Transitioning to subscription pricing

When William Edmondson joined 1E, he had come to a company whose software was popular among large enterpises to help their IT support staff do a better job responding to service requests. But the way the company charged for its software needed revamping. It used a perpetual licensing model, which led to revenue visibility problems and, too often, tricky end-of-year adjustments. Edmondson's solution was risky but potentially game-changing: switch to a subscription-based licensing model.

"Its really hard to operate as a CFO [under a perpetual licensing model] because you might get that $5 million deal on the 28th of December, just before your financial year end, or [payment] might slip four days, to the second of January, and suddenly your whole financial year looks totally different," Edmondson said in a CFO Thought Leader podcast.

Even more than the tricky management issues it raised is the difficulty of attracting investment into your company. 

"That sort of volatility in revenues and new business is just so hard to sell to an investor," he said. "It was really clear to me we needed to do something [different], but what was that going to be?"

Moving to a subscription model helps companies create a recurring revenue stream by having customers renew their license to use the software annually. But until the transition to the new system is complete, the company is faced with the potential for declining revenue since it generates only a fraction of the income it otherwise would when it brings on a new customer.

"When you make this transition there's always a working capital crunch, so once I decided we needed to do this, I spent a lot of time just modeling it out, looking at all of the scenarios, sensitivities, what would be the result if x happened, or if y happened, all the normal things you'd expect a CFO to do," he said. "And I finally got reasonably comfortable with the fact that we were ready to do it."

But the timing wasn't right so Edmondson pulled back at the last minute. 

"There was actually a bit of a downturn in the business and we were just about to go live with this subscription model," he said. "I got the board together and talked about it and ultimately they agreed with me we did have to just pause this massive transformation. So, we went through another six to nine months."

Edmondson used the delay to secure a stand-by credit facility to give the company access to money in the event the switch led to a cash crunch. 

"I went to our bank, a Silicon Valley bank — great technology bank, great partner for us —  just in case things didn't pan out the way that I expected them to," he said. "We would have that as insurance."

Once he pressed the button on the change, two years ago, the company made the transition quickly. 

"Most organizations take three to four years to do it; we did it within two years, and now we're a 100% subscription-based business," he said. "It’s been just great for us. One of the most important moments of my career, I think, both in terms of the potential risk but also the potential reward. And it wasn't just a financial exercise. In order to make this transition, you’ve got to get your product right, your marketing, your sales, you've got to understand how to position subscriptions to customers, and then, crucially, the post-sales, the customer success team. We invested pretty heavily in the success team to make sure customers would renew a year after buying their initial subscription."

Accounting training key

Edmondson, a U.K. chartered accountant (the equivalent of a CPA in the United States), credits his solid background in accounting with enabling him to approach his work with confidence.

"Without a high quality accountancy qualification, there will always be gaps in a CFO's ability to deliver the very core of a CFO’s responsibility, which is basically safeguarding shareholders' interests," he said. "While I do come across other CFOs who might just have an MBA, for me personally, that qualification was really a bedrock for everything that then followed."

His first move at 1E was to split his finance and accounting staff into two teams: one to manage traditional accounting operations and the other to focus on commercial finance. The move was necessary, he said, to reach his company's goal of growing annual revenue from $30-$40 million to $100 million.

"What I found is, if you do all finance together, in one pot, with one team, the transactional stuff — the taxes, the months end, the years end, the audit — will always shout louder than the commercial finance piece," he said. "Then, guess what? The commercial finance piece never actually gets done."

Edmondson said he was lucky to have a finance executive already on board who could step in as head of the new commercial division.

"I identified he was a very talented individual quickly," he said. "I put him into heading up that role, and then, within about six months or a year, we hired a couple of more people into that team and also expanded the responsibility to also include sales operations."

The new team oversees the financial planning and analysis (FP&A) function, which covers reporting, budgeting, and forecasting, and also works on the business side of things: contract negotiations, pricing, and ROIs.

"Even today my commercial finance function is out there talking to customers, negotiating with customers on contracts and on pricing structures and models, so it’s really quite a broader role than the way you'd traditionally be an FP&A," he said. 

Non-financial metrics

Edmondson said the numbers he looks at in the morning have changed over the last five years, mainly because of the company's shift to the subscription model, which puts heightened importance on annual recurring revenue (ARR) and renewal rates.

"There’s little point in selling a new subscription if you lose it the following year," he said. "If you imagine a bucket, you've got the new subscription business coming in at the top but you've also got some leaking out the bottom when they don't renew. What I focus very much on is how to reduce that leakage."

Another metric he looks at is new subscription contracts. "Clearly, that over time is going to add to our annual recurring revenue," he said.

The subscription model also puts a premium on customer satisfaction, a qualitative measure which, if tracked carefully, can open the door to individual customer metrics that can be used in encouraging subscription renewals.

"We can actually point to a particular customer and say, 'We have done this for you,' and that’s very rewarding for us and what we’re about as an organization," he said. "And of course it's very good for us in marketing messaging and things like that, so as an example, we saved the Department of Veterans Affairs [the company’s largest client] $57 million in software licensing costs over the past couple of years just by them implementing our technology and us holding their hand and helping them use that technology. For me, that's an astonishing statistic. What they actually paid for that software was a fraction of that. So, we try to look more at what real tangible impacts we have had on our customers."

With its new revenue model and ability to sift through its data to let customers know its software is helping them, Edmondson believes his company is well positioned in a market space that's set to keep growing.

Subscription-based pricing models attract companies because they come with a predictable cash flow, which leads to higher investor valuations and easier access to debt. They also generate more data than transactional models, which helps you tweak products and services to keep customers happy. 

Now that SaaS applications and cloud-based platforms make the transition to subscription pricing realistic, there's little reason for companies to hesitate before going this route. But you have to prepare for a short-term downturn in revenue, higher customer acquisition costs, and inquiries from nervous investors who worry how long the transition will take, executives specializing in recurring revenue models say.

"If you want to make this happen and keep your job, you have to be able to show long-term value, even if, temporarily, it's not going to look like that," Daniel McCarthy, assistant professor of marketing at Emory University, said in a CFO.com webinar.

Infrastructure in place

Subscription applications like Zuora and Ordergroove and online platforms like Amazon Web Services and Google Cloud create an infrastructure that makes subscription pricing feasible for many companies, McCarthy said.

Customers are pushing businesses in this direction because they like the choice and flexibility subscriptions give them, and upfront costs are lower because they're not paying the entire purchase cost as they do in a transactional model, said Chris Hemenway, director of solutions consulting at RecVue. 

Adobe is a prime example of a company that moved from transaction to subscription licensing. About seven years ago, it unbundled the elements of its creative suite —  Photoshop, Illustrator, Premier Pro, and so on — and made them available individually, on a subscription basis, in the cloud. "Previously, you had to buy all the elements as part of their suite," said Hemenway. "Now, under their cloud-based model, you can pick discrete services on monthly, quarterly, or annual basis."

Over time, companies tend to sell more services and generate more income per customer using the subscription model, but your income will almost certainly drop over the short-term, since your new customers are only paying the subscription amount rather than the full price when they come on board, and that's something executives have to make sure investors understand before the transition begins.

"You can think of it as a J curve," said Robbie Baxter, founder of Peninsula Strategies. "You need to set expectations for that dip in revenue and have a long enough transition time that you can see the revenue coming back, at some point. You want some interim metrics, like engagement, that can be early indicators that your model is working."

Experiment with metrics

McCarthy recommends tapping the data the new model generates to track metrics — what he called a customer-based report card — that show success even while revenue is playing catch-up.

"I would track the number of customers acquired, period by period, how that breaks down into payment plans, purchase frequency, validated models of lifetime customer value, 12-month retention, different measures of retention points," he said. "Track every period and make sure you're comfortable with where these are trending."

Keep tinkering with your metrics, because your ability to identify what your best customers want, and will want in the future, leads to renewals. 

"Experimentation is key," McCarthy said. "Constantly run randomized controlled studies. Put a system in place to track leading indicators of churn, things like net promoter score, other measures of happiness, and engagement of your customers. Capture all of that on a regular basis, and if things don't come in as expected, you can very quickly jump on that."

Once the data comes in, share it across the organization — not just with the CEO and board — because, for the subscription model to work, all functional areas of the organization — finance, operations, product, marketing, technology — must work together to match product and services and their delivery to what customers want. "This isn't a business model that works in silos," Baxter said.

One company she worked with, she said, appeared to have a good customer acquisition team but a poor customer retention team. "It turned out the acquisition team was pitching a feature that could only be used once, so customers were signing up, using the one feature, and then canceling. They were going after the least valuable kind of customer, which looked like a retention problem but was really a product and acquisition problem."

Simple, transparent pricing

To make the transition successful, you have to get your subscription pricing right. That means keeping your model simple and being transparent about how you derived the amount. 

From the customer's perspective, "I need to understand why I’m being priced the way I am for these services," said Hemenway.

Baxter recommends pricing not just for customer acquisition but for engagement and retention. "Make sure your pricing attracts and maintains your best customers," she said. "If your offering requires a lot of upfront investment, once they've gone over that hurdle, they're very likely to stay for a long time."

Make it easy for customers to either reduce their product use or leave, because if they feel they can do those things without penalty, they're more likely to trust you and return when the time is right.

Hemenway calls this pricing for the downsell journey, not just the upsell journey. "What's often overlooked is just allowing customers to consume less of the services you offer," he said. "If you over-purchase out of the gate, or you're just not consuming as much you signed up for, getting something from that customer is dramatically more valuable than getting nothing. So, follow usage pattern, and look for those slight drops; you can reach out with an offer to downsell, as opposed to a new promotion."

Hemenway pointed to a California law that took effect a few years ago. It requires any subscription-based service, whenever it emailed customers with a price increase, to include an opt-out at the bottom of the email. Companies were concerned that the requirement would lead to a flood of opt-outs but the opposite occurred: people overwhelmingly stayed with their service. "Customers not feeling trapped was actually a retention strategy," he said. 

Netflix has been good at this, Baxter said. "When raising prices, they always have a cancel button in the email," she said. "It shows a level of integrity and trust. Consumers behave like a member."

That applies to business-to-consumer models, like Netflix, as well as business-to-business models, she said. 

RecVue was a sponsor of the webinar,  What CFOs Need to Know About Creating and Sustaining a Recurring-Revenue Business.

Moving from a transactional to a recurring-revenue business model requires rethinking your product’s value proposition and assessing your back-office capability, Chris Battles, chief product officer at Zuora, told CFO Dive.

Executives in all types of industries are considering the recurring-revenue model because it can lead to increased business over time, as customers pay for your product in regularly occurring amounts and, as part of their relationship with your company, purchase upgrades and related products and services. 

For companies already in the market with a product or service, the transition can be significant. As you bring in new customers, you realize less revenue upfront since customers are only paying a start-up fee and a monthly or quarterly installment rather than the full product price. For their existing customers, you have to find a way to transition them to the new model without losing their business.

William Edmondson, CFO of 1E, an IT services platform for organizations, called the transition to a recurring-revenue model a game-changing move for his company because it smoothed out its revenue, making it more attractive to investors who liked the predictability and visibility that came with the model.

"It’s been just great for us,” he said. “One of the most important moments of my career, I think, both in terms of the potential risk but also the potential reward.”

Battles, who joined Zuora three months ago after being on many sides of a recurring-revenue platform, including the user side, said it’s no longer the traditional software company that’s moving to the model; companies in construction, the Internet of Things (IoT), and even consumer products are starting to go this route. 

"Half of our companies you wouldn't consider a classic software firm," he said.

He pointed to Fender, the iconic guitar manufacturer, which now earns recurring revenue by offering subscribers access to a suite of services to help them get the most out of their instruments.

"Fender realized a lot of guitars are aspirational purchases that end up being like shelfware," he said. "They look pretty against the wall, so the Fender app is a subscription app where, once you buy the guitar, you can get help becoming a better player. They help teach you, coach you, keep you on track to improve your abilities."

Roots in SaaS

SaaS is the classic recurring-revenue model company. Customers pay a fee to get started using the company’s software — typically cloud-based on the company’s platform — and increase or decrease their regularly occurring spend based on how much of the services they use. 

Today, traditional manufacturing companies, including business-to-business manufacturers, are going to market with products and services using the SaaS model. Battles pointed to an aerospace company Zuora is working with that is launching a SaaS service. In the past, those customers would have bought the company’s technology but now they're subscribing to it. 

“We do a lot in that space of helping non-traditional software firms enter this B2B SaaS market,” he said. 

Preparation is key

Before committing to the model, you have to work through two exercises, Battles says. First, rethink how you see your products and services. Like Fender, decide whether you provide a product or something broader, like making better guitar players. 

Battles characterizes it as working back from the consumer perspective to identify the value they’re looking for from you.

“You have to put yourself in the shoes of the end customer,” he said. “‘Okay, what’s this new value proposition I can have? How valuable is that, and what could I charge for it?’”

Adobe is a classic example of a premise-based software company that made the shift to the recurring revenue model by unbundling its suite of creative products — Photoshop, Premier Pro, Illustrator — and making them available on the company’s cloud platform, with the subscription amount based on the number of licenses you're buying and the products used. 

"They actually had a value proposition that was different than just buying the box," he said. "That is the heart of SaaS: what is the ongoing value I will deliver to you so that you will want to subscribe to me and pay me on an ongoing basis? If you don’t have that thought through, your SaaS business isn’t going to be successful."

Second, you have to make sure your back office is prepared to handle a new way of billing and collecting revenue. 

"It’s no longer shipping a box out and having customers use it," he said. "Now, someone needs to sign up, provide payment credentials and start this ongoing relationship." 

Battles said it’s not necessarily a matter of bringing in new staff to handle the change as much as preparing your team for a different — and higher volume — course of action. 

"Obviously, in certain parts of the organization you’re going to need to have an understanding of the accounting treatment of these transactions, which is a little bit different from some of the others, so having people in your organization who have that experience would be valuable," he said. "For folks who are in some of the other areas, it’s more about the volume of work that will change. You just have more touch points, which taxes your back office."

Iteration through metrics

Post-transition, the work is only beginning. Your ability to maintain product value and keep long-term customers depends on how you iterate your offerings over time. 

CFOs are integral to this process because of their role in collecting, processing, analyzing, interpreting, and sharing the generated data.    

"It’s never just launch and grow," he said. "You’re always in this iteration mode, so be prepared as an organization. You’re going to have to launch and tune and tune and look at the data and refine. It’s building a new muscle of how we look at the business in a data-driven way all the time."

Among the types of data CFOs typically look at are annual recurring revenue and annual customer value as well as non-financial metrics like churn rate, bookings, pipeline coverage, sales productivity, time-to-value, lifetime value, cost of acquisition, customer satisfaction and net promoter score, among others. 

"Your customers are changing a lot," he said. "They’ll start with one suite of your product, one license, like, 'Hey, I want to add five more,' or 'I want to shift from this rate plan to this other one and upgrade.'"

Platform set-up

If you rethink your value proposition and have staff in place to handle the new way of processing transactions, you make the transition by selecting a platform and this is where Battles’ company comes in. Zuora and the companies it competes with, like Ordergroove and Sage Intaact, create the e-commerce environment in which the ordering, billing, and payments are processed. 

Depending on the degree to which the company is making the transition — that is, turning its entire product and service portfolio over to recurring revenue, or just some products or services within it — the platform can be set up and made operational within two months, he said.

"We have a platform that can be extensible, and get into your existing environments and plug into your system," he said. "If you’re launching your first product and you’ve isolated it from other parts of your system — which we recommend — we can get you up and running pretty fast."

What you don’t want, he said, is to try to do this using your existing e-commerce system if it’s not set up to handle recurring revenue. 

"You’re going to want this new business, this new product line, to be able to move and iterate at its own speed and not be gummed up by the legacy business," he said.

When Jody Cire was interim CFO at LogRhythm in 2018, the cyber security company was bedeviled by a volatile revenue stream. It booked its business and recognized revenue upfront as an on-premises software company. In any given quarter, in addition to its bread-and-butter smaller deals, it might book half a dozen million-dollar enterprise deals — or it might book only half of that. And that degree of volatility was a key reason the company was unable to go public when it had tried to in the past.

"Investors and investment bankers want predictability," said Cire, now CFO of AllCloud, a professional services company that helps clients optimize their cloud spend.

To smooth out its revenue, LogRhythm could either pivot to a subscription-based, on-premesis licensing model, or it could reinvent itself as a software-as-a-service (SaaS) company. But both of those options entailed disruptive changes that finance couldn't fully control.

Cire spied an opportunity to make a change, however, when the Financial Accounting Standards Board (FASB) that year released guidelines on its new ASC 606 revenue recognition standard. The standard took effect at the beginning of this year.

Under the guidelines, if your company has an ongoing delivery requirement for its customers, you can adopt a ratable revenue recognition model that lets you spread your revenue over a period of time. 

Although LogRhythm's product wasn't antivirus software that required daily definition updates, it did require updates that would qualify it for the ratable accounting method. And that proved to be a crucial change, Cire said in a CFO Thought Leader podcast; it enabled the company to smooth out its revenue as recognized in its P&L.

"Even though our booking and billings would still be lumpy, at least our P&L would be smooth," said Cire, who joined AllCloud 15 months ago after a six-year stint at LogRhythm. "The bankers loved it."

Cire said the new system positioned the company to go for the IPO that previously eluded it but it chose not to go that route; instead, it opted to be acquired by Thoma Bravo, a private equity firm specializing in enterprise software companies. 

"Thoma Bravo loved that most of the work [migrating to a subscription model] had already been done," he said. "Now all we had to finish migrating was the billing model and work the architecture into a SaaS model. So, finance basically led the charge in smoothing our lumpiness."

Tech focus

Since his early days as an external auditor for KPMG, Cire has specialized in tech companies, particularly startups. At AllCloud, he focuses on building an infrastructure that can accommodate the company's plan to grow through acquisitions. 

"We were born with the idea of being a hub for merging multiple companies together," Cire said. "We started with raising money to buy an existing company, and then within less than a year bought another company, so we started off as a hub and spoke model."

And yet the company hadn't fully thought through what its back-office systems and processes needed to be to accommodate that model. 

"As you bolt on new companies, they need to be on the same systems and also the same instances of those systems," he said, whether it's for sales, professional services, accounting, payroll, or banking. "We've never done any of that. I've got five countries right now and we're in the middle of rolling out NetSuite, but as I sit here today I’ve got five different general ledgers in five different countries. Simply to close the books is a much bigger manual effort than it should be."

The five countries the company operates in are the U.S., Canada, Israel, Germany and Romania. 

Team hires

To help him build his system and processes, Cire brought on board key members of his team as one of his first orders of business at AllCloud.

"We were pretty raw in all things back-office," he said. "We were not only understaffed but under-skilled. I did have to replace my former head of finance and accounting and bring in someone senior to that individual."

In addition to finance and accounting, Cire oversees Legal and IT, whose top person he had to replace. 

"We ended up taking one of the founders of a company we acquired who's a Salesforce expert and used to be an ERP consultant," he said. 

The person had experience implementing accounting systems and was also well versed in professional services. "We promoted him into senior vice president of information systems and information technology, and he's been an amazing hire," he said. "He's also taken on all of the compliance functions, so everything about ISO and GDPR."

ISO refers to the ISO 9001 management quality standard, and GDPR refers to General Data Protection Regulation, the European Union’s comprehensive data privacy and security law.

Growth despite pandemic

For 2020, Cire said, AllCloud had completed its budget process early — by January 6 — but the fast work was quickly superseded by the pandemic, forcing his team to come up with an alternative plan it calls its COVID re-forecast.

"Originally we were forecasting over 40% growth," he said. "But even in the COVID re-forecast, we still see growth: it’s about 25% to 27%, year-over-year."

The reason for the relatively optimistic picture is the nature of its business. As a company that helps its customers optimize their use of the cloud, it’s well-positioned as its customers rely on cloud systems to keep their operations going remotely during the pandemic.

"This sudden transition, with everyone having to work from home, really supports our line of work," he said.

"No one would ever wish [the pandemic] on the world," he added. "And we've had to cut and project slower growth. But this raises to everyone's awareness that the cloud has tangible benefits."

A technology company Laurie Fleet worked with several years ago had some of the best computer engineers in the world, so it was a no-brainer to company finance leaders to use in-house talent to build its software-as-a-service subscription billing system. It was a project that took three years longer than expected and the system still required updating after completion.

"At the outset, they thought this was easy," says Fleet, a partner with PricewaterhouseCoopers, who consults with companies on their SaaS billing systems. "'I just have to do some calculations, slap them on a piece of paper, and send it out to my customers. How hard can billing be?'"

The company estimated an 18-month build time, but the project took five years and still only captured about 85% of the company’s pricing models. It took another three years to get the system to 100% and also incorporate flexibility to accommodate pricing models the company expected to use in the future. 

"Subscriptions are a little harder in the back office than one-time sales," said Fleet during a CFO Live virtual conference session. "You have recurring pricing. You have fixed pricing. Or you have a combination of both. You can have different billing frequencies: monthly, quarterly, semi-annually, or annually. And then after customers have signed up, contracts change. You might have multiple amendments a year. And the way the relationship is ongoing, you have to manage renewals."

Subscription models on rise

Most technology companies today launch as subscription-based SaaS businesses, and most existing companies, in technology as well as other sectors, are moving to a subscription model if they haven't already made the move. The reason is a predictable revenue stream and the chance to upsell or cross sell at renewal.

Because of the variety and complexity of subscriptions, though, billing presents a challenge, especially for companies transitioning from a traditional model in which the customer relationship ends after the purchase is made.

Finance leaders have three options if they're looking to create or upgrade their billing system to accommodate a growing subscription business, Fleet said.

They can build their own, but that will likely take longer, cost more, and consume more resources than expected, or they can buy an off-the-shelf solution and use their in-house resources to customize it to their needs. But that can be just as fraught as building it on their own. 

"When we were looking at the billing system [of a company that customized an off-the-shelf solution], we estimated they were spending roughly $20 million a year just to maintain that system," said Fleet. "And that was just to keep up with point-in-time requirements and not give them flexibility for whatever came up in the future."

The third option is to buy a robust off-the-shelf solution that integrates with the finance organization’s ERP and has flexibility to accommodate any pricing variant company executives might conceive in the future.

"You never know what that next new way of pricing a product is going to be," she said.

New models

One trend she's seeing is usage-based pricing, which involves pricing that fluctuates up and down based on how much of the service the customer consumes. 

"You might have started off with a simple subscription model, but now, to get even more revenue and more margin, you start adding consumption-based models to your portfolio or go-to-market offerings," she said.

Another trend is advanced subscription billing, in which subscribers pay upfront for their use of services, maybe in exchange for a better deal. 

Complexity increases when you combine an advanced billing model with a consumption billing model. "Now you have a subscription model that bills in advance and a consumption model that bills in arrears," she said. 

Additional complexity is added as you merge with or acquire other companies and incorporate their billing processes into your own, or move into other countries, each with its own currency, language, and billing rules. 

"In Brazil, they're very specific that you invoice on paper that you have to buy from the government," she said. "They also have many reporting requirements as well."

Moving upmarket can also increase complexity, especially if you add enterprise solutions, which tend to come with greater pricing customization.

"You're going to do every acrobatic you can to get that sale," she said, "And your backend office, particularly your billing system, cannot hinder you from getting to that growth strategy."

Key features

Fleet recommends you evaluate billing systems against five criteria:

• Automation. Anything that can be done by bot should be done by bot, so finance staff can spend more time on the analytical side of the work, especially as finance teams shrink in future years, as they're expected to do. 
• Agility. The system should accommodate whatever pricing model is conceived without requiring IT staff to make changes to accommodate it. "It needs a user interface that is intuitive and simple enough that [sales staff] can go in and make changes, whether that’s promotional changes or pricing changes," she said. 
• Analytics. Subscription pricing uses a different set of metrics than traditional pricing, so the system should be built to isolate annual recurring revenue, average revenue per account, churn, and lifetime value, among other SaaS measures. 
• End-to-end functionality. The system should integrate with your other systems, including your ERP and CRM.
• Flexibility. The system should also be customizable to accommodate all of your use cases. "The reality is, no out-of-the-box system will meet 100% of your use cases," she said. 

Software-as-a-service (SaaS) companies looking for a quick cash raise can monetize their subscription contracts using a trading platform launched by Los Angeles-based start-up Pipe.

Pipe touts its platform as an alternative to equity raises, which force owners to dilute their interests, and loans, which typically come with warrants or covenants that constrain how companies can operate.

"We're something completely new," Pipe CEO Harry Hurst told CFO Dive. 

The company launched with a $6 million investment fund and in late June added $60 million to that. 

The company is built around a trading platform that treats the predictable income stream of SaaS companies' subscriptions as a tradable asset. On the sell side are the company's annualized customer contracts and on the buy side are investors, including financial institutions and banks, who buy the contracts as assets. 

Depending on the SaaS company's underwriting characteristics, the market clearing price of the assets is anywhere from 85 to 95 cents on the dollar, although that range could change over time. 

"As more buy side participants enter the market, it'll get more competitive, which is beneficial for the SaaS company," Hurst said. 

Because it's a clean sale of assets, the SaaS company doesn't put any collateral at risk and doesn't file a UCC-1, the form creditors rely on to stake a claim in the company’s assets if it goes bankrupt.

"There's no seniority of liens," Hurst said. "It doesn't even come into the conversation because there aren’t any liens."

Self-serve platform

Like the SaaS companies it serves, Pipe is a cloud-based software company whose platform is built on a self-serve model. 

Companies enter in their credentials, connect the platform to their bank account, and provide information on their subscription billing manager and accounting system. Pipe's goal is to come back with a market clearing price for a company's contracts and trading limit within a day. 

The underwriting isn't based on the company's monthly or annual recurring revenue but rather individual subscription contracts it enters into the platform. If one of the contracts can't be fulfilled because of churn — the customer stops paying on its subscription, for example — the company replaces that contract with another so the investor stays whole. 

"They very simply [add] another subscription of equal or greater value to the principal amount, prorated," Hurst said. "There are no penalties or fees."

CFOs like the flexibility of swapping out contracts because it resembles an interest-free loan, Hurst said. If a contract stops performing before the end of the year-long term, the company can use the replacement contract to rebate the remaining principle, prorated for the remaining time on the contract.  

"You actually end up with more cash flow," Hurst said. "Let's say the customer churns at month nine. There are only three months of contract period being unserviced. When you pipe in another subscription, you're actually trading another whole year's worth of contract value on the other contract, so you end up with more cash flow instead of less."

CFOs also like being able to report the trade as an asset sale because, unlike contracts that are prepaid upfront at a discount, there's no reduction in the company’s top line income.

"The problem [with prepaid contracts] is that when they give them a significant discount it's also reducing the company's top line revenue," he said. "When they trade a contract on Pipe, for a discount to the annualized value, it's not reducing that top line, and that’s really important when you're raising money or if you sell the company."

Put another way, it's as if your customer prepaid its year-long contract with your SaaS company to get a discount, but instead of you showing the discounted income on your books, you show the full contract price, because income from your customer hasn't changed. Your customer is still paying the full price.

That makes it an option to consider, even if your company has no trouble getting customers to prepay their contacts. 

"From an accounting and revenue recognition standpoint, you get the cashflow upfront and you recognize the revenue each month as you service the customer," Hurst said. "The benefit here is the top line revenue is the same; you don't have to offer your customer a discount."