Funding From Data

Thursday, you say? It’s INTRO to Finance time. This is Jason, coming in remotely from the desert in Arizona. Even though I’m doing everything I can to keep cool, we’re going to bring the financial heat in today’s post. The topic today is:

“What are some ways I can get funding without traditional assets?”

Most software businesses these days can start with a laptop and an AWS account. Even if you’re selling physical products online, there are partners and configurations that allow you to go from order to fulfillment without ever touching the goods you’re selling. This can create a huge cost advantage in the near term, but the lack of any real assets, like machinery, real estate, or physical inventory, can often work against you. Lenders have historically looked for security in assets they can sell-off if something goes sideways with your business and negatively impacts your ability to repay.

That was the old world that many banks, and some lenders, are still tied to. But there’s a new world emerging of lending products driven by data instead of dirt. They say data is the new oil, and many lenders are springing up to tap that well and unlock returns others legacy lenders can’t. The data you’re using to drive decisions in your business can be as valuable to lenders as it is to you – if you know where to look and how to frame your numbers. This can sound more complicated than showing someone a piece of real estate, but it’s much easier than you might think, thanks to many tools you’re likely already using.

Financing ROAS

For ecommerce companies, the revenue you’re making from each digital channel is an asset-like opportunity for a financier. By leveraging modern digital marketing solutions, these firms can pull data and run analysis on how much funding is appropriate – without you creating special reports.

A basic way some capital providers evaluate your online customer acquisition performance is by calculating your Return On Ad Spend (ROAS- pronounced RO-az). While ROAS isn’t a perfect metric, it can provide a simple analysis of how many dollars you can expect from each dollar you’re spending on ads. This metric allows the financier to see if there’s enough of a return to support some form of financing.

Here’s the quick calculation: 

ROAS = Revenue / Advertising Costs

For example, if you were in the business of selling socks and wanted to run a campaign to advertise your new INTRO branded socks, you would divide the total revenue generated from the campaign by the total costs to market the product. If you made $10k in sock revenue by spending $2k on Facebook ads, you’d have a ROAS of $5 for every dollar that you spent. Having a ROAS over 3 can be a starting place to talk with ecommerce financiers.

Because your ROAS is a constantly fluctuating number, these ecommerce financiers typically start with a smaller amount of funding, say sub-$10k, to see how the initial dollars perform. If your numbers continue to look good, the financiers will offer you the option to draw down more funding. Rather than waiting for more funding every 12-18 months, these firms will provide more capital every couple of weeks or months. Prove the channel, earn more capacity.

Financing SAAS Sales

Software companies have similar financial products available to them based on the sales efficiencies in the business. Recurring-Revenue Lines of Credit and Revenue-Based Financing firms leverage your SaaS metrics to find comfort that their financing will successfully bring in growth to the business.

Because SaaS companies have an endless supply of sales metrics to monitor, these firms use a combination of data points to assess the health of your sales function. Unlike ecommerce, it takes time to understand if a SaaS customer relationship will be profitable. SaaS businesses with a limited sales history will find it harder to tap into these financing options, because the data may not be extensive enough to understand what future expectations should be. 

Once you have this history, SaaS metrics can be a convincing argument to attract capital into the business. Many of these firms look to the SaaS equivalent of ROAS, the Magic Number for insight into the efficacy of your sales efforts. To accommodate the SaaS business model, we have to convert the revenue numbers to an annualized number to account for the on-going income stream customers pay. Here’s how you calculate the Magic Number:

(New Revenue in Current Quarter) * 4 / Prior Quarter Sales & Marketing Expense

For instance, if you spent $4k on Sales & Marketing in Q1 to bring in $1k of new revenue in Q2, you’d have a Magic Number of 1. This tells us that every dollar we spend today will pay back $1 in the next 12 months. To start having productive conversations with financiers, you’ll want to have a ratio of over 0.5, but ideally over 1.0. The higher the ratio, the stronger the argument you have to justify financing.

Data is an Asset

As you can see, not having tangible assets doesn’t mean you have to resort to personal guarantees or selling equity. Your business can tap into your performance data to find the funding needed to scale. Use this capital towards even stronger revenue generation, and you’ll continually have access to larger funding amounts. 

Taking financing based on your sales efficiencies to fund your sales activities can create a self-funding cycle, allowing you to dedicate your own cash resources elsewhere in the business.

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Have a question on funding options or looking to understand more about finance? Let us know!