Startups, and even small businesses that have been around for a while, typically have one thing in common. The vast majority will need to access some financing at some point along their growth journey.
This poses a significant challenge for many, especially those who are not yet profitable.
Traditional options like small business loans, venture capital, and equity financing usually approve companies with positive earnings before interest, tax, depreciation, and amortization (EBITDA), so these types of financing can be difficult to access with minimal or no profits.
The good news is that alternative funding options can give your company the infusion of working capital it needs. One form of alternative funding is the recurring revenue loan.
What are recurring revenue loans?
Recurring revenue loans are a type of debt financing based on different metrics than traditional financing options. Rather than approvals based on profitability, recurring revenue financing is centered around how much revenue your company brings in on a regular basis, typically regardless of profitability.
Revenue-based financing makes it possible for startups and small businesses to access funding with certain financial covenants based on their annual recurring revenue (ARR) or monthly recurring revenue (MRR) rather than the amount of profit that revenue results in.
These types of financing don’t typically have an amortization schedule, a table that breaks down how much interest you pay with each payment. That’s because interest is typically paid-in-kind, meaning it’s added to the total value of the loan up-front, rather than the interest being charged in smaller amounts at regular intervals like traditional loans.
On the repayment side, it is typically directly attached to revenue. As your company drives revenue, it repays the loan. When payments are higher and revenues are low, payment obligations shrink.
Recurring revenue loans are essential because they provide companies with access to cash flow without dilution, regardless of the results of a profitability analysis. That means that companies that haven’t generated their first penny in profit can access the growth capital they need as long as their revenues can support such access.
Who should use recurring revenue loans?
Recurring revenue loans are typically a liquidity tool for startups and small businesses in high-growth industries that don’t have positive EBITDA. For example, business models like Software-as-a-Service (SaaS), online subscription services, and e-commerce platforms are all prime candidates for recurring revenue loans. These types of loans are becoming pillars of e-commerce financing.
These companies typically have minimal profits due to innovation spending and may find it difficult to get a traditional loan. However, they’re also known to produce regular revenue, making them perfect candidates for recurring revenue loans.
They can also be used by small businesses with high levels of foot traffic, like convenience stores and retail outlets, that may need extra cash to cover the cost of purchase orders or other operational costs.
When to apply for a recurring revenue loan
Recurring revenue loans aren’t for every small business, but if you answer yes to any of the questions below, you have a reason to consider applying for one:
- Are you in need of financing but have been turned down by traditional lenders?
- Do you need to support growth but don’t have the profitability needed to attract equity financing?
- Does your revenue support payments on the money you need? The average recurring revenue loan term is up to 36 months with factor rates as high as 1.5. That means if you need $100,000, you’ll pay back up to $150,000 over the next three years, or around $4,166 per month.
If so, recurring revenue loans can provide the working capital your business needs to thrive. As an added benefit, it can improve your business credit in the process.
However, although recurring revenue loans can give you access to funding in a pinch, they tend to come with relatively high pricing. That means you’ll pay higher interest rates than you would with traditional lending options. Be sure you know the total cost of any type of loan before you sign on the dotted line.
How to apply for a recurring revenue loan: best practices
If you want the best chances of approval, follow the best practices below.
1. Track retention traction
The longer you retain your customers, the more money you make from each of them. Keep a log of your customer retention rates and consider the following:
- Your goal is for your retention rates to increase on a month-over-month basis.
- If you realize customer retention is falling, consider the things you’ve changed before the drop started and adjust your strategy to improve customer retention.
- Pay close attention to customer retention rates when making changes to your service. This will tell you whether your change is helping your business head in the right direction.
This is important to recurring revenue lenders because they want to make sure they get their money back. That means they want to see that even if growth in new customers slows, your customer retention is enough to sustain payments.
2. Log churn rates
Customer churn could reduce revenues. As with customer retention, keep a close eye on customer churn. Doing so not only gives you a better chance of being prepared to apply for revenue-based loans but can also help you grow your business. Here’s how:
- Start by looking for points when customer churn rates are high. If you realize churn rates increase after eight months of service, consider what changes at the eight-month mark and what you can do to keep your customers.
- Log customer churn rates after changes to your service. If churn rates decrease, that tells you the changes you’re making are positive, and you should continue heading in the same direction. If churn rates increase, this tracking will make it possible for you to revert to the service that had better churn rates quickly, limiting losses.
Lenders use customer churn information to make sure that your company isn’t losing customers too fast. If it is, you may find it difficult to make your payments on your recurring revenue loan in the future.
3. Follow financial record-keeping best practices
Follow financial record-keeping best practices. This means you should track business expenses and income diligently and keep that information on record for at least three years. Lenders like to see a consistent financial record, regardless of the type of loan you seek.
Invest in finance tools to help with your record keeping.
- Corporate cards: Get access to a corporate purchase card that you and the members of your team can use for easy expense tracking.
- Financial analytics & reporting software: Track your spending in real-time. Analyze the data to find trends and take action. Also, take advantage of spend forecasting to see if your business is on the right track.
- Spend management: Take control with tools that help you manage your spending, leaving more money in your pocket for the improvement of existing or development of new products and services and marketing and selling those products and services.
Use Ramp to manage your spend
Ramp is the leading spend management platform for small businesses. We offer corporate cards (with sales-based underwriting that offers limits up to 30x higher than traditional offerings), real-time reporting, and savings insights to help you maximize your revenue. As your revenue grows, your chances of approval for revenue-based loans improve. Try Ramp today