So far we have covered standard types of debt – revolving lines of credit and term loans. Both of these can be available to venture-backed companies.
In the next two posts I’ll cover two options specifically designed to help tech companies – the MRR line and venture debt.
The MRR line.
The best features of a revolving line of credit are that it grows with your business and it helps smooth out fluctuations in working capital that seasonality or delayed invoice payments can cause.
But it can’t fund much more than that. Take our earlier example of a company generating £1mm a month in revenue with customers who pay, on average, in sixty days. That company will have about £2mm of receivables and could borrow up to £1.5mm from a line of credit.
What happens, though, if this company offers subscription software with thousands of clients who pay monthly on credit cards:
- Great news – no need to fund a receivables balance because the company gets cash up front which is always better than getting an IOU from its customers.
- Bad news – no receivables to fund so a bank won’t offer a line of credit.
In the past few years lenders have concluded that SaaS companies with contracted monthly recurring revenues (MRR) and low churn have a good credit profile. They will offer these companies a revolving line of credit based on the size of MRR and churn.
Back to our example company with £1mm of MRR. If the annualized churn is 5%, a lender might offer:
- £5mm operating line
- margin formula of three times the trailing 3-months MRR multiplied by annual retention rate
In this case the company could draw 3 x £1mm x (1.00 - 0.05) = £2,850,000
A few notes:
- this option provides nearly twice the availability (£2.85mm vs. £1.50mm) of a receivables-based line of credit;
- as with a receivables-based line of credit the lender will often offer a facility larger than can be drawn today in order to allow for growth;
- this type of a facility from a bank may come with a financial covenant (as would a receivables-based line of credit);
- the lender will want to see high retention rates to offer this type of facility.
- SaaS companies with solid MRR may be able to access a line of credit margined against that MRR;
- This type of facility can offer better availability than a traditional receivables-based line of credit;
- Low churn will be necessary for a lender to offer this structure.