An interesting way to finance business growth
SaaS companies are subscription based businesses, meaning they have a recurring revenue stream. Subscription-based business models are highly scalable, which makes them so attractive to investors, but they also have some drawbacks. The biggest is that the business model is capital intensive: it takes a lot of money to get started, and a lot more to scale up. This means that SaaS companies have very high burn rates at the beginning, but as they grow they need less investment to keep growing.
It is not uncommon for SaaS companies to finance growth, as the capital-intensive nature of a SaaS business makes it very difficult to finance growth internally. You have to invest a lot upfront and will only see a return in the form of revenue over time as the business grows. This means that many businesses need external financing to succeed. They can finance their receivables to improve their working capital – which is called factoring.
Factoring as a unique way to finance growth
Factoring is a way to finance your business by selling your accounts receivables to a third party (called a factor). This allows you to receive immediate payment from your customers, and then pay back the factor over time through the original recurring revenue stream. The factor takes on the risk of non-payment from your customers, so they charge a fee (typically 1%-3%) for this service.
In other words, factoring is when a company sells its invoices at a discount to a third party, the third party gives money to the company before it has been paid by the customer, but is paid back once the original invoice is due. For providing this service, the third party charges a percentage of the amount provided.
The amount of money that is freed up immediately is used by the entrepreneur to finance his activities and make investments for the growth of the company. By selling invoices at a discount, businesses can have more money available at the same time, rather than having to wait for payments from customers over time. This can help them cover expenses related to scaling up their operations and investing a larger amount in their marketing and sales activities, for example. In this way, you can grow your business without having to wait months for the money to trickle in and make these kinds of large investments.
Factoring can be used by companies of any size, from start-ups to SMEs to even large companies with a significant volume of outstanding invoices.
The process of applying for factoring as a SaaS company is quite simple. All you need to do is provide some basic information about your business and then submit your invoice. The factor will review it and make a decision within a few days. Once you have been approved, you can use the money immediately. You don’t have to wait months like with some other financing options.
The pros and cons of factoring
The benefits of factoring as financing option for a business:
- You don’t have to give up ownership of your business: you can still own 100% of your business while using factoring as a funding source.
- It can be a good way to finance growth without taking on additional debt or diluting shareholders’ equity.
- Factoring only uses your invoices as collateral, so you do not have to give up any other business property as collateral for this financing.
- Fast access to cash: the money from your accounts receivable will be deposited directly into your bank account usually within a few days, meaning the process is much quicker than bank loans or investor financing.
- Perhaps most beneficial is how easy it is to get started with factoring. There are no minimum credit requirements or strict underwriting standards like there are with other types of financing options.
However, factoring is not without its drawbacks. Factoring services usually charge a fee on top of the invoice amount, which can be quite high, depending on the amount and the payment term of the invoice. It is also important to note that not all factoring companies charge the same rate; some charge much more than others, so make sure you look around before choosing one.
When is factoring a good financing option?
Factoring is a good option for companies that already have paying customers, as it is a way of collecting subscription-based payments in advance. Therefore, factoring is a popular financing option for B2B SaaS companies that have been operating and growing for some time.
If your company has a steady stream of incoming invoices and you are looking for financing options for expanding your business, factoring might be an option worth exploring. But how do you know when it is the right funding choice? The answer depends on a number of variables, including your business model and cash flow. Here are a few key questions to ask yourself:
- How much money do you need? Many SaaS companies start with low revenues and high expenses. Your existing customers may not provide enough revenue in the beginning for the upfront payment of your invoices to make a real impact. The percentage you pay to the factor, on the other hand, can have an impact on the growth of your business over time.
- What other financing options are available to you? If you have strong relationships with banks or investors, factoring may not be the best option as you may have other better alternatives with favourable terms at your disposal. But if your credit is not good or you have no other options, factoring can be a good choice.
- Can you afford paying the factor for their services? You need to know what your business can afford in terms of the percentage you have to give up to the factor. It can be very convenient to release a larger sum of money at once, but you will have to take into account that you will ultimately have less income.
Factoring allows you to have the money you need immediately, without having to give up equity or take on debt, and is therefore an excellent way to finance the growth of your business. It allows companies to free up a sum of money by selling their accounts receivable (money owed by customers who have yet to pay their invoices). The factor pays the company a percentage of those invoices and takes care of collection from the customers while they are waiting for payment from the company.
If you are interested in other forms of financing such as venture capital or crowdfunding, continue reading here.