Monthly Recurring Revenue (MRR) Line of Credit

What is Monthly Recurring Revenue (MRR) Line of Credit Financing?

An MRR line of credit is a loan facility in which the amount available for borrowing is tied directly to the borrower’s monthly recurring revenue.

Normally, lines of credit are for companies that have accounts receivable and/or inventory that provide a collateral base for the loan. Software-as-a-service (SaaS) companies have minimal accounts receivable because customers pay up front, and no inventory because they sell a service rather than the product. However, SaaS companies have subscription-based business models. The subscription is not always contractual, but subscription revenue tends to be “sticky,” which means it often continues for many months or years. Lenders view this recurring revenue as an asset that, in effect, can provide a collateral base for a loan.

If you have a SaaS company or other subscription-based business with recurring revenue and a low customer churn rate, then you might be able to obtain an MRR line of credit.  At Find Venture Debt, we have a fast, easy process to determine whether you qualify. Contact us to get started.

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How an MRR Line of Credit Works

MRR is one of the most important metrics for SaaS and subscription-based businesses. SaaSOptics defines MRR as the predictable and recurring revenue components of your subscription business. It will typically exclude one-time and variable fees. Calculating MRR can be very complicated but, at a basic level, you simply add up the monthly fee paid by every single customer of your installed base. It is based on monthly amounts even if customers actually pay annually or quarterly. When MRR is annualized, it is called annual recurring revenue (ARR).

 

With an MRR line of credit your business can obtain financing based on revenue instead of your assets or profits, like traditional financing. The credit line has a revolving structure, meaning you can use the funds again and again as you pay down what you owe. However, the maximum borrowing amount of your credit line will vary from month to month based on your company’s revenue.

 

Lenders will determine your maximum loan amount based on a multiple of your trailing MRR, adjusted for your customer retention (or renewal) rate. For example, assume your line is based on a multiple of 3x, your trailing three month MRR is $500,000, and your retention rate is 95%. In this case, your maximum loan amount would be $1.425 million (3 * 500,000 * 0.95). An alternative version of the formula may show the retention rate as (1- 0.05), where 0.05 is the churn rate, a measure of customer attrition or loss.

Use Cases for an MRR Line

An MRR line enables a business to pull forward some of its revenue from future periods in order to invest in growth opportunities. Due its structure, companies can draw down capital as needed, rather than all-at-once or for a single event. The most common use of proceeds is to support sales, marketing and product development efforts that are expected to have a fast, relatively predictable payoff.

 

MRR financing is not appropriate for growth opportunities that require a multi-year investment period or have an uncertain payoff. An example is research and development related to a new, unproven product. Long-term investments are better matched with long-term capital, such as equity or certain types of term debt.

 

Although an MRR line could be used to fund an acquisition, the buyer would have to be much larger than the seller and borrow against its own revenue. The primary reason is that the advance rate is only 3x to 6x monthly revenue (or 0.25x to 0.50x annual revenue) and software companies often sell for more than 3x annual revenue.

 

Lenders prefer to see their loans used as growth capital. Therefore, lines of credit are generally not used for management buyouts, shareholder buyouts, recapitalizations, or refinancing.

What do Lenders Look for in Potential Borrowers?

MRR lines of credit are for companies with recurring revenue business models. Typically, these businesses are ready to scale and need $1 million or more of capital. Some lenders focus exclusively on software-as-a-service businesses. However, some lenders will consider non-SaaS companies with subscription-based revenue models or other types of “sticky” revenue (e.g. certain B2B services) as long as they have high renewal rates and strong gross margins. Good examples include Content-as-a-Service (CaaS) companies such as media or data providers, and membership organizations.

 

B2C e-commerce companies that offer subscription boxes or auto-ship services are less attractive. Their renewal rates and gross margins are often much lower than SaaS or CaaS companies.

MRR Financing Qualifications

  • Industry: Technology or technology-enabled services.
  • Business model: Should be proven and ready-to-scale in SaaS or other type of subscription-based, membership-based, or “sticky” services.
  • Size: Varies by lender, typically annual recurring revenue (ARR) of at least $3 million. Practically speaking, there is no maximum.
  • Churn rate: Prefer less than 5% annually, but can be as high as 15% annually.
  • Growth: Positive historical and projected growth.
  • Profitability: Business does not have to be profitable, but should be at or near break-even.
  • Existing debt: Lenders unlikely to permit other senior obligations, except for equipment financing. Lenders may require limits on total debt.
  • Ownership: Depends on lender, but can be VC-backed, angel-backed, or bootstrapped.

 

MRR financing is one of the lowest-cost sources of growth capital for recurring revenue businesses. If your company qualifies, Find Venture Debt provides a fast, easy process for connecting with lenders. Contact us today to learn more.

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What are the Key Provisions of an MRR Line of Credit Term Sheet?

MRR loan terms depend on the risk profile of your company and the preferences of each lender. As with other types of venture debt, banks tend to offer lower interest rates but more restrictive terms than non-bank lenders.

  • Structure: Senior debt.
  • Amount of loan: Depends on the borrower’s size, profit margins, existing financial leverage, and other factors. The minimum is typically $1,000,000. The maximum is 3 - 7x your current MRR (avg of last 3 months).
  • Term: Usually 1 to 3 years.
  • Amortization: No periodic amortization unless revenue declines, and the loan balance exceeds a specified multiple of MRR. Principal is due at final maturity but can be reborrowed if company is in compliance with loan agreement.
  • Interest rate: Bank rates range from Prime to Prime+5%. Non-bank rates are typically 12% to 14% annually.
  • Fees: Lender will charge a commitment fee and often an unused line fee.
  • Equity participation: The lender will usually require warrants or other equity participation. Warrants enable your lender to buy stock in your company at a fixed price up to a certain date. If your business does well the lender will likely exercise its right to buy the stock at the price that was set at funding. The increase in value provides additional income to the lender. The ownership percentage will vary depending on the lender’s required rate of return, the borrower’s expected growth, and other factors.
  • Collateral requirements: Varies, usually first priority lien on all business assets and a negative pledge on IP.
  • Restrictive covenants: Financial covenants typically focus on customer retention or churn rates, revenue growth, gross margins, and liquidity. Banks tend to have the strictest covenants, especially with regard to material adverse change (MAC) clauses. However, all lenders will likely require affirmative covenants and negative covenants. Affirmative covenants require the borrower to take certain actions such as paying required taxes, maintaining financial records, maintaining adequate insurance, etc. Negative covenants limit actions that the borrower can take without the lender’s permission such as borrowing additional money, paying dividends to shareholders, selling significant assets, or other actions that may affect the ability to repay the loan.
  • Governance: Most lenders do not require board seats or other direct involvement in governance.
  • Personal guarantee: Not usually required.
  • Access and audit rights: A normal requirement is access to financial statements and bank account data to monitor the borrower’s financial performance and verify compliance with loan agreement.

If your company has multiple lenders, an intercreditor agreement is usually required. This is an agreement between the senior and subordinated lenders, which specifies how their relative rights and obligations are enforced in a distress or bankruptcy situation.

 

Unfortunately, lenders often write term sheets in an overly technical manner. This can make it difficult to understand the key business terms and even more difficult to compare term sheets from multiple lenders. At Find Venture Debt, we have extensive experience reviewing term sheets. Let us know if we can help you.

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Before making a decision on which financing is right for you, we recommend considering the following pros and cons of MRR financing.

The Pros and Cons of an MRR Line of Credit

An MRR line is a low-cost source of growth capital for recurring revenue businesses with ARR of$3 million or more. It can be a great alternative to raising equity, or provide a bridge to your next equity financing.

Of course, no type of financing comes without drawbacks. Unlike equity, debt requires periodic interest payments and the principal must be repaid upon maturity.

 

The pros (advantages) of an MRR line include:

  • Access to more capital than traditional bank line: MRR financing provides access to more capital than a traditional bank line of credit based on accounts receivable and inventory.
  • Access to capital when you need it: Since MRR financing is structured as a line of credit, you can draw down capital as needed, rather than all-at-once. This reduces your interest expense since you do not borrow funds until you need them. The principal can be repaid at any time, and then reborrowed when you need it. This revolving structure provides quick access to capital to take advantage of growth opportunities as they arise.
  • Borrowing limit grows with your company: As your monthly recurring revenue grows, your credit limit will increase, enabling you to fund your company’s growth.
  • Low cost capital: The all-in cost of an MRR line is lower than most other debt alternatives, and is substantially lower than raising equity.
  • No loss of control: Generally, lenders do not require board seats and will allow you to operate your business as you see fit, assuming you are in compliance with the loan agreement.

The cons (disadvantages) of an MRR line include:

  • Requires recurring revenue business model: If your business in not based on a recurring revenue model, then this is not a financing option for you. Instead, you will need to consider other types of venture debt financing.
  • Requires annual revenue of at least $3 million: If your company has annual revenue below $3 million, you will need to consider other types ofdebt financing.
  • Requires low churn rate: In order to qualify your company will need a low annual churn rate, preferably around 5% or less but no more than 15%. This might be difficult during a growth phase if you’re still refining your product-market fit and testing what works.
  • Usually requires equity participation: Most lenders offering an MRR line of credit will require warrants to purchase equity in your business. This means that similar to VC funding, you could be giving up some ownership in order to grow your company. However, it will be substantially less dilutive than VC funding.

Where to Get an MRR Line of Credit

Generally, there are two types of lenders that will offer an MRR line of credit to your business: venture banks such as Silicon Valley Bank and non-bank lenders that focus on the technology industry. Tech banks will likely offer lower interest rates and total costs than a non-bank lender, but they will typically only lend up to 3x MRR. Banks also have a strong preference for borrowers that are backed by a venture capital firm.

 

Non-bank lenders are almost always more expensive in a couple of ways. First, their interest rates are going to be higher than a bank since they do not have access to low cost deposits. Second, they will also require more warrants than venture banks. The trade-off is that non-bank lenders do not require borrowers to be VC-backed, they are willing to lend up to 7x MRR, and their covenants are less restrictive.

How Do I Start the Process to Obtain an MRR Line?

To obtain debt financing, you need the right partner. Find Venture Debt can help you determine whether your company qualifies. If it does, we’ll identify the type of venture debt that best fits your company and provide access to our extensive network of bank and non-bank lenders that have the capital you need to grow your business.

 

We help you through the entire process. All you have to do to get started is fill out our simple online form.

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MRR Line of Credit Frequently Asked Questions(FAQs)

Below we’ve answered the most commonly asked questions pertaining to MRR financing. If you don’t see your question here then please reach out to us by filling out some basic information and we’ll get back to you with the right answer!

How does an MRR line of credit compare to a traditional bank loan?

Banks are subject to significant regulatory constraints. Therefore, bank loans are normally dependent on the borrower’s assets or cash flow. As a result, most banks do not lend to growth-stage SaaS companies and similar businesses. However, venture banks view recurring revenue as an asset that, in effect, can provide a collateral base for a loan. Therefore, the venture banks are willing to provide MRR financing even if the borrower does not meet the traditional standards for obtaining a bank loan.

How does monthly recurring revenue (MRR) financing differ from revenue-based financing (RBF)?

While MRR financing and revenue-based financing have similar names, the actual facilities are quite different. MRR-based loans are lines of credit in which the amount available for borrowing is based on monthly revenue. RBF is a loan in which repayment is based on monthly revenue.

 

MRR loans are primarily for SaaS and similar businesses with at least $3 million in annual revenue. RBF is less narrow in scope and is available for smaller companies. MRR will generally allow you to qualify for much more funding (6-7x MRR) and does not require monthly amortization, but lenders usually require warrants. RBF is non-dilutive (no warrants) but has a higher effective interest rate.

MRR financing is a line of credit that offers more flexibility in draw downs, and repayments can be borrowed again and again as you grow your business. Revenue-based financing (RBF) is generally structured as a one-time loan; you’ll need to reapply for future funding events.

The table below summarizes some of the key differences. The best choice for your company will depend on your specific situation.

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