Subscription-based financing RBF – how does it work and is it for you?

In recent years a new financing option for recurring revenue businesses has emerged: Subscription-based financing – a type of revenue-based financing (RBF). With the continued adoption of the subscription business model, this non-dilutive financing option is an attractive alternative for recurring revenue companies. 

This financing model works by lenders using the future revenue of the company’s subscription base as a security for a loan. Depending on the lender and the specific risk parameters, companies can get 40-100% of the ARR paid out in a few days. The lender will take a fee in return. 

It solves one of the fundamental problems in subscriptions: Investments are needed today to get more subscribers and improve the service, but the cash flow from subscribers is somewhere in the future. 

In this article, we’ll compare this financing model with traditional models (debt and equity), detail how subscription-based financing works in practice, discuss the pros and cons, and finally list the current players in this market. 

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What financing alternatives are there?

For most companies there are two main types of financing: Debt funding and Equity funding. What are the pros and cons of these, and how do they compare to revenue-based financing?

Debt funding

This simply means that you take business loan from a bank or other financial institution. You’ll receive an interest based on your risk level and will likely ask for monthly paybacks. You get to keep the ownership of your business, but most banks require some form of security. 

Equity funding

If you don’t want to get a loan, you can find a VC or PE firm willing to invest in you. They’ll do valuation, produce a term sheet, and acquire a stake in your company for a certain amount of cash. This will result in a capital injection and new owners (with all the pros and cons of that). 

Revenue-based (subscription) financing 

The third option, financing based on your future revenues. A relatively new model where a lender makes an assessment of the value of your future (subscription) revenues, and gives you cash in hand today. Revenue-based financing is also known as RBF. 

How does revenue-based financing work in practice?

Subscription-financing lenders all work in a similar manner. These are the steps you have to go through. 

• Pre-assessment: On each lender’s website, there is usually a form where you submit answers to a few basic questions. These include: ARR, growth rate, burn-rate / run-way. This will result in a pre-assessment, where you get an understanding of your possible lending amount. 

• Assessment: The next step varies a bit depending on the respective lender. Some lenders need you to book a demo / sales call, where they walk you through the process. Some lenders offer a fully digital solution where you connect your billing system and bank account to their platform. 

• Payout and repayment: After the assessment is completed you know the amount you can get financed and you’ll get a payout to your bank account. You’ll repay continuously depending on your commercial terms. 
• Repeat: For most lenders, you can reassess your recurring revenue up to every week. This allows you to get more funding from your new subscribers and unlock even more cash flow on a continuous basis. 

What’s their business model?

The lenders/RBFs usually offer upfront cash for up to 12 months of recurring revenue, basically a portion of your ARR. Let’s say you have 100 customers paying €100 monthly. That’s an MRR of €100,000. 

If approved, the lender would offer you €1,200,000 but with a small “discount” or fixed fee (usually 5-15%). Let’s say the discount is 10%, then you get €1,080,000 in the bank. You’ll pay back your full MRR from those subscribers each month. 

The RBFs make money on the difference between the discount and the full amount. 

What players are out there?

New RBF players seem to be popping up all over the place. Here is a non exhaustive list as of April 2022. 

Final thoughts – and advice 

Before considering a revenue-based financing for your business, ask yourself the following questions: 

• Do you need the extra funding? More cash might seem like an attractive option, but do you have a plan for it? Can you invest it to make your business grow faster?

• What happens if your customers churn or you need to make a significant change to your business? Study the terms to make sure you understand the outcomes. 

• How stable is the lender/RBF? Many of the RBFs are startups themselves, heavily financed with venture capital. Make sure they are serious and in it for the long-term. 

• Can you modify your pricing and plans to improve your cash flow? There are ways to improve your cash flow without funding – e.g. switching from monthly to yearly plans. 
  
  
• Subscription-based financing is a quick, secure and attractive option for financing your recurring business, but what’s the actual cost? Do your maths before signing up. 

Are you considering revenue-based financing and need a sounding board? Reach out to us for a discussion.