Credit & Capital

The Case for The Recurring Revenue Asset Class

Recurring revenue is rising as its own asset class and one that deserves a new financing model.
Harry HurstApril 19, 2021

Harry Hurst is the co-CEO of Pipe, a platform for companies to trade monthly recurring revenue for upfront annual revenue from yield-seeking buy-side investors.

Just a few years ago, if you wanted access to something, you bought it or maybe leased it. This was true for office space, automobiles, or software. Today, WeWork, Turo, and thousands of software-as-a-service companies are working under a very different model. How we think about assets is changing, but what does that mean for companies looking to finance and scale?

As subscription services become a more ubiquitous part of professional and personal lives, recurring revenue streams need to be seen in a different light. Recurring revenue is rising as its own asset class and one that deserves a new financing model. Instead of leveraging a company’s equity, this new model leverages the recurring revenue underpinning that equity. What role does this new financing model play, and where does it fit in with traditional equity and debt financing?

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Equity: A Powerful Tool

There will always be an important place for equity financing. Equity can be very founder-friendly during early pre-seed or seed-round funding. Even later on in the company’s development, equity is a powerful tool when financing is needed for research and development, human capital, or any aspect of growth where the timeline of the return on investment is hard to predict.

Those early investors and those willing to buy equity with a more open-ended timeline take a bite of the risk because it could be a long wait for a return. Still, they also wash that bite down with a significant upside in the potential of that equity. From the company’s perspective, equity financing can be lifegiving, but dilution can be a death sentence if the timing isn’t right. What if you dilute the company more than you need to? What if you didn’t need to at all?

Taking On Debt

Debt financing has been the traditional answer to the problem of dilution. Selling debt rather than equity allows a firm to maintain ownership interest and can be less expensive because of that other kind of interest — the tax-deductible kind it will be paying out.

Unfortunately, for many companies taking on debt can put them in a cash-flow crisis. These companies may find themselves in a cash shortfall if their primary income sources come in slowly over time and they struggle to service the debt. Unfortunately, debt often comes with financing covenants, which can be very restrictive. Then there’s warrant coverage, which gives the lender the right to buy equity. This can be very expensive and can pose another risk to the company’s ownership interest.

In addition, not all companies have access to debt when they need it, and for those that do, it can come at outrageously high interest rates in some cases. Arrangement and legal fees also add up quickly if a company pulls together multiple one-off deals with lenders.

A Third Way

If recurring revenue is becoming a new asset class, doesn’t it deserve a new approach to financing? For companies with recurring revenue streams (think SaaS, telecommunications, direct-to-consumer subscription products, and media companies), recurring revenue is a very predictable and stable asset. The only problem is in the timing.

In some cases, the need for cash is so urgent that they offer discounts as high as 15% to 30% to customers who sign up for annual rather than monthly contracts.

Businesses often have to wait for that recurring revenue to be realized as cash flow over many months when they need an infusion of cash right now to take their business to the next level. In some cases, the need for cash is so urgent that they offer discounts as high as 15% to 30% to customers who sign up for annual rather than monthly contracts. Essentially, these companies are forced to choose between profit margin and cash flow.

Access to cash could make or break the next stage in a company’s evolution — an acquisition, expansion, or opportunity to jump on just the right market moment. That next stage may not be able to wait for the months-long process to take on venture debt or jump through bank hoops.

What’s an ambitious company with predictable revenues to do?

Pipe — a third way of financing — makes sense for companies with recurring revenue models. Pipe has turned recurring revenue streams into a tradable asset on a two-sided trading platform giving companies direct access to 100s of institutional-grade buyers — think of it as real-time NASDAQ for recurring revenue.

Companies receive upfront cash for the annual or multi-year value of their traded contracts in a financing transaction (a trade), less a discount determined by the bid price for the asset. That bid price is rated algorithmically and can improve month after month as buyers create a diverse marketplace for revenue and companies prove their reliability in bringing in that revenue.

Booking It

While a recurring revenue trade is not a loan, it has all of debt’s accounting benefits. Recurring revenue trades are booked as a short-term liability. Since the fees are booked below the line as an interest expense, there’s no adverse impact on gross revenue or EBITDA. This approach to recurring revenue financing is like debt without the baggage or equity without the dilution.

Unlike factoring, investors aren’t buying the subscriptions, just the revenue itself. As usual, the company continues to collect the revenue from its customers, repaying investors via Pipe with no impact or disruption to its customers.

Harry Hurst, co-founder and co-CEO, Pipe

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