—RBF could be a good option. Just remember that repayment is accelerated as your revenue grows, which can make the effective interest rates much higher than they appear on the surface.
If you have recurring revenue, a lack of traditional assets is no longer a barrier to liquidity. The recurring revenue itself becomes the underlying asset to support your financing. By trading that recurring revenue asset to investors, founders can get the growth capital they need without taking on loans or diluting ownership.
Growth on your terms
Traditional financing is no longer the only option when you need fast access to non-dilutive growth capital. Consider your goals, the type of growth you’re financing, and where you are in the business lifecycle in order to scale your business on your terms.