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How startups can use recurring revenue financing

March 31, 2023
5 min read

Are you a SaaS or subscription-based startup considering recurring revenue financing (RRF)? Selecting the right funding option can be quite the process. You have to weigh the pros and cons of different funding options like venture capital, venture debt, revenue-based financing, or other alternative funding options isn’t easy. And you have to convince your stakeholders (VC investors) to use recurring revenue financing.

Let’s dive into the most important questions and aspects of recurring revenue financing and then see how we can answer the most common questions asked by VCs when startups are looking to use RRF. 

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What is recurring revenue financing?

With recurring revenue financing Software-as-a-Service (SaaS) and subscription-based companies receive debt capital based on their recurring revenue streams. 

The amount of finance and the interest rates are based on the amount of recurring revenue and remain the same over the entire repayment period. It’s usually based on the Annual Recurring Revenue (ARR). The ARR serves as a limit on how much capital the company can finance. 

Recurring revenue loans are particularly interesting for companies with predictable revenue that want to grow their business. It is an opportunity for them to grow without giving up any of their ownership stake in the company – it’s non-dilutive

Another funding option relying on revenue is revenue-based financing (RBF). With RBF, the investors get a fixed monthly percentage of a company's revenue in return for their investment. The amount usually is capped and ranges from 1.5 to 3 times the initial investment.

What is ARR?

Annual Recurring Revenue is a metric associated with SaaS businesses. ARR represents the predictable and recurring subscription revenue that a company expects to receive annually from its customers. 

The formula to calculate ARR 

The formula to calculate ARR is: Monthly Recurring Revenue (MRR) * 12

For example, if a company has 1,000 customers and every customer pays a monthly fee of €5,000 it has a MRR of €5m and an ARR of €60m. 

Whereas ARR looks at revenue yearly, MRR looks at revenue every month. 

ARR is valuable because it represents the recurring revenue that a company can count on, usually based on long-lasting contracts. It provides a more predictable and stable financial outlook.

Software-as-a-Service businesses track their ARR (and let’s assume it’s all of them) to assess their growth over time. Increasing ARR indicates that a company is successfully acquiring new customers, expanding existing relationships, or upselling additional services. Decreasing ARR means a company loses customers due to churn or downgrading customers to less valuable contracts. 

What impacts the ARR? 

Customer acquisition

More customers mean more recurring revenue.

Churn rates

Churn means customers cancel or do not renew their subscriptions. High churn rates can hurt ARR. It reduces the total number of subscribers contributing to recurring revenue.

Expansion and upselling revenue

This includes additional revenue generated from existing customers, such as upgrades, add-ons, or increased usage of services (e.g., additional users). 

Contract length

Encouraging customers to commit to longer contract lengths can positively impact ARR. It provides more predictable revenue over an extended period.

Customer Lifetime Value

Improving the overall value derived from each customer over their lifetime can contribute to higher ARR.

When is revenue recurring? 

Recurring revenue refers to a company's income that is expected to continue and is generated through ongoing, predictable payments. This revenue model is characterized by customers making regular payments at consistent intervals, e.g., monthly, quarterly, or yearly. Unlike one-time transactions, where a customer makes a single purchase, recurring revenue models involve continuous, often subscription-based, relationships between the business and its customers.

Types of recurring revenue are

  • Subscription services
  • Membership fees
  • Licenses renewals
  • Maintenance and support contracts 
  • Retainers 
  • Automatic reordering

Recurring revenue is highly valued by companies since it provides them with a predictable and stable income stream. It helps companies better forecast their future revenue and plan for growth. Additionally, businesses with a significant amount of recurring revenue may be more attractive to investors, as it demonstrates customer loyalty (low churn rates) and a solid foundation for sustained financial performance.

Why is recurring revenue financing an alternative funding option?

Classic corporate funding relies on known instruments like loans and subsidies, typically provided by established financial institutions like banks or equity and debt funds.

Usually, those traditional providers look at tangible assets (machines, real estate, vehicle fleet) and evaluate business models that are already profitable and have been operating successfully on the market for many years. 

With recurring revenue loans it’s different. It is an alternative funding instrument. Providers, usually fintechs, thoroughly assess a company's business by treating customers and revenue streams as tangible assets. Those fintechs focus on data and digitization and assess risk profiles and the future growth of SaaS companies. Usually, the underwriting models of banks are not able to do that. The business model of those kinds of tech companies operates outside their frame. 

How do companies benefit from recurring revenue financing?

  • Recurring revenue financing is completely non-dilutive: companies do not have to sell their share in return for equity. Also, there are no warrants, covenants, or personal guarantees included.
  • Recurring revenue loans leave you in control: You don’t have to give up any of your ownership stakes in the company and stay in full control where your company is headed. 
  • Recurring revenue financing is based on your predictable cash flow from ARR, which makes it much faster to access since you don’t have to negotiate things like company valuation. The investment decision is based on bare KPIs.

So, now you have learned about the basic aspects and principles of recurring revenue financing. When you already have investors on board and want to pursue a new funding option, you need to convince your shareholders during board meetings. 

Here are 5 questions that might pop up during those meetings – and of course the respective answers to them. 

1. Why do you need additional capital? Your startup is already sufficiently funded. 

It's shortsighted to only think of financing as a means of providing extra runway. Of course, having sufficient funds is crucial for a startup that is operating at a loss to stay afloat. re:cap can be of assistance in this area, for instance to finance a journey to profitability. re:cap's debt financing can also be utilized to finance short-term investments. 

Everyone running a startup knows that each measure and investment has a unique risk and reward profile. That's why a one-size-fits-all solution isn't ideal. Some financing options are better suited to certain measures than others. 

In the early stages of product development, for instance, risk is high and ROI is difficult to calculate. Equity financing is the best choice here.

Later on, when more concrete measures with more calculable ROIs are involved, such as sales and marketing initiatives, investments in new technology, or other equipment, debt financing from re:cap can help optimize cash flow and reduce the cost of capital.

2. Is the amount of funding possible with re:cap sufficient to make an impact?

With re:cap Software-as-a-Service businesses can get up to €5m and increase the amount over time. A re:cap funding does not replace a VC financing round, but it is well-suited for the above mentioned measures and investments. In addition, the financing limit of each company is flexible and can change based on a company's annual recurring revenue. 

If the company grows, the financing limit grows with it. 

3. Doesn't the possibility that the financing terms could change during a partnership between re:cap and a startup mean a disadvantage? 

The terms for the financing costs change depending on the risk profile of the startup, which re:cap determines with the help of a detailed underwriting process taking into account accounting data, bank data, and revenue streams. These costs range from 2 to 15% of the capital disbursed. 

Startups, which develop positively, reap the benefits of the flexible re:cap conditions, which are much more accommodating than other forms of financing. In addition, re:cap is very transparent about how long those conditions will remain in place, allowing startups to plan accordingly and adjust to any changes. 

4. RRF may make sense in principle, but is now the right time to make use of it?

The tech startup sector has been in a state of flux since 2022, with funding increasingly needing to be used with utmost efficiency. VCs are asking startups to reach profitability in a timely manner, which requires cutting costs and accelerating growth – both of which can be achieved with recurring revenue financing. 

This is an ideal moment to strategically optimize capital structure, investing in measures that are set to bring tangible success and profitability. 

5. What information do VCs want to see?

VCs want to see what exactly startups want to achieve with the funding. We recommend preparing documents that can be used in board meetings to clearly outline these goals. 

re:cap has experience with such documents and can support startups in their preparation if needed.

Interested in your funding scenario?

Get access to re:cap and calculate your funding terms or talk to one of our experts to find out how we can help you with our tailored debt funding.

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