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How the Cloud Will Be Capitalized

Cloud-based software and services will be the backbone of businesses, but can lenders and investors find a way to finance the providers?

Broadly, debt providers are willing to lend a multiple of several months’ revenue on the premise that committed monthly recurring revenue (CMRR) is highly predictable and sales expenses are variable — and decoupled. Unlike a company that sells widgets, a high percentage of a SaaS company’s forward top-line revenue will be already baked and independent of any incremental marketing spend. Accordingly, RRL commitments range from 1x to 12x CMMR. This is possible because a lender’s downside modeling will show that existing client revenue can be quickly turned into cash flow and service such debt loads. Lenders factor growth rates, revenue granularity, client churn and billing frequency into their borrowing formulas. Companies with positive EBITDA can find even more aggressive borrowing multiples beyond the aforementioned range.

Equity. Institutional equity is a preferred path for fast-growth SaaS companies that are selling, marketing and on-boarding at rates that can double top-line revenues year-over-year. While equity represents the highest-cost capital for an entrepreneur, it can also accelerate enterprise value and offers inherent advantages: committed funds, flexibility relative to debt and certainty relative to yet-proven organic cash generation. The cost or valuation multiple will be a function of current sales and forecasted, defensible net growth rates. Many investors have modeled (as Scale Venture Partners has) that companies will need initial growth rates in excess of 80 percent and not slow that growth more than the norm of 10 percent to 20 percent per annum to achieve a targeted venture return of 10x in five years.

Companies interested in financing their cloud-based business via an external debt or equity source must have tracking and reporting tools that explain the real performance metrics that drive value in their businesses. The best cloud-based managers are data geeks, relentlessly measuring and making adjustments to front-end sales or back-end support in pursuit of increasing acquisition and retention.

Additionally, early and periodic conversations with potential financiers are critical to optimize timing and cost. For example, an RRL facility could be the perfect tool to help reach a significant recurring revenue threshold before securing a larger equity round with significant step-up in valuation.

Scott Bergquist is the central U.S. division manager for Silicon Valley Bank, overseeing business development and client relationship activities with 2,000 companies and managing more than $1 billion in committed capital. He specializes in financing solutions for high-growth technology and life-science companies. Gary Jackson of Silicon Valley Bank in Salt Lake City contributed to this column.

4 thoughts on “How the Cloud Will Be Capitalized

  1. Excellent post that highlights the need to have granularity when it comes to complex sectors like this. One also needs to look at this from a ‘local’ use of capital as funding arrangements may vary by state, country, continent as tax, interest and cost of capital comes into account.

  2. Great analysis on the hard impact of cloud computing. There are many other soft impacts, such as the ability to be more agile and change the business rapidly vs needing significant investments in people and hardware. Another is the ability to “swim up steam” into your customers other business processes.

  3. Thank you for the article. It brought clarity to the financing arena for start up cloud based software companies for me. We have a product, Accountants’ Workflow Solutions, Inc. that provides a practice management, client relationship management, document management and task/project management solution for small firms. It is implementable in 7 to 10 business days with a fully populated database. When I moved from a server based product to a hosted product, I transitioned from the higher original purchase price plus implementation fees to a monthly subscription fee plus a smaller implementation fee. I knew it was going to be financially challenging to make this transition, but the best decision for the long term. Our onboarding costs are minimal and the costs are covered by our fees. You answered a lot of questions I had regarding the ability to obtain financing or funding. The flywheel is creeking over the first turn for the hosted product. We haven’t marketed other than social media while we complete the development of the SaaS version. This will be ready for release in late April 2014. The onboarding costs for the SaaS version will be significantly reduced and the feature/function will be greatly improved. We invested a lot to create the best technological platform for future development of significant applications for the accounting industry. Again, thanks for the thought provoking article.

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