ARR financing – a flexible funding solution for growing companies
As more companies build their business models on recurring revenue (Annual Recurring Revenue, ARR), ARR financing has emerged as an attractive alternative to traditional bank loans and venture capital. But what exactly is ARR financing, and when might it be a suitable choice?
What is ARR Financing?
ARR financing is a form of debt financing that is based on a company’s recurring revenue rather than traditional assets, EBITDA or cash flows. For companies with stable and predictable subscription revenue streams, particularly in the SaaS sector, this can be an appealing alternative that provides faster access to capital without requiring the company to give up ownership.
How Does ARR Financing Work?
Lenders offering ARR financing assess a company’s recurring revenue streams expected to be ongoing based on a contract or a subscription and use this as the basis for determining the loan amount and conditions. Key factors typically considered include:
- The level and stability of the company’s ARR
- Customer churn rate and customer retention
- Contract length and renewal rates
- Growth rate and market potential
These parameters provide the lender with an understanding of the company’s future recurring revenue and its ability to service interest payments and amortisation.
Documentation, ARR Multiples and Transition to EBITDA-based Metrics
ARR financing documentation, especially in larger-scale deals, typically mirrors traditional EBITDA-based leveraged loan agreements. This similarity stems from the need for a clear structure and set terms around debt repayment, leverage tests, and covenants. However, the key distinction is that in ARR financing, the focus initially lies on the recurring revenue stream from contracts or subscriptions, with metrics related to ARR being the primary performance indicator for assessing financial health and risk.
SaaS companies in their growth phase often have low or negative EBITDA as they reinvest cash flow into customer acquisition. Thus, ARR is used to calculate borrowing capacity. An ARR covenant may include a minimum cash liquidity requirement, ensuring sufficient funds. ARR financing agreements often allow lenders to switch from ARR to EBITDA metrics after a certain period or profitability milestone.
This transition typically occurs when the company reaches a more mature phase where profitability stabilises, and cash flow becomes a more relevant indicator of the company’s ability to manage debt. For the company, this shift may present an opportunity to improve loan terms, particularly if EBITDA levels at this stage support increased borrowing capacity or improved interest conditions.
In ARR financing, terms like regular amortisations before maturity and provisions for excess cash are generally excluded. Most lenders do not require them before transitioning to EBITDA-based metrics. Pre-maturity amortisations can pressure cash flow in high-growth businesses better served by reinvestment. Avoiding excess cash provisions helps companies use surplus funds for growth. This flexibility supports cash flow needed to scale, especially in subscription models where customer acquisition and retention are vital.
Typical Loan Volume
- Loan amounts vary depending on the company’s size, growth phase, and ARR stability. Generally, loan volumes range between 2–5x ARR.
- For companies with highly stable revenue streams and low churn, the multiple can sometimes reach 6–8x ARR, though this is more common for larger, established SaaS companies.
- In practice, this means that a company with SEK 50 million in ARR could expect a loan volume of approximately SEK 100–250 million.
Typical Pricing (Interest Rates and Fees)
- Interest Rates: ARR financing is typically priced as a premium product compared to traditional bank loans. Rates can vary depending on risk level and market conditions but generally fall within the following ranges:
- 5–10% annual interest for stable and well-established companies.
- Up to 20%+ for smaller, less established, or higher-risk companies.
- Arrangement Fees: Many lenders charge an arrangement fee of 1–3% of the loan amount.
- Exit/Prepayment Fees: Some agreements also include fees for early repayment.
Key Factors Influencing Multiples
- Growth Rate: Companies with high ARR growth can often secure higher multiples.
- Customer Churn: A low churn rate (below 5–7%) reassures lenders about the stability of future cash flows.
- Contract Length: Long and binding agreements can improve the potential for securing a higher financing volume.
- Industry and Competition: Lenders often favour SaaS companies with a strong market position and limited competition.
When is a Higher Multiple Reasonable?
A multiple of 4–5x ARR or higher is most common for:
- Companies with high scalability and strong gross margins.
- Companies that can demonstrate a steady stream of recurring revenue with low churn.
- Businesses with strong customer contracts and high renewal rates.
Structured Financing Solutions in ARR Financing
ARR financing can be structured in various ways to optimise capital access and risk management:
- Tranche-Based Financing: Capital is disbursed in stages, linked to the company achieving certain milestones or ARR levels. This minimises risk for both lender and borrower.
- Working Capital Facilities Tied to ARR: Some lenders offer flexible credit facilities that adjust dynamically based on the company’s ARR growth.
- Combination with Equity Components: In some cases, ARR financing is combined with warrant structures or other instruments to provide additional flexibility and reduce interest costs.
Risk Management in ARR Financing
To minimise risks, companies using ARR financing should take the following measures:
- Careful Cash Flow Planning: Ensure that loan costs and amortisation can be covered by the company’s expected revenues.
- Diversified Customer Base: Companies with revenue concentrated among a few large clients risk unstable cash flows if a major customer is lost.
- Proactive Reporting: Keeping the lender informed about key metrics and ARR developments reduces the risk of misunderstandings and builds confidence in the relationship.
Comparison: ARR Financing vs Traditional Bank Loans
| Aspect | ARR Financing | Traditional Bank Loans |
| Speed of Access | Typically faster due to focus on ARR | Often slower with extensive due diligence |
| Collateral Requirement | Based on ARR rather than tangible assets | Requires significant collateral |
| Loan Amount | Higher multiples possible (2–5x ARR) | Typically lower multiples based on EBITDA |
| Interest Rates | Higher (5–20%+) | Lower (typically 3–7%) |
| Flexibility | More flexible, scalable with growth | More rigid with fixed conditions |
| Reporting Requirements | Frequent reporting on ARR and key metrics | Standard financial reporting |
When is ARR Financing a Good Alternative?
ARR financing is particularly suitable for companies that have:
- A predictable and stable revenue stream from subscriptions or long-term contracts, making it easier to forecast future cash flows.
- High-growth businesses in the technology or SaaS (Software as a Service) sectors, where traditional forms of financing may be less accessible due to a lack of immediate profitability or tangible assets.
- A need for quick access to capital for growth or expansion.
- A limited desire to give up ownership to external investors.
Final Thoughts
ARR financing can be a powerful tool for growth-stage companies that build their business on recurring revenue. By ensuring that the financing solution is tailored to the company’s business model and risk profile, businesses can maximise the benefits and minimise the risks.
At RE:FI STHLM, we have extensive experience advising companies and investors on various types of financing solutions, including ARR financing. Please feel free to contact us if you would like to learn more about how this financing model can support your company.
