A Looming Crisis: Selling MRR Contracts to Fund Long-Term Cash Burn

In the past month, we’ve shared a few articles about the increase in short-term loans that promise to convert a SaaS company’s MRR to ARR.

In the examples we have seen, the debt provider offers to pay ten months of MRR today in exchange for collecting 12 months of MRR directly into their own account. We calculated the actual cost of these loans by working out the actual amortized interest rate here. While the cost is concerning, the bigger problem is how the loans are used.

Using short-term loans to finance long-term cash burn is unsustainable and creates additional transaction costs due to the need to frequently refinance.

When to Choose MRR to ARR Loans

Companies like Clearbanc, Stripe Capital, Pipe, and FounderPath offer short-term MRR to ARR loans.

MRR to ARR loans are similar to a well-known form of finance called Accounts Receivable Factoring. This financing model is common in manufacturing and other capital-heavy businesses to help manage month-to-month cash flow.

For example, a manufacturing business may sell, or factor, a receivable due in 60 days in exchange for cash now in order to facilitate the purchase of inventory to keep manufacturing going at full speed. Manufacturing businesses often have a 120 to 180-day lag between when they spend money on raw materials and when they collect from customers. This gap between cash out and cash in is called working capital.  

When used to fund a short-term need that will result in more inbound cash in the near future, accounts receivable factoring is a useful tool. However, the software industry equivalent of accounts receivable factoring—known as MRR to ARR loans—may not be the best option available.

Exchanging a small percentage of your 12-month MRR contracts for cash to invest in a proven revenue-generating program that can add value to your company. However, this is not what we see happening in the market. Instead, companies are:

1. Selling a large portion of their MRR contracts
2. Funding larger cash burns, including product development and general and administrative costs
3. Relying on sales and marketing programs that are not yet mature enough to deliver proven results

In effect, companies are funding product development and general and administrative costs by selling their near-term MRR contracts. Product development and general and administrative expenses will not directly create new MRR contracts in the near future. 

We caution against the use of our own investment facilities to fund product development. The best use of TIMIA Capital’s products is to directly fund marketing expenditure. Funding product development costs with short-term MRR loans is risky and unsustainable.

Why Does This Matter?  

If a company converted 50% of its MRR contracts to cash with an MRR to ARR loan and spent that capital on three months-worth of cash burn, where will the funding for the rest of the year come from?  

Few technology lenders would work with a company that has adopted that financing model, since technology lenders view revenue as their security. 

The bottom line is that factored revenue can not be used as security. New equity investors would sense a bargain—if they were interested at all!

Success with MRR to ARR loans is dependent on several major factors:

1. You are delivering a product or service with good margins
2. You don’t have high churn
3. You see a direct correlation between marketing spend and new MRR
4. The loan amount is small and in proportion to the online marketing spend
5. Your business keeps growing and there is no economic downturn

If any of these factors are missing or change, MRR to ARR loans will make your cash flow situation unsustainable.

Capital for Long-Term Growth

Long-term debt like TIMIA Capital’s offerings makes much more sense for growing SaaS and software-enabled companies. 

Unlike MRR to ARR loans, TIMIA’s growth capital is transparent and supports sustainable growth. Come talk to us if you’re a growing SaaS or software-enabled services business with between $2 and $20 million ARR.

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