Software-as-a-Service and subscription revenue business models have exploded in recent years, largely due to the invaluable benefit of having cash flow predictability.
While it can be expensive to acquire customers, ensuring that payments will be made at the same time every month is an attractive asset to a SaaS business, particularly younger ones in growth mode. Yet the recurring revenue model isn’t always an asset, according to Miguel Fernández Larrea, co-founder and CEO of Capchase.
“Revenue comes in two shapes,” he told PYMNTS in a recent interview, explaining that a customer usually has the choice to pay month-to-month or to receive a discount for paying for service upfront. When customers choose the monthly payment plan, “there is a cash gap at the beginning, which SaaS companies need to fund in some way.”
In other words, while receivables are booked as a result of a customer signing a contract to pay on a periodic basis, the SaaS company still has to provide service while waiting for the next payment. And that, said Larrea, can spell trouble for SaaS firms in need of working capital.
In addition to having to provide services while a customer pays for those services in installments, Larrea noted that SaaS firms also have the additional weight of customer acquisition costs, particularly at the beginning of growth.
For B2B SaaS companies compared to B2C players, this can create a particularly steep cash gap, because customer acquisition costs can be so high. While a consumer can sign up for a subscription in mere minutes, when the client is a business, there is usually a longer conversion cycle – meaning more time and effort from the sales team to secure the contract.
For a traditional bank, the financials of a SaaS company at this point in the firm’s lifespan may look dire.
“SaaS is not such a new business model, but traditional banks look at it like any other company,” said Larrea. “When they see negative cash flows and a SaaS company burning cash, banks run away from it.”
Alternative sources of funding, like venture debt, can take several weeks to close, while venture capital leads to dilution. Other types, like factoring or revenue-based financing, tend to apply a one-size-fits-all approach to SaaS companies, which isn’t always an appropriate strategy.
As such, Capchase launched as part of a growing number of alternative finance companies, with underwriting specifically tailored to the recurring revenue business model of its borrowers.
When it comes to mitigating the risk of SaaS companies, financiers have a lot to consider.
While B2B SaaS firms’ cash gaps tend to be larger than B2C firms, Larrea noted that the quality of contracts signed tends to be much higher, as customer churn is significantly lower when a corporate signs up for recurring services or products. That customer churn is “one of the highest risks” of financing this industry, he said – but not the only one.
Fraud, for example, can be a particularly damaging threat, and can come in the form of fake contracts or even fake customers.
Amid this landscape, the risks became even higher as a result of the global pandemic. Again, this was felt particularly acutely in the B2B SaaS arena, said Larrea, because businesses were trying to cut costs at every turn.
“In some industries, like retail, travel and hospitality, customers were cutting spend everywhere,” he said. “We saw a lot of B2B SaaS companies suffer losses and face a lot of churn, as a lot of customers cut out spend for everything that wasn’t absolutely mission-critical.”
That churn, however, is beginning to slow, and customer acquisitions are starting to pick up pace once again. In a post-COVID environment, both B2B and B2C SaaS organizations will need to prepare for the future – and will need the capital to do so. For Capchase, that means providing several months of runway for organizations that have a proven future revenue stream (which Capchase validates through integration with borrowers’ back-end finance and banking systems).
As these SaaS firms prepare for a return to pre-COVID volumes, interest in advancing deferred revenues is on the rise, said Larrea, and can help the recurring revenue world once again find balance.