Alex Danco wrote a thought-provoking blog post that investors and founders in Silicon Valley have spoken to over the past two weeks. In his tweet where he shared the blog post, he wrote: “Someday, and not today, but soon – and first gradually, but then suddenly”, a new option for start-up financing “Arrives in Silicon Valley”.
That day has come.
Founders of fast-moving Software as a Service (SaaS) startups should always think about how they will finance their growth. Will they grow with the income they generate or will they trade part of their business ownership for capital from technology investors? Founders usually go for the latter option, as engaging in venture capital funding at an early stage allows them to grow faster. However, they dilute themselves (and their employees) as equity is traded for more capital to continue their rapid growth path. Serial entrepreneurs Harry Hurst, 30, Josh Mangel, 27, and Zain Allarakhia, 31, observed the canonical cash flow problem in SaaS startups, creating Pipe as a solution. Pipe is a funding platform that provides non-dilutive funding to SaaS businesses in the form of an instant cash advance. The Los Angeles-based startup raised $ 6 million in a funding round led by Craft Ventures, with participation from Fika Ventures, MaC Ventures, Naval Ravikant, WorkLife Ventures and The Weekend Fund.
“The primary funding option for SaaS companies so far has been dilutive fund rounds,” said David Sacks, co-founder and general partner of Craft Ventures. “Pipe is the tool every SaaS founder has been waiting for. It enables SaaS companies to grow without dilution by financing their SaaS receivables.
For B2B SaaS companies, the trade-off between cash flow and growth is particularly painful, as most of their products and services have high upfront costs. The dilemma is compounded by the relatively slow growth in income at the start to offset these initial expenses. At this point in the business, the founders lack the flexibility to offer their customers attractive monthly payment plans. Sometimes founders need to discount the full value of an annual subscription so that customers pay in full at the time of purchase. Lack of payment flexibility prevents transactions from closing faster, which negatively impacts the rate of revenue growth. Given these canonical cash flow issues, early stage founders backed by venture capital are more inclined to raise funds rather than seed. However, a large number of SaaS companies in the United States indicate that a large customer base needs a non-dilutive solution to their growth problems.
AngelList CEO and Pipe investor Naval Ravikant urges SaaS companies to “come forward to customers, not investors, and let Pipe convert subscriptions into instant, no-dilution funding.” Fountain CEO Keith Ryu adds, “Having efficient cash flow is essential to our mission to grow. We often risked losing business by requiring annual upfront payments when customers wanted to pay monthly. Pipe solves this problem for us and allows us to invest more heavily in our growth. It can easily save us a fundraiser. ”
Cloud service companies are a type of business that provides an essential function for most businesses that depend on the Internet to operate today. Without these suppliers, many of their customers would not have the digital capacity they need to do business in today’s economy. Gartner believes the global public cloud services market will grow to $ 266.4 billion in sales in 2020, an increase of 17% from $ 228 billion in 2019. The global cloud services market provides a great bridge opportunity for Pipe due to the need for offerings from these vendors.
“SaaS businesses have wonderfully predictable recurring revenues that, assuming a negative churn rate, last forever. The problem is, their customers want to pay their subscriptions monthly or quarterly, ”says Hurst, co-founder and co-CEO of Pipe. “Founders of high growth startups find themselves slashing their revenues by up to 40% to get clients to prepay each year and, at the same time, raise dilutive equity to close the cash flow gap.” . “
Pipe offers a clear, non-dilutive alternative to founders who choose how to grow their business. By providing a cash advance equal to the annual price of the software subscription, a business using Pipe can gain immediate access to the full annual value of a customer subscription. In other words, startups using Pipe can immediately turn their monthly recurring revenue (MRR) into annual recurring revenue (ARR). Converting MRR to ARR allows businesses to focus on acquiring more customers and investing in the critical infrastructure needed for expansion. The fees charged to Pipe are comparable to those of current competitors in the financing industry. The key to Pipe’s financing is its integration into its customers’ accounting, billing and subscription management systems. Information from these systems is used to instantly decide whether the business qualifies for funding from Pipe. The founders say customers can turn their MRR into ARR “within hours of demand.”
Jon Runyan, Okta General Counsel, explained, “Having overseen thousands of sales and contracting processes over my career, I immediately saw the value of Pipe’s elegant solution to the contract conditions problem. payment versus the cash flow that so many businesses face. “
Pipe’s “smart solution” competes with specialist banks that offer venture capital and late-stage venture capital firms. The Kauffman Foundation definition of risky debt is “a form of debt financing for venture-backed companies that do not have the assets or cash flows for traditional debt financing, or who want more flexibility.” Specialized banks offer this financing tool which has two key components. The first element is the debt itself structured as a series of loans (usually a term of three years is the norm). The second and most important part of venture capital debt is the warrants included in the loan package. Warrants are debt securities that give the loan creditor the opportunity to buy shares in the indebted start-up. These equity instruments can prove to be costly in the last fundraising for a startup, especially if a company was about to go public.
If they took on risky debt, the mandate would allow the creditor to buy part of the equity in the business at a predetermined price, which would cost the business up to hundreds of millions of dollars. However, by using Pipe, a SaaS business can avoid the dilution and debt caused by raising additional funds or borrowing venture capital debt. Pipe’s co-founders discovered the appeal of their funding option to fast-growing SaaS startups and the potential new market for the financial instruments they created. The three realized that the underlying value of their clients’ contracts is equivalent to an asset.
Why is calling Stable MRR from Pipe customers a remarkable asset?
Going back to Danco’s blog post, he makes a bold prediction:
“The tipping point occurs when an important person, and possibly a local one, announces a new fundraising product: securitization of recurring income. ”
Danco’s conjecture is what Pipe aims to produce. Hurst says, “Pipe is creating a new asset class for investors: a fixed income type product that generates attractive returns from recurring, predictable, asset-backed income streams. ”
Vista Equity Partners CEO Robert Smith understands how valuable these cloud service providers are, saying in his Forbes Mars cover story, “Software contracts are better than senior debt. A business will only pay interest on its first lien after paying its software maintenance or subscription fees. We get paid our money first. Pipe provides cash advances ranging from $ 10,000 per month to several million per month to its clients. The financing of this type of SaaS startups is less risky because of the essential nature of their services and, above all, the stability of their recurring revenues.
The consequences of such an asset class are unclear, but Danco extrapolates further:
“If you think there is too much money flowing into startups now, just wait for someone to create a high yield fixed income product for institutional investors to buy recurring income … imagine how it goes. be to compete with someone who is connected to the debt market. “
With Pipe providing non-dilutive funding to hyper-growing SaaS startups, the day of debt-fueled competition will come sooner than we think.
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