Say you’re a SaaS company and looking to turbocharge your growth. If your business isn’t generating sufficient free cash flow, you need to consider outside sources of funds.
Increasingly, firms are turning an old finance mechanism on its head to achieve the accelerated growth they desire.
Can it work? It’s possible. But SaaS founders and executives need to be aware of the pros and cons.
From Reverse Factoring to Forward Factoring
So-called ‘reverse factoring’ has long been standard practice in many industries. Here’s how it works. Companies with outstanding receivables will effectively sell them, at a slight discount, to a firm willing to offer cash up front. The firm offering the finance makes money on the difference between what they pay for the receivables and what they ultimately collect. Meanwhile, the business that had the receivables gets much-needed liquidity immediately.
A clever financier realized that this arrangement could be reversed at some point: Companies could pledge future contracted revenue to receive financing upfront. And this financing could be used to manage cash flow or grow the business.
Increasingly, this tactic is being used by SaaS companies. They’re taking their current monthly recurring revenue (MRR) and using it to obtain financing to increase their annual recurring revenue (ARR) hopefully.
2 Ways SaaS Companies are using MRR to grow ARR
1. Increasing Sales and Marketing Budgets
Armed with an infusion of cash, SaaS companies may decide to invest in their sales and marketing efforts to win new customers and increase their revenue with their existing customer base.
2. Product Development
A SaaS company may use the funds they receive from selling their MRR to invest in new products or product enhancements to meet customers’ needs.
The Potential and Possible Peril of Forward Factoring
It’s easy to understand the appeal of using monthly recurring revenue to grow annual recurring revenue. The prospect of accelerated growth is alluring for SaaS companies and being able to leverage a flurry of recent business to grow ever-faster is challenging to ignore.
So, is it worth it? Using MRR to grow ARR can make sense in some cases, but only if it’s done in small doses and if the funds received are used ultra-efficiently.
There is a glaring risk when it comes to forward factoring. Forward factoring is a short-term source of finance that must be repaid within 12 months, so the monthly cash outflow is higher than fixed-rate term loans.
Namely, you’re taking on a liability based on the expectation that your monthly recurring revenue will be stable. If business dries up, you’ll still owe the financier, and you may not have the funds to meet that obligation.
The risk is that if your growth slows and you’ve sold your future revenues, you have very little cash flow to operate your business. Even Netflix recently announced that it has started to lose subscribers!
Despite what many advocates for forward factoring like to say, it’s just another form of debt. And if the debtor runs into cash flow troubles, their operating SaaS business may not be operating for very long.
We see companies use this form of funding aggressively when they need a longer-term form of finance.
Are you interested in founder-friendly finance for your growing SaaS company? Give us a shout. We offer easy-to-understand term loans for all kinds of SaaS businesses. And we’re always thrilled to chat.