Funding growth – recurring revenue financing

For young companies in growth-mode which lack the assets to attract asset-based lending or the bottom line to secure more traditional leveraged facilities, venture capital money may have been the only viable option to continue to fund growth. Now though, recurring revenue financing may offer the right business access to previously out of reach debt funding. What, then, is recurring revenue financing and how are businesses benefiting from it?

What is recurring revenue financing?

Recurring revenue financing (RRF) is a debt facility which references a borrower’s reliable and sustainable revenues to gauge debt capacity. It’s still a cashflow facility which lends against and monitors the credit of the business – as opposed to asset-based lending which is more concerned with the value of an asset, or pool of assets – but whereas cashflow facilities have traditionally been structured against a multiple of EBITDA and use EBITDA as one of the key financial performance metrics, a RRF facility will lend against a multiple of recurring revenue which it also uses to monitor the credit.

A RRF facility will aim to capture reliable, sustainable revenues arising from contracts which the borrower or group has with its customers, usually over a minimum period of 12 months. Historically therefore, RRF borrowers have predominantly been businesses operating subscription models, such as SaaS software providers, although as the market has deepened the product has been adapted and developed for scale-ups in other sectors.

Is it suitable for my business?

RRF funding is best suited to young, fast-growing businesses with a high cash burn as the business reinvests in marketing, R&D and customer acquisition but with a clear pathway to profitability. Predictability of ‘sticky’ revenues will be key so models featuring ongoing, mission critical software, maintenance or service contracts and have a track record for low customer turnover lend themselves well to RRF.

What are the key features?

There is no standard set of terms, particularly among smaller deals. However common features are emerging, with the emphasis on the borrower’s journey from revenue generating scale-up to EBITDA positive operations.

The key features are as follows:

• There is likely to be short term debt – around three years
• Comprehensive security across the borrower group, with a focus on IP assets and the key revenue sources
• Increased due diligence and enhanced ongoing information requirements on all things revenue. Some similar diligence criteria used by receivables finance providers, such as analysis of customer concentration and counterparty risk, are likely to apply
• RRF funding is more expensive than traditional leveraged financing, at least until any conversion – see below – so may perhaps be coupled with a PIK (payment in kind) interest option to ease cashflows
• Financial covenants will emphasise cash and revenue, so there’s likely to be an ‘Annual Recurring Revenue’ to net debt covenant and a liquidity ratio, both of which will be tightly drafted to ensure that revenues and freely cash are accurately reflected, until…
• ‘The flip’ – where, by a set date or when the borrower reaches a certain leverage ratio, and is therefore EBITDA positive, the facility converts onto typical EBITDA or leveraged terms, with the net debt:ARR covenant superseded by net debt:EBITDA. This may also involve a general loosening of covenants and lower pricing.

This is a fast-moving and evolving product which is developing into new areas of the market.