How does recurring revenue financing work?

Recurring revenue businesses charge a periodic fee for access to their services, often on a monthly or annual basis—think Spotify, Salesforce, LMNT, or the New York Times.

These business models have grown in popularity in recent years and come with a few benefits. Once a customer has signed up, all a company needs to focus on is making sure they don't churn. The longer the customer is subscribed for, the more time a company has to understand them. The more time a company has to understand their customer, the more predictable their contract is.

And yet, the benefits of recurring-revenue business models haven’t translated into capital. Even when companies have large numbers of predictable subscriptions, they’re often stuck waiting for their monthly or annual payouts.

Recurring-revenue financing attempts to solve this problem—what happens when you lend a company the money its customers would pay in the future? In this article, we’ll outline how it works, who it’s for, and when to decide to take it.

• Recurring-revenue financing can get you access to your customer’s future payments in exchange for a discount on your subscriptions.
• It’s debt, so you don’t have to give up equity—but you do have to pay back your lenders.
• Calculate the ROI of recurring-revenue financing carefully. Will it help you grow fast enough to pay back your lenders and invest in your business?

Recurring-revenue financing gets you access to your customer’s future payments in exchange for a discount on your subscriptions.

Let’s say your company sells an app to track how much water people drink. You charge $5 a month and have high-quality subscriptions—you’ve kept churn (or the rate at which customers are canceling) low, only losing about 20% of your customers since your launch a year ago. In total, you have 1,200 customers.

A lender on a recurring-revenue financing platform like Capchase might offer you $44 upfront in exchange for one year of a customer’s contract ($48).

You can instantly put this money towards improving your product, expanding your team, or marketing to new customers. On the other end, your monthly payments go straight to your lender.

Here's how the math works in practice. Let’s your company has $50,000 in MRR from 200 B2B subscriptions at $250/month each. A recurring revenue lender advances you $540,000, which  90% of the next 12 months of your expected revenue ($600,000). The lender takes a discount of $60,000 (10% of the annual contract value) as its fee, which it collects as the subscriptions pay out over the year. 

Each recurring-revenue lender has a unique underwriting model to determine how much money you’ll receive upfront and the total amount of credit you’ll have access to. Lenders usually take a few things into account:

• Your existing revenue traction: Typical eligibility for recurring revenue financing is several months of subscription history, over $10K–$15K in monthly recurring revenue (MRR). or over $120K–$180K in annual recurring revenue (ARR), though requirements will vary.
• Your revenue growth: How fast is your revenue growing? You can measure this month-over-month or year-over-year.
• Your subscription quality: How long have they been with you? Are they buying other things from your company, like merchandise?
• Your retention: What’s your churn (or the rate at which customers are leaving)? How long does the average customer continue paying for your product? The longer your retention, the more predictable your subscriptions are.

A combination of these factors determines both your advance size and the discount rate. For example:

• A B2B SaaS company has $50K MRR, 95% net dollar retention (NDR), monthly churn under 2%, and 80% gross margins. It might qualify for an advance of 8-10x MRR ($400K–$500K) at a discount rate of 6–8%. Strong retention and high margins signal that the subscription revenue is reliable.
• A B2C subscription app has $30K MRR, 90% NDR, monthly churn around 5%, and 65% gross margins. This company would likely receive a smaller advance (4-6x MRR, or $120K–$180K) at a higher discount rate of 10-14%. Higher churn means the lender has more risk that subscription revenue will decrease and cause repayment issues.
• An ecommerce subscription box has $40K MRR, 88% NDR, seasonal fluctuations in sign-ups, and 50% gross margins. It might qualify for 3-5x MRR ($120K–$200K) at a discount rate of 12–15%. Lower margins and seasonal variability impact what the lender is willing to advance.

Is recurring revenue financing a good fit for my business?

ARR loans may be a good fit if you meet most of the following criteria: 

• Monthly churn is below 5% (ideally below 3% for B2B SaaS)
• Your net dollar retention is at or above 100%
• Gross margins are above 60%, so you can absorb the financing costs and still invest in growth.
• No single customer accounts for more than 15-20% of your MRR, since high revenue concentration increases the lender’s risk (and yours)
• Your CAC payback period is under 12 months, meaning the subscriptions you're financing will generate a return before the financing term ends
• You have a specific use for the monthly recurring revenue financing that will produce ROI. For example, you might scale a proven acquisition channel, hire for a revenue-generating role, or bridge financing before your next fundraising round

What happens if I can’t pay?

If your customer churns, you can swap in a new subscription to pay your lender for the remainder of the financing period. If you don’t have any other subscriptions, your financing agreement will have recourse provisions that determine what happens next. Some providers can place a lien on your receivables or accelerate the remaining balance, requiring you to repay everything at once. 

If you have repeated shortfalls, it can also affect your eligibility for future draws. The lender may also reduce your credit limit. 

The concept of advancing companies for future payments has been around for a while. One option is revenue-based financing, which operates on a similar thesis to recurring-revenue financing—companies should be able to have access to predictable future payments before they hit their bank accounts. However, revenue-based financing has its criticisms. Most methods take a strict percentage of future payments, meaning that your lenders get more money as your company grows.

On the other hand, recurring-revenue financing is considered a better fit for subscription businesses. They tend to work on flat rates and operate at the cadence of subscription businesses. They grow with you, but only by increasing your trading limit.

For example, Capchase takes a sum of money for your annual subscriptions and gives you the rest. Or Pipe connects you to lenders on a marketplace that treats subscriptions as tradable assets (Pipe makes money by taking a small cut from both sides for using the platform). There’s little standardization across these platforms, but there are a few common terms you’ll come across.

• Amount: The amount refers to the total capital that you can draw up to your credit limit.
• Credit limit: The credit limit is a fixed percent of forward-looking annual recurring revenue. Depending on the platform, this number can change based on the health of your subscriptions.
• Discount rate: The discount is a fixed percentage applied on your total contract’s value that is taken by the platform. It’s generally calculated when a draw request is submitted.
• Draw: A draw refers to when you withdraw money.
• Cadence of draws: Cadence is the number of times you can draw money up to your credit cap.
• Minimum draw: The minimum draw is the lowest amount that you can draw at any point.
• Duration: The duration is the amount of time you can draw money for.

• You have a subscription business with steady contracts. Typically, to be eligible your company needs several months of subscription history and $10K-$15K+ in MRR (or $120K-$180K+ in ARR), though the requirements vary by lender.
• You need capital quickly. Platforms like Capchase and Pipe can fund recurring revenue loans within days. You can use the financing for cash flow, investing in product improvements, growth initiatives, or hitting milestones that make you more appealing to VCs.
• Your location doesn't limit you. Recurring revenue financing is geography agnostic. All lenders care about is the quality of your subscriptions.
• Banks aren't built for your business model. Many subscription businesses — particularly SaaS  — struggle to raise capital from traditional lenders. Banks typically lend to mature, asset-heavy businesses. Recurring revenue lenders understand ARR-based models and can offer better terms.
• You want to preserve equity and board control. Unlike venture capital, annual recurring revenue financing doesn't dilute your ownership or require giving up board seats. You retain full control of your company.
• You want to avoid customer discounts. Subscription companies often discount annual plans aggressively (a $14.99/month product discounted to $130/year, for example) to get cash upfront. Recurring revenue financing can be a more affordable alternative.
• You want fewer restrictions than traditional debt. Conventional debt often comes with warrants, covenants, and other burdens on your business. Recurring revenue financing is much simpler.

You're planning to raise other capital, but you aren't ready yet. Recurring revenue financing works alongside other forms of capital, like VC, and can be tapped when you need it.

Like all capital, it’s important to remember the dangers of recurring-revenue financing.

Churn. High churn impacts both the amount you can raise and your total costs. Lenders factor risk into the discount rate, so a company with 8% monthly churn will pay significantly more per dollar advanced than one with 2% churn. If your churn is seasonal (which is common in B2C subscription boxes or fitness apps), consider your worst-case months before committing to a draw. If you take an advance during a strong acquisition month, it can become a burden if the following quarter has a higher level of cancellations.

Revenue concentration. If a single customer or a small handful of accounts make up a large portion of your MRR, it’s a risk for both you and the lender. If one of them churns, you may not have enough replacement subscriptions to cover the shortfall. Some lenders cap the percentage of your advance that can come from the subscription revenue of a single customer. Review the concentration limits in your agreement before drawing.

Recourse and covenant-like restrictions. Some recurring revenue financing agreements include provisions that let the lender accelerate the balance if your revenue drops below a certain threshold. This type of provision would require you to repay the balance in full. Others may have financial conditions, or restrict your ability to take on additional debt. Make sure you can comply with all conditions of the agreement.

ROI. Map out several scenarios that take the implications of recurring-revenue financing into account. Consider the ROI—is the price of the financing worth the payoff?

For example: is using cash from recurring revenue lenders to hire a new engineer today worth having to repay lenders over several months? Would an investment in growth marketing generate enough cash to repay your lenders and keep your business moving?

ARR financing is like debt: it’s a promise to pay lenders back at a fixed rate. If you don’t know how you would spend the cash or can’t estimate the ROI of raising funds, it might not be right option for you.

Want to learn about other types of financing?

Capital is the lifeblood of startups. However, there’s not much education on when, how, and why to use it. Plan for your startup’s future by learning about SAFEs (Simple Agreement for Future Equity), venture debt financing and business credit cards.