Three Ways to Use Recurring Revenue to Finance Business Growth

Editor's note:Harry Hurst isPipe's co-founder and co-CEO. Pipe is a platform that helps businesses convert their recurring revenue streams into growth capital. The views expressed in this article are solely those of the author.

When executives are preparing to scale their companies, a lack of liquidity is often one of the main obstacles they face. Making key hires, building infrastructure, or gaining traction in new markets all require substantial working capital, and these investments often take time to generate returns.

To drive growth, many companies turn to equity financing, loans, or venture debt. However, taking on restrictive debt and equity dilution is not always the best option. This is why alternative financing solutions have gained more attention recently. As subscription and recurring revenue models become increasingly prevalent in nearly all markets, businesses are looking for financing solutions that better fit their needs and are increasingly exploring how to leverage their own revenue to fund growth.

Here are three ways to use recurring revenue to fund growth for rapidly expanding businesses:

The slow and steady approach

This is the most obvious way, so let's briefly explain it first. If a company needs capital to expand, they can always use incoming revenue to self-finance. The problem is that the timing and speed of revenue realization may not be ideal.

SaaS companies are a great example. While they may charge a $480 annual subscription fee, revenue actually flows in at a rate of $40 per month. When you need to scale quickly, you often can't wait.

Many companies try to accelerate revenue by: a) offering only annual payment options (which may lose customers who are unwilling or unable to pay upfront); b) offering significant discounts to annual-paying customers (which impacts revenue and profitability).

Revenue-based lending

Companies with substantial revenue but limited assets often lean toward revenue-based lending. The basic principle of revenue-based (or royalty) lending has remained largely unchanged since the early 1990s. Companies use revenue rather than assets to obtain loans and repay them by sharing a percentage of their revenue with the lender.

In recent years, revenue-based financing (RBF) has been transformed as new lenders have made it easier to access loans online. But for recurring revenue companies trying to avoid loan restrictions and equity financing, RBF may not always be a suitable alternative.

RBF is still essentially a loan, and it's crucial to understand its repayment structure to ensure alignment with business goals. Since repayment amounts are calculated as a percentage of revenue, they increase as you scale. This can divert cash flow, leading to thinner margins during expansion phases. If revenue is predictable but not recurring, RBF can still be a good option when growth capital is needed. For example, e-commerce companies may have substantial non-recurring revenue, and RBF may provide the most affordable capital for their expansion.

Recurring revenue as an asset class

As recurring revenue business models become a common phenomenon in the economy, these revenue streams need to be treated differently. From SaaS and direct-to-consumer subscriptions to property management and professional services (such as monthly accounting services), recurring revenue has become the de facto standard model. The value of these contractual revenue streams is finally being recognized as a distinct asset.

With the rise of recurring revenue as an asset class, investors have also shown strong interest. For example, on the Pipe trading platform, institutional investors purchase recurring revenue streams to achieve portfolio diversification and risk management.

Investors purchase revenue streams at a discount—similar to fixed-income products like bonds—with the discount rate based on the risk level of the underlying revenue and customers. Unlike equity investors, these investors only purchase the underlying revenue, not a portion of the company. This does not lead to equity dilution or affect company control, allowing businesses to grow on their own terms.

This is a significant shift in the landscape because founders and business owners no longer have to rely solely on lenders and venture capitalists to finance growth, nor do they have to weigh the interests of both parties. Instead, they can leverage the power of their own revenue to expand faster without making compromises.

Choosing the right financing at the right time

While there is more than one way to use revenue to finance growth, not all methods are suitable for every situation.

Expanding slowly as revenue flows in is a way to minimize the cost of capital, but you also need to consider opportunity costs. If waiting to expand prevents you from acting when needed, then that waiting can actually be costly. Accelerating revenue by offering upfront discounts can be even more expensive. However, if you are investing in the company without a clear return timeline (such as long-term R&D), this approach may be more reasonable than external financing.

RBF offers an option for companies that want to avoid equity dilution and may not have sufficient assets or track record to obtain traditional debt. For businesses with stable non-recurring revenue (such as e-commerce), RBF can be a good choice. But remember, as revenue grows, repayment speeds up, which can result in an effective interest rate much higher than the nominal figure.

If you have recurring revenue, a lack of traditional assets is no longer a barrier to liquidity. Recurring revenue itself becomes the underlying asset supporting financing. By selling these recurring revenue assets to investors, founders can obtain the growth capital they need without taking on loans or diluting ownership.

Grow on your own terms

When you need quick access to non-dilutive growth capital, traditional financing is no longer the only option. Consider your goals, the type of growth being financed, and the stage of the business lifecycle you are in, so you can scale your business on your own terms.