What-Makes-Subscription-Based-Financing-a-Robust-Business-Model-to-Avoid-Dilution
ESOP

How Can Subscription-Based Financing (SBF) Keep Dilution at Bay

The subscription-based financing model has become increasingly popular to raise capital—a method of raising funds without dilution of equity for companies, thanks to a company’s recurring revenue streams.

So, what is this mode of financing, and what makes it a robust method to avoid dilution? In the latest webinar from trica equity, Raise Capital – Don’t Dilute, expert founders covered all these topics and more.

Subscription-based Financing: The Nuances

A variety of reasons are driving the growth of the Subscription Economy. Some are:

  • Customers are requesting more flexibility in how they consume services.
  • Managers want to introduce new features and pricing to customers rapidly.
  • Executives have realized that this will build long-lasting relationships with customers.
  • Finally, investors realize that subscription economy companies’ revenue and return models are fantastic if executed well.

So, what exactly is subscription-based financing?

What is Subscription-based Financing or Subscription Credit Lines? 

Simply put, subscription-based finance is credit extended to an investment vehicle—a credit facility, considered mainly through private equity funds.

Investor commitments are used as collateral for securing loan agreements, typically without recourse to actual investments.

Subscription lines were originally repaid within 30 to 90-days, purely as a short-term bridge loan.

Low-interest rates and less restrictive borrowing provisions are other factors contributing to the expansion of subscription lines of credit.

Like Ekalavya Gupta, co-founder of the Recur Club, said, “Building a great business needs a raise in the capital, but choose it wisely without dilution. Depending on your business and VC capital, a mix of non-dilutive alternative financings, such as revenue-based and subscription-based financing, is what today’s startups need.”

Why do Orgs Need Subscription-based Financing?

As provocatively stated by Manoj Agarwal, co-founder of XoXoday, “There are too many moving pieces as you build your startup. One of the biggest moving pieces is how do you manage your cash flows? How do you manage your working capital? How do you navigate through new expenses? How do you adjust the need for new revenue?”

Subscription-based financing (SBF) is usually intended to provide funds with liquidity faster than capital contributions.

For example, a credit facility like SBF typically provides loans within 24 hours, while a typically limited partnership arrangement might require 10 business days or more to obtain funds.

As its nature suggests, subscription-based financing is typically used to bridge short-term capital calls. However, despite SBF’s apparent short-term appeal, they can also be used to bridge the gap in longer-term financing.

SBFs: A new method of instant, upfront capital

Pranav Mahajani of trica says, “It’s very important that you raise a good quality VC capital in the first phase of business life. If you have proof of concept that needs to take shape into a product, then never back off from taking one. More money in the bank is far better than no money in the bank.”

Businesses undergo ups and downs. Churning clients, key employees leaving midway, and high acquisition costs result in negative cash flow.

These companies often seek venture capital because it provides a large safety net

But to raise such funds, entrepreneurs must endure several lengthy processes that can last anywhere from three to six months (sometimes even longer).

As a result, the number of non-dilutive funding models is gaining traction with regard to raising instant upfront capital. Like, revenue-based financing and subscription-based financing.

So, how to go about it?

What is SBF’s role in Helping Founders? 

Abhinav Sherwal, co-Founder and co-CEO of Recur Club said, “With a valuable product and raising customers, your business must evolve accordingly. So you have to retain the customers who are valuing you. That’s the validation to start engaging on alternative finances.” 

By exchanging subscription revenue for upfront capital, recurring revenue companies can raise cash without diluting equity.

Due to its predictable cash flows and maturity, investors will find it comparable to a fixed income-yielding asset. As a result, it is well suited for businesses seeking money to expand or acquire customers.

SBFs: New capital in a new equation

From the onset, founders aren’t even required to give up any equity or ownership of their company with SBFs.

“It saves a lot of time for founders, and it can technically ease the lives around working capital loans or invoice discounting,” adds Abhishek Sherwala.

Obtaining subscription-based financing is very straightforward and starts with signing up for a trading platform that provides such funding options.

As soon as the platform syncs the founder’s accounting and invoicing software, the trading limit is lifted within 48 hours.

Through trade contracts, companies can raise money quickly and easily, within a click.

Transactions take place in real-time. As a company grows, it can raise more money (its trade limit). A recurring revenue deal is a founder-friendly way to raise capital.

A good capital stack also ensures that the company does not take on too much debt or dilution of equity.

In addition, non-dilutive funding methods ensure that the company retains control and grows without imposing covenants.

So, the fundamental equation of this entire subscription financing is that you need to get a profitable Annual Recurring Revenue with this financing. So, how is that equation done?

Take the current year’s ARR and add Annual Contract Value (ACV) to it. Now subtract the Churn (example, lost customers, down selling, etc.). It gives the financial picture of your business with this new capital and the value of ARR for the following year.

ARRn + ACV – Churn = ARRn+1

Seems interesting! Doesn’t it?

Raise capital, only because of THIS

Finally, as wisely said by Manoj Agarwal, Cofounder, XoXoday, “Never run for capital just because it is a trending thing to make news with raising investments.”

Go for funding only if it means upgrading your business, expanding your customer base, and meeting the core objective of the business. Not for the rat race of doing it. 

So, yes, subscription financing can turn your business on its head—finally, a robust business model to avoid equity dilution. Whether you’re a company of two or a growing startup trying to find the right equity solutions, trica equity has got you covered. Find out more, or get in touch for a demo

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