The shift involves not only financial engineering know-how, but entails a completely newstrategic approach from all C-level players.Introduction
As we see a continued shift in businesses looking to move from once-off sales to a servitized approach, we often see the primary questions being raised around the topic of funding for such a model. For those with limited or no previous exposure to the servitization business model we use this article to touch on some key points in aiding in the understanding of As-A-Service equity.
Service based sales, as the name suggests, results in revenue generation that is directly related to asset usage and service provision, and therefore is typically billed in a pay-per-use format to the end user. This however, raises the question of how to fund the initial purchase of assets and often requires a significant change in a company's financial and operational management. For many companies, initial asset purchase would require pre-financing from financing bodies, the knowledge and understanding of leasing schemes, as well as a new risk assessment and management plan.
Although it makes the future less uncertain, recurring revenue does not provide an answer to the financial gap created by the subscription business model. The move to the servitization business model must be accompanied by an increase in the company's financial resources.
The shift involves not only financial engineering know-how, but entails a completely new strategic approach from all C-level players.
Capital increase or Debt will not allow you to scale up your offer
One of the most common initial responses of a company in search of cash is to resort to a capital increase. For the SMEs or integrators the capital increase most often takes the form of successive fund-raising which requires the manager to invest a large amount of energy and/or recourse to external advice, which is obviously not free, in order to build up a file that will motivate venture capitalists.
This lengthy process does not guarantee a success that lives up to the entrepreneur's expectations. For example, insufficient fundraising may have the main effect of diluting the manager orinitial founder without providing a long-term financial solution.
Before resorting to venture capital, the entrepreneur must therefore set very precise objectives in terms of the value of their company, without forgetting that the arrival of new shareholders will inevitably generate its share of constraints particularly in terms of profitability, reporting, monitoring, etc.
Another classic solution is debt. Here, a realistic business plan and coherent pricing will be essential for ultimate success, as the repayment amounts will place the company in a situation where commercial results are imperative. It is therefore once again a solution which involves vital risks for the company which would be committed to a debt. Moreover, it is an operation that will require its entrepreneur to make regular sales in order to ensure repayment of the debt.
Finally, in very few cases will the debt be able to keep up with the company's growth and the debt capacity will very quickly be limited.
Financing of the sales cycle or asset based financing is an interesting tool
In order not to be subject to the risk of debt or dilution, another solution exists: asset based financing (assignment of contracts, assignment of receivables etc..)
You can thus mix the three sources of funding and adapt the proportion of each according to your needs and objectives.
The financing of the sales cycle is a new component that can be added to the financial mix. Its financial contribution: converting the future fees from the contract into cash by transferring the asset and the contract rights to a third party.
In order to ensure the success of this solution, certain criteria must be met:
- This is suitable for B2B models only
- You will need to insert a contractual commitment over an irrevocable duration, e.g. by means of adapted and attractive pricing
- You will have to mix fixed fee and variable invoicing
- Sufficient financial strength is needed for your company so as for the financial body to assess positively the performance risk it takes on your company
- Your contractual documentation will need to be adapted to this type of financing
Asset based financing will diversify your sources and reduce the risks of exposure
The move from traditional transaction sales to recurring revenue requires a completely new approach both in terms of financial engineering and strategy. An understanding of the funding options, as well as planning around the key aspects is pivotal to successfully executing such a model change and requires buy-in and adjustment by all C-level team members. For many organisations the specific and essential knowledge to achieve this is simply not readily on-hand, in-house.
To ensure the greatest possibility of success when a primary function skills gap exists, it is always recommended to enlist the resources of external subject matter experts. These individuals/organisations are paramount to providing the necessary information, support and strategic recommendations on the funding aspect of the As-A-Service model.
At Black Winch, our team of Experts hold over 25 years of experience in the leasing and finance sector. Reach out to firstname.lastname@example.org for an inspiration session on how we can help you build your funding capabilities.