Unlocking Contracted Recurring Revenues to use for Debt Collateral
January 24, 2014 7:15 AM   Subscribe

Every month my company sells roughly $15,000 worth of monthly recurring revenue contracts with five year term lengths. The service sells for $1,000 per month so every month we sign on 15 new customers. $15,000 * 12months * 5 years = $900,000 (total contract revenue for all 15 contracts sold during the month) We've maxed out our borrowing on physical assets held by the company and I need to find a way to unlock these revenue streams to use as collateral for further growth. What's the best way to do this? I would prefer to not have to go to every customer and amend their contracts in any way. Thanks!
posted by Paalen to Work & Money (16 answers total) 3 users marked this as a favorite
 
Look into factoring.
posted by Admiral Haddock at 7:31 AM on January 24


Have you spoken with your bank about an expanded line of credit?
posted by alms at 7:43 AM on January 24


If you're actually generating $15k in (new?) revenue every month and are asking this question, that suggests that you are being woefully underserved by your accountants and lawyers. Any business with those kind of numbers should have both of those professionals on speed dial.

Professional expenses for accountants and lawyers are absolutely a cost of doing business. People think we're expensive (IAAL, but IANYL), and we are, but that's because as much as you may hate to admit it, you really can't do business without us. Or, rather, you can wing it and get away with it a lot of the time, but as soon as something goes pear-shaped (and it will!) or you need to do something even slightly unusual (like now!), you're going to be in such a world of hurt that you'd do anything to go back a year and pay us the few grand we asked back then to make sure everything was copacetic.

This is a question you ask your accountant. The factoring suggestion is a good one, but really, what you really need to do is to go to your accountant and say "We need to borrow more money." Let him figure it out.

Or tell you you're out of your bleeding mind because you're already leveraged to the hilt and now you want to borrow directly against future earnings? I'm just sayin' is all. Whether to borrow more money is as important a question as how to borrow more money, and again, it's accountants and lawyers that answer those questions.
posted by valkyryn at 7:50 AM on January 24 [3 favorites]


companies borrow against receivables all the time. If you are doing it to fund working capital its a perfectly reasonable thing to do.

This is not something your lawyer or your accountant should be helping you with, but rather the bank you have your other credit lines with. If they won't help you, keep shopping.

I'm not sure a traditional factor will be interested in these kinds of receivables.

Also its not 900k - its the present value of the total revenues - which given I assume the contracts are in someway cancelable/default-able should be discounted at a reasonable high rate.
posted by JPD at 8:43 AM on January 24


Thanks Admiral! I'll study this more. Every time I learn something I discover 10 additional things I need to study more and that expensive piece of paper that say MBA doesn't do a whole lot to prepare you for the real world outside of learning terms and theories.

Alms - I have and am working with banks to see what they can help with. They are mostly regional banks that want me to reassign our contracts or use physical assets as collateral. We are beginning to turn the corner to work with the larger banking institutions but EBITDA won't be there for another 6mos-1yr. We are in a very unique situation where initial CapEx costs are extremely high but profit margins from there on are in the 90%+ margin (fiber optics). Payback on the five year contracts fall in a range of 8-11 months.
posted by Paalen at 8:48 AM on January 24


Thanks JPD, I agree fully and definitely understand the discounting of future cash flows. Really looking to learn what I can from the hive mind and see what I can do outside of going back to our customers to amend their contracts.

I've seen many places like "The Receivables Exchange" website that allows for this but most seem to be geared towards payments that are not recurring.
posted by Paalen at 8:54 AM on January 24


You have $900,000 in revenue annually and you need to generate more liquidity, if I understand correctly.

This is exactly what your company's treasurer (or outside accountant if you don't have a treasurer/comptroller) should be doing. Admiral Haddock is correct, factoring is an option.
posted by dfriedman at 9:00 AM on January 24


not just one off, but also the receivables themselves have much shorter tenors. Also I'd guess a lot of the guys who buy Adwords and what not are charging extortionate implies rates/credit losses.
posted by JPD at 9:12 AM on January 24


Not exactly Fried. We generate $900,000 in total contract revenue per month. This $900,000 is spread out over five years. Let's say gross revenues will be roughly $8mm for FY2014.

Yes, this is what an experienced CFO or Treasurer would do although I'm not ready to fork over the $300,000/yr for that salary and have had some poor experiences with them in the past (a few other reasons I'm not quite ready for one but that's a very lengthy discussion for another time).

I have some business experience (10 years in finance + a little education) but not in leveraging this exact type of asset to use as collateral. I do not think I agree that a lawyer or accountant will generally be able to help in this capacity. Although I'm sure there are a few specialists out there you could find to prove me wrong.
posted by Paalen at 9:12 AM on January 24


I think you can get a decent CFO for a lot less than 300k.

If you are looking to do this sort of financing on a going forward basis it might be a bad idea to get someone in house who can do it for you. Also you can find part-time guys as well.
posted by JPD at 9:15 AM on January 24


JPD -

I'm researching some CFO outsourcing firms but am still on the fence with these.

I'm in a very rural area which makes finding a solid CFO harder. Plus, as I mentioned earlier, I've had bad experiences with very intelligent CFO's with very bad work ethics and ethics in general. They impress me until they get settled into the position then are lame ducks.

In 2-3 years I hope this will be a nonfactor as my cash flow will be much greater and CapEx expenses will be much smaller and I will be able to use the cash from these recurring revenues to finance additional expansion plus once I get a few years of solid financials under my belt and a history of positive EBITDA using solely my recurring revenues then the bigger banks will love me (I've already a few that are working hard to keep in contact or potential future business).
posted by Paalen at 9:26 AM on January 24


Hold on: your contract revenues are $900,000 per month but your new business run rate is only $15,000 per month?

Am I missing something here? If true, your business isn't growing - your new business is simply replacing the contracts that will die off after the five years are up.

Because of revenue recognition, you can only recognise $900,000 per month. By tweaking how you generate/recognise revenues from *new* business short term you can greatly increase your profit on the balance sheet. This is bread and butter stuff for a CFO.

In their position, I'd be looking at:

- how to defer costs, or amortise them over a longer period
- how to change revenue recognition
- how to deliver new streams of revenue where the bulk of them can be recognised earlier

For example, new streams of revenue: total lifetime value of a typical five year contract is $1,000 * 12 * 5 = $60,000, of which you recognise $1k each month.

For new business, imagine the set up was this (hypothetical, I know nothing about your business):

option a - no discount: $5k set up and $920/month. Total lifetime cost is just over $60k. Revenue in the first 12 months of the contract is $16k.

option b - discount to encourage switchover to new contract style: $5k set up fee + $850/month. Total cost = $56k, a discount of nearly 7%. Revenue in the first 12 months of the contract, however, is $15.2k. Yes, you are taking pain later for short term gain, but only from year 2 of the contract onwards.

Basically, if you are confident of your new business capabilities, or your ability to create added value services later in the contract, you might want to look at short term measures to drive recognisable revenues.
posted by MuffinMan at 9:34 AM on January 24


$15,000 in new monthly recurring revenue generated (sold) per month. Our contract lengths are five years. So total new monthly contracts will gross $900,000 over that five year period.

The business is still new so we have not lost a customer because they are still under their initial contracts and we are first mover into this rural area so we basically have a monopoly on the area that needs to be exploited as long as possible until our competitors make their move.
posted by Paalen at 10:05 AM on January 24


There are a number of specialized lenders that loan against these kind of recurring streams. Some of them also do traditional factoring. For example, First Capital does this sort of thing but perhaps only at a larger scale.

Your contracts sound like alarm services. If that's the case, there are a bunch of lenders focused specifically on those. Just google "alarm funding."

Otherwise, try the Commercial Finance Association's referral website.

Among the big banks, Wells Fargo's Capital Finance business is the most likely to do this sort of thing. They also lend to other lenders, so perhaps they can refer you to a borrower of theirs that does smaller deals.
posted by mullacc at 11:10 AM on January 24


Thank you mullacc. You've given me some good homework assignments.
posted by Paalen at 12:32 PM on January 24


JDP has it exactly right. My company borrows against AR (and with our new LOC, inventory as well) as do most companies in my industry, albeit at far higher amounts than what you are proposing.

IANAL or a CFA, but you should get an attorney to look at the contract because you will have to commit to covenants, regular reporting (often weekly) and quarterly (or more) auditing. Some covenants and reporting requirements might seem fine at the time but could become onerous down the road, and only a lawyer and accountant can tell you that. You really want to get the contract right because there can be substantial penalties, not to mention the disruption to your business, if you leave the bank or violate a covenant.

I can confirm a certain company mentioned above offers this service. I can also confirm that they are complete assholes while doing it and lost our (high 8/low 9 figures USD) business because of it. Memail me if you want details.
posted by digitalprimate at 7:06 AM on January 25


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