What makes a good investment in subscription-based companies?
In today's world, subscription-based business models are quickly gaining popularity as the most preferred way for customers to access products or services.
A subscription business model is one where customers pay a regular fee to access a product or service, often on a monthly or yearly basis. This business model has become a trend in the "membership economy," where consumers are more interested in accessing services than owning the product (think Spotify or Netflix). This trend has created enormous opportunities for businesses that want to leverage subscription models to drive growth and profitability.
Why invest in subscription-based businesses?
Subscription models offer several advantages to both businesses and consumers, making them an excellent opportunity for investors:
- A high growth rate and an above-average valuation because revenues are recurring and most of the time the lifetime customer value is higher. Consequently, typical exit revenues are also higher.
- A proven model that reflects the modern desire for flexibility, instant access, and low commitment to companies and services
- Scalable businesses as long as businesses can control churn, with servicing and acquisition costs per client that decrease over time.
- Predictable revenues leading to increased customer engagement and profitability as long as they continue to provide value to their customers
How to invest in subscription-based businesses?
One way to invest in subscription-based businesses with recurring revenues is through recurring revenue-based financing (RRBF). This model gives companies capital in exchange for a percentage of their future subscription revenue. Capital is advanced on the basis that companies will cede a certain percentage of their subscription revenue every month. This idea, which enables subscription-based businesses to raise funds by selling their recurring revenues (just like assets) at a discount, is currently spreading rapidly around the globe. In Europe, Levenue is the largest European revenue-based financing marketplace.
Levenue is a two-sided trading platform that connects investors with companies that have a recurring revenue business model to buy their future revenue streams, without loans or dilution. Investors get a regular, attractive flow of income, while entrepreneurs gain access relatively low-cost capital without diluting their shareholding. This type of investment is well-known by institutional investors, but Levenue has recently made it available to private investors as well.
Which data should be tracked to invest in subscription-based businesses?
Some KPIs (Key performance indicators) are major to assessing recurring-revenue business. At Levenue, the investors (buy-side) are required to define their investment strategy based on 6 main KPIs.
1. Monthly Recurring Revenue (MRR), Annual Recurring Revenue (ARR)
- MRR is a financial indicator that measures the monthly recurring revenue from a company's subscriber base. It measures a company's normalized monthly revenue from a product or service, particularly those with a subscription-based model. It is calculated by multiplying the number of paying customers by their monthly subscription fee.
- ARR, or Annual Recurring Revenue, gives a vision of the recurring revenue embedded over the next 12 months. It measures a company's normalized yearly revenue from a product or service, particularly those with a subscription-based model. It is used to predict the company's annual revenue, assess the effectiveness of its business model, forecast future revenue, and secure revenue-based financing. Investors use ARR to evaluate the growth of a company.
This is important to note that some revenues are not considered recurring when they are not generated on a regular, recurring basis. Examples of non-recurring revenues include one-time sales, or one-time fees (setup fees or consulting fees). Those non-recurring are more uncertain.
Minimum MRR for companies to be financed through Levenue is 10K€.
2. Churn rate
- Churn rate measures the percentage of MRR or lost customers. This is a metric used to measure the number of customers who have discontinued their relationship with a business over a specific period of time, usually one month. This metric helps businesses track customer retention and identify trends over time. For example, a churn rate of 10% means that 10% of the customers stopped their subscriptions in a given month.
3. Net growth rate
Net growth rate is the net increase (or decrease) in recurring-revenue from one period to the next (usually month). It is calculated by subtracting the number of lost customers (churn) from the number of new customers acquired during a specific period. This result is then divided by the total number of customers at the beginning of that period.
Sometimes called Net MRR growth rate but a monthly net growth rate calculation.
This metric is useful for tracking changes in customer base and making forecasting and budgeting decisions.
The runway refers to the amount of time a company has before it runs out of cash, assuming no additional funding or revenue is obtained. It is calculated by dividing the company's current cash balance by its burn rate (or monthly expenses), ie the amount of cash the company spends each month. For instance, a 12-month runway means that a company can continue to operate for a period of 12 months without additional funding. A short runway requires the company to raise more capital or increase revenue quickly in order to continue operating. When a company reaches the break-even point, where its revenue exceeds its expenses, it has an infinite runway.
Minimum runway for companies to be financed through Levenue is 12 months.
5. Maximum exposure / XaaS (/investment)
Maximum exposure per XaaS refers to the highest possible financial loss that a company or individual is willing to accept on a single investment. The maximum exposure per investment is determined by the investor's own risk tolerance. It is a way for investors to control their risk and manage their portfolio.
This is basically the price, investors want to pay: how much do investors want to pay per 1€ they will receive over the next 12 months? A 0.95 price means that the investor will pay 0.95€ for a 1€ subscription of the each subscription
The Levenue platform seeks to match entrepreneurs with as many investors as possible and, since investors have to bid to buy the revenues, the most attractive price (offering the lowest borrowing cost) wins. By contrast, there is only one bidder in the “on balance” model.
4 others KPIs that worth mentioning to invest in subscription-based businesses:
- Customer Lifetime Value (CLV) vs. Cost per Acquisition (CAC): A healthy balance between CLV and CAC is important. CLV should be at least three times higher than CAC, and the months to recover CAC should be less than 12. If CAC is higher than CLV, the company may be spending too much to acquire new customers which could jeopardize its long-term development.
- Average Revenue per User (ARPU): ARPU is the total revenue divided by the total number of users. A rising ARPU is a good indicator of a healthy customer base, less competition, and more opportunities for cross-selling and upselling. Conversely, a declining ARPU could be a sign of poor value proposition, increased competition, or low customer spending power.
- Burn Multiple: The burn multiple measures how much each euro invested in the business translates into an increase in Annual Recurring Revenue (ARR). To calculate the burn multiple, you need to know the cash burn, which is the rate at which the company spends its cash. A burn multiple of less than 1.0 is ideal because it shows that the company is generating more than a euro of new revenue for every euro spent. A high burn multiple, on the other hand, may indicate that the company is burning through cash too quickly without generating enough revenue to justify the investment.
Overall, these KPIs can give investors a better understanding of the health and growth potential of subscription-based businesses. By considering these metrics and conducting thorough due diligence, investors can identify the most promising investment opportunities and make informed investment decisions.
If you want to know more and are interested to invest in a new asset class with revenue-based financing and get the chance to be part of something new and innovative: feel free to contact Levenue’s team (here) or book a quick call with us from this link.