What is subscription finance?
Subscription finance is a term for financial services and plans to help growing businesses make regular money. More and more subscription-based services, especially SaaS products, have made the subscription model more common.
Over the last twenty years, it has become more common for traditional companies to switch to subscription-based business models. This is called the “subscription economy.” That’s because of several things:
- Subscriptions help brands build connections with customers that last longer.
- People want to use goods whenever they want without having to spend a lot of money or keep them forever.
- Companies can test pricing and product features on customers without worrying about having a bad sales year.
- Recurring revenue is more stable, which makes it easier to make accurate predictions and build businesses that can grow.
- As technology improves, companies no longer need to own software licenses because so many tools are available that doing so would be impossible.
The main thing that drives the subscription economy is SaaS goods. The membership market is worth $1.5 trillion, and cloud-based services make up 45%. It’s hard, expensive, and doesn’t grow to maintain software. Cloud-based technology changes itself, so the customer doesn’t have to do anything.
Imagine having to pay a lot of money for a Netflix license and then having to install fixes every month or two. Luckily, cloud services have taken away the need to maintain old technology.
Many different types of companies have started offering subscription-based services to meet the needs of customers who are used to the ease of using them.
Synonyms
- Recurring revenue model
- SaaS financial model
- Subscription business model
Essential Parts of SaaS Subscription Finance Financing Based on Expected Revenue
One-time sales are not crucial to subscription finance; recurring income matters. Businesses that offer subscriptions keep track of their monthly (MRR) and yearly (ARR) income. MRR and ARR are the steady amounts of money a business plans to make monthly or yearly.
Traditional ways of measuring revenue look at the past, but these measures look to the future. Churn, or the rate at which users stop using the service, and annual contract value (ACV) are also things that subscription finance takes into account.
Keeping track of recurring payments from subscribers
Subscription finance also includes complex ways of reporting and keeping track of money. This is because transactions in subscription-based business plans are often complicated. They have deals, upsells, cross-sells, and different levels of subscriptions. When it comes to B2B SaaS goods, there is sometimes also a usage-based part.
Advanced tools are needed to bill customers and accurately record and handle this money. ASC 606 and IFRS 15 say income is only recorded when “earned.”
Most subscription services let you pay as you go, or they charge customers in advance for a month’s worth of entry. This means that even though the money is in their account, they won’t “earn” it until the payment cycle ends.
For each customer, businesses record income the following month (or yearly subscriptions every 12 months).
This makes it harder to make financial records and then show investors and other essential people the information.
Dealing with Cash Flow Management
Subscribers automatically pay for your services, but the time you get paid and the time you have to handle your business’s costs or investments probably won’t match up.
Options for subscription funding can help you cover your costs between when you start making money and when you have enough to cover your costs. That way, you can keep your cash while spending on new products and growing your market (more on this below).
Funding for growth capital
Traditional ways of getting money, like loans and venture capital/debt, can be used by subscription businesses. However, new ways to get money have come up recently that are just for subscription companies.
Revenue-based financing (RBF) is a unique part of subscription finance. It is a way for a subscription business to get money based on how much it will make. Lenders look at how much a company’s current subscribers, acquisition/revenue retention numbers, and expected revenue are worth. Then they give you cash right away.
This model is usually safer for the borrower because they expect things to go as usual. Many people leaving at half the average length of time would be extraordinary if nothing major changed. That doesn’t happen very often.
Funding subscription businesses are often easier and faster than getting standard debt or equity funding. The payment is based on how much money the business makes, making it a good choice for companies with steady incomes.
Getting rid of risks
When customers leave or don’t pay, subscription finance companies use risk reduction tools and services to deal with the problems that come with it. Their main goal with their methods is to predict and stop churn before it happens.
Some of these are:
Some of the things that can help keep customers are credit insurance, risk-sharing agreements, churn prediction models, cohort analysis to find customers who are likely to leave, automated payment reminders and account tracking systems, and customer success strategies.
Calculation of Recurring Revenue
Investors think that businesses that make money repeatedly are extremely valuable—more valuable than all the others.
Aventis Advisors says that the average value of a SaaS business from 2015 to 2023 was 5.1 times its sales. And 25% of the businesses were sold for more than 9.7 times their income.
Based on other information, SaaS companies are usually worth between 4.0x and 8.0x EBITDA. That’s a lot more than any other kind of business.
It’s almost certain that SaaS businesses will continue to make steady money. It’s simple to figure out the total value of a customer and guess how much it costs to get new customers, how many will leave, and how much the business will grow in the future.
Because of these things, SaaS businesses are the best places to invest.
Pay attention to keeping customers.
Relationships that last a long time are essential. Getting a new customer costs $X, and running a membership business costs $Y. However, your recurring subscription fee is a small part of those costs.
To break even, you need to keep your customers for long enough to recover the costs of getting new ones (this is known as a CAC return). To make a profit and keep the business going, you need to get at least three times as many subscriptions as it costs to get them. That is, you need at least a 3:1 LTV: CAC ratio.
You can’t break even if a lot of your customers leave. If your customers like the service enough to stay with you for a few years, you’ll have one of the most flexible businesses in the world (as long as you keep your costs low).
This is the main reason why subscription businesses are so focused on keeping customers. In contrast to standard businesses, the sale doesn’t end when the money changes hands.
How to Set Prices
Pricing is easy to understand for simple monthly services, like a meal delivery box or a streaming service. Their prices are based on a flat rate, meaning customers pay one price for either endless access or a set number of deliveries each month.
It’s not so easy for SaaS goods that are complicated. They use a mix of these things:
- Fixed prices (a base rate for each level of the product) • Prices based on usage; • Prices per user (a rate for each spot)
- Customized prices (for business clients)
- Fees that only need to be paid once (for example, implementation)
Setting reasonable prices for product worth, price sensitivity, and ease of use is challenging. But based on your wants and usage, you’ll always know how much you could owe the most.
These pricing models are considered by subscription finance choices when figuring out how much money to lend and how long to pay it back. Because subscription pricing is flexible, companies can change prices and still know they’ll get paid back. This lets growth and planning happen more quickly since there’s no need to keep getting new rounds of funds.
Metrics for Subscription Finance
Subscription businesses need to pay close attention to the following factors to get funding:
Recurring monthly income (MRR)
Your monthly recurring earnings are the sum of all the subscription fees you pay each month. It gives you a quick look at how your sales are going.
When you zoom out, you can see how much you’ve grown by looking at month-over-month sales. You can even look back at more than one month to find patterns.
MRR is the most straightforward way to measure subscription finance. It shows potential investors how well your short-term growth and customer retention plans are working. It also tells you how your business is doing financially right now.
Annual Recurring Income (ARR)
The bigger picture of MRR is annual recurring income. It will help you make big-picture predictions, look at long-term trends, and make yearly reports.
ARR growth shows investors that you can grow sustainably. ARR looks at the big picture, while MRR focuses on how well your company can keep users and get more through sales, marketing, and customer success programs. It also helps you understand how good or bad a month was.
Value of a customer over time
Customer lifetime value tells you how much each customer is worth to your business throughout their subscription. Looking at lifetime worth, you can see how much money each customer usually brings in before they leave.
Regarding subscription finance, lifetime value helps companies figure out how much money they’re making from each customer compared to how much it costs to get new customers and run the business.
Annual Value of the Contract
The annual contract value tells you how much money you can expect to get from each yearly client each time you bill them. This number tells you how much the average customer will spend on your service over a year. It is used in subscription finance.
Churn Rate: One of the most critical numbers for subscription companies is the churn rate. If your churn rate is too high, you won’t be able to keep up with the costs and growth of getting new guests. So, the churn rate is significant when trying to get subscription funding because investors will want to know that your business has a good plan for keeping renewal rates high.
A company should aim for net-zero churn. That means their growth in sales is more significant than any shrinkage or turnover. This is a good sign of growth, and it usually means that the business will get more funding because investors are sure that the company can stay in business for a long time (and have a great product).
Best Practices for Managing Subscriptions
Here are seven valuable tips for managing subscriptions that will help your business make more money and eventually get funding:
- Always compare your company’s performance to that of other companies in the same industry so you can set reasonable goals for growth and know where you stand in the market.
- Keep a healthy balance between getting new customers and keeping old ones by managing customer acquisition costs well and constantly lowering churn rates.
- If you have a subscription business model, focus on keeping customers instead of getting new ones. This will improve the lifetime value of each customer and help you maintain stable and predictable revenue streams.
- Add self-service features so that users can upgrade themselves without calling sales.
- Know that you can handle more than just recurring billing with a subscription. Recurring billing is an integral part of subscription management. Still, it’s also about keeping track of subscription plans, making it easy to change subscriptions, rewarding customers for loyalty with discounts and benefits, and keeping customers happy by giving them content and a good experience all the time.
- Use usage-based prices to ensure your sales align with what your customers are worth.
- Add secure payment methods to your subscription management system to make the payment process more accessible and your business more smoothly.
