A New Kind of Financing for SaaS Businesses
When it comes to funding for SaaS (Software as a Service) businesses, there can be a heavy emphasis upon equity finance. This means the usual route every founder is familiar with - creating & styling the perfect pitch deck, readying your financial model, shareholders’ agreements, subscription letters, the whole 9 yards.
In this week’s newsletter, Dragon Argent are using the entry of a new financing provider into the UK market as an opportunity to look at alternative funding models for SaaS businesses that potentially offer more efficiency and longer term shareholder value. We've done this in conjunction with our partners at FundOnion who have kindly helped us pull this content together
What if there was another way?
Traditionally for SaaS firms it can be difficult for them to secure non-equity (i.e., debt) funding, especially if they are early on in their journey. Limitations to the current lending environment around SaaS firms are often that lenders & banks aren’t fully familiar with the space, fear customer churn, and prefer to lend to businesses with assets that are easily sold - so a preference towards machinery & vehicles rather than bespoke software products.
However, there is a new type of financing tailored to SaaS firms and businesses with Monthly Recurring Revenue (MMR).
Pipe, a US-based lender, is one example offering capital to firms based on upcoming subscription revenues.
How does it work?
Pipe looks to treat SaaS subscriptions as an asset which their investors can lend against via their platform. So, as an example, if you’re a SaaS firm and you have a number of customer contracts each with a minimum term of 12 months; then those contracts can be considered a guaranteed source of income for the business which investors can use to get comfort and security on their lend.
While creatively applied to the SaaS industry (or any businesses with recurring revenue models), this is really just a novel play on a traditional financing product: invoice finance - which is a kind of catch-all name for any kind of financing service which uses a company’s receivables as security to give them cash in advance.
However, invoice finance does not usually provide funding for invoices which are to be issued or for work that has not yet been completed. On this basis, most typical invoice finance providers would be unlikely to look favourably upon a company’s balance sheet which is made up of recurring revenue from subscription services not yet performed.
Why is it important for UK SaaS firms?
It’s important because there isn’t any kind of lender like this currently in the UK. The incoming positioning of Pipe in the UK would open up another funding avenue to SaaS businesses who are currently made to focus more on equity financing.
What are the benefits and the fees?
Like with all kinds of finance, the financing option for each firm depends on the unique circumstances that business is facing.
Subscription-based funding is going to be an interesting route for companies looking to avoid any equity-dilution, want funding fast (well, faster than a 3 – 6 month equity raise), and are happy to pay the associated fees (more on that below).
The clear position on how fees will work in the UK is not yet available (as their lending operations aren’t currently active), however the Pipe lending model works by having the borrowers on their platform sell their subscription revenues (either monthly or quarterly) at a discounted rate of between 2% - 8% of the full value.
The main takeaway here is that the fees work by pre-selling your subscription income at a lower price than you sell to your end customer, and you do that to get the benefit of being paid earlier.
Just a pipedream?
Pipe’s impending arrival into the UK signals a new wave of subscription-based financiers looking to British shores. Another potential lender is recap, a German fintech who just raised a $1.5M funding round and look to model themselves similarly to Pipe’s structure: indicating further that this could be the beginning of a great new funding strategy for SaaS firms looking to grow outside of the traditional equity model.
If you want any advice on raising investment and commercial strategy, or If you would like to discuss your business strategy and learn how Dragon Argent could support your SaaS business, book a free consultation with us today by clicking the link below.
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