• Eklavya Gupta

Subscription-Based Financing and the rise of a new asset class

In the tech era, start-ups have usurped and easily captured the market share of their larger and more established counterparts because they were not afraid of challenging the status quo through innovation. Now, emerging technology companies are applying their innovative way of thinking to finance, steadily moving away from conventional venture funds and bank loans that dilute their equity and saddle their businesses with debt.

Subscription-based financing allows businesses to trade their recurring revenue cash flows at an upfront discount.

For recurring revenue companies like SaaS-based tech companies, Services companies, D2C Subscriptions, Ed Tech among others, this new financing option will not only revolutionize early to growth -stage fundraising but has the right bells and whistles to become a new asset class altogether.

Why traditional financing isn't right for start-ups

It can be extremely challenging for start-ups and founders to raise money through traditional channels. Equity has been the most prominent way in which they have raised capital till date (thanks to the global liquidity as well!!). While equity capital is great as it gives the headroom to a company to experiment and start the business. Post generation of recurring revenue, bank lending seems to be the most common source of finance for many aspiring techpreneurs, but it is far from ideal. Financial institutions often view venture funding as high-risk, and even if they are willing to extend finance, it's largely dependent on traditional debt, which can cripple a fast-growing business with its restrictive financing covenants, personal guarantees, high-interest rates and legal fees. We also know from experience that while some businesses enjoy high returns in their first few years, others experience catastrophic losses. The burden of debt remains even if the business doesn't break even.

Equity is far more founder-friendly, especially in the early seed funding stages or when the company starts eyeing expansion. This does come at a price, however. Early-stage investors are willing to take on the risk in exchange for equity. Existing shareholders are disadvantaged, and the founders' equity positions and control over their business are diluted.

Recurring revenue companies like Software-as-a-Service-based (SaaS) tech companies, Services, D2C Subscriptions, Ed Tech have new ways of alternative financing, ways that are uniquely suited to their revenue model.

Finance for the early to growth stage start-up ecosystem

SaaS companies typically host an application via the cloud that users can access and use remotely through monthly or annual subscriptions. Many tech companies have pivoted from selling software solutions to this subscription-based model. According to Gartner, the SaaS industry has grown fivefold between 2015 and 2021 and is expected to reach a value of $171.9 billion by the end of 2022, continuing its current growth trajectory.

Clients don't need to pay a high upfront cost and can enjoy the freedom of a month-to-month contract rather than being locked into a single software solution. However, the lifetime value of customers is harder to balance, which creates an interesting conundrum. The more users the company can onboard, the higher their chances of success. In order to onboard more customers, the company needs capital to fund its growth, predictable expenses and sales efforts. The capital investment will only yield over time, making it harder to acquire financing.

While growth is of paramount importance to every start-up, there comes a point in time where every business owner has to weigh up the value of their growth against the cost of the capital used to fund that growth.

The venture capital model is the most common route for founders but comes at a huge cost - dilution, wasted time, increased interference from outside parties and making founders lose their control. Traditional debt still can be hard to come by, especially for asset-light tech businesses that do not have an extensive track record.

Many founders are confronted by financiers that do not understand why these companies need so much capital, to begin with, because they are not hiring workers or building factories to scale.

For modern companies, customers are their factories and data is the new collateral. Users are the bedrock of the very predictability that will ensure the company's continued success. Customers are, in every sense of the word, a tech company's most valuable asset.

Predictability in the subscription economy

Monthly recurring revenue (MRR) is the part of a business's total revenue that is expected to continue monthly. Recurring revenue indicates stability as the company will receive revenue every month; companies with a growing or stable customer base spend less time and money acquiring new users, which in turn increases their valuation and attractiveness to investors and consumers.

This relative stability and maturity of the recurring revenues can be compared to a fixed income, similar to any other yielding asset profile for an investor, which means that investors are more comfortable deploying their capital because they can predict their rate of return with reasonable accuracy - at least in principle. Traditional financial institutions are still lagging behind in realizing the value of this asset and its current fixed income nature.

A New Asset Class

Companies like Recur Club have recognized that companies with recurring revenue should be funded differently. Businesses that were able to maintain or even grow their monthly recurring revenues during the pandemic have clearly demonstrated their ability to realize a steady and reliable income stream; they should be able to borrow against this new asset class.

Recur Club built a trading platform for recurring revenue contracts that bridges the gap between high-growth, subscription-based companies and traditional financial institutions. Companies can obtain the capital investment they need in a straightforward, non-dilutive way within a matter of hours, based purely on the quality of their recurring revenues.

As a founder, the most valuable optionality you have is the equity you haven't sold, the debts you have avoided and the dilution you haven't taken. By leveraging the power of their subscription-driven revenues, companies can acquire financing without making a trade-off between investment and control, and investors can access attractive risk-adjusted returns generated by a vibrant, stable and growing industry.

Recur Club is addressing some of the most common and burning problems the tech and investment world have always faced by adopting a disruptive and forward-thinking approach to finance. It's a principle befitting the tech pioneers that built the recurring revenue model, to begin with and will soon disrupt the industry for good.

331 views0 comments

Recent Posts

See All