3 Ways Recurring Revenue Can Fund Business Growth
Harry Hurst is co-founder and co-CEO of Pipe, a platform for businesses to exchange their recurring revenue streams for growth capital. The views are those of the author.
When leaders are ready to scale their business, lack of cash is usually one of the hurdles they face. It may take significant liquid capital to hire key people, build infrastructure, or gain traction in new markets. It often takes time to see returns from these investments.
To fuel growth, many companies are turning to equity financing, loans or venture debt. But going into debt restrictively and diluting isn’t always the best approach. This is why alternative financing solutions have been receiving more attention lately. With subscription and recurring revenue models becoming more popular in most markets, companies are looking for financing solutions that are more compatible with their needs. Increasingly, they are finding ways to use their income to fund their growth.
Here are three ways recurring revenue can fund the growth of fast-growing businesses:
The slow and steady approach
This is the most obvious approach, so let’s eliminate it. If a business needs funds to scale, it can always be self-financing using the revenue as it comes in. The problem is that the timing and speed with which these revenues are realized can be less than ideal.
SaaS companies are a good example. While they might charge, say, $480 per year for a subscription, that revenue trickles down to $40 per month. When you need to grow fast, you can’t always wait.
Many companies try to generate revenue faster by a) only offering annual fees (and potentially losing customers who are unwilling or unable to pay for everything at once) or b) offering significant discounts to customers who pay annually (impacting turnover and profitability).
Businesses with a decent income but few assets are often attracted to income-based loans. Revenue-based (or royalty-based) loans are basically the same as they have been since the early 90s. Companies use their revenue rather than their assets to get a loan, repaying that loan by sharing a percentage of the revenue with the lender.
RBF has recently had a facelift as new lenders make it easier to get loans online. But for recurring revenue businesses trying to avoid lending 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 business goals. With payouts calculated as a percentage of revenue, your payouts grow as you scale. This can divert cash flow and reduce your profit margins during your scale-up phase. If your income is predictable but non-recurring, RBF may still be a good option when you need access to growth capital. For example, e-commerce businesses may have significant revenue that is non-recurring and RBF may provide the most affordable capital to scale 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 monthly recurring accounting services), recurring revenue has become the de facto model. The value of these contracted revenue streams is finally recognized as an asset in its own right.
With the rise of recurring income as an asset class, investors are excited to buy these assets. On the Pipe trading platform, for example, institutional investors buy recurring income streams to diversify their portfolios and manage their risk.
Investors buy the income streams at a reduced rate, similar to a fixed income product like a bond, depending on the level of risk of the underlying income and the customers. Unlike equity investors, these investors only buy the underlying earnings, not a part of the business. There is no dilution and no impact on corporate control. This allows businesses to grow on their own terms.
This is a powerful change in the landscape, as founders and business owners no longer have to rely solely on lenders and venture capitalists to fund their growth, negotiating the interests of both parties. Instead, they can harness the power of their own revenue to scale faster without compromise.
The right financing at the right time
While there are many ways to fund growth with your income, not all of them are suitable for all situations.
Scaling slowly as your revenue comes in is one way to keep your cost of capital down, but you also need to consider the opportunity cost. Waiting for scale can actually be very expensive if it prevents you from taking action when you need to. Accelerating revenue by offering discounts for upfront payments can be even harder. However, if you are investing in your business without having a clear timeline on returns (long-term R&D for example), this may make more sense to you than external funding.
RBF offers an option for those looking to avoid dilution and who may not have the assets or track record to obtain traditional debt. For businesses with stable, non-recurring revenue, such as e-commerce, for example, RBF could be a good option. Remember that repayment accelerates as your income increases, which can make effective interest rates much higher than they appear on the surface.
If you have recurring income, the lack of traditional assets is no longer a barrier to liquidity. The recurring revenue itself becomes the underlying asset to support your funding. By trading this recurring income asset with investors, founders can get the growth capital they need without taking out loans or diluting ownership.
Growth on your terms
Traditional financing is no longer the only option when you need quick access to non-dilutive growth capital. Consider your goals, the type of growth you are funding, and where you are in the business lifecycle in order to scale your business on your terms.