IT services funding: recurring contracts, hiring ahead and hardware you front

IT services firms and managed service providers have two incomes: recurring monthly contracts, which are steady, and project work, which is lumpy. The cash pinches come from hiring before the revenue arrives and from buying hardware or licenses on a client's behalf. Most IT firms are better served by revolving money than by anything fast and expensive.

The cash-flow shape of an IT firm

• Recurring revenue. Managed services, support agreements and hosted services bill monthly. This is the part funders like: predictable and visible.
• Project billing. Migrations, deployments and builds are often billed on milestones, with the final payment held until sign-off.
• People first. Engineers are the main cost. You usually hire before the new contract's first invoice, and a good hire takes time to find and onboard.
• Pass-through hardware and licenses. Many firms buy servers, laptops, firewalls and software subscriptions for clients and invoice them. That's a short-term loan you're making to the client.
• Low physical assets. Apart from your own kit, there's little for a funder to secure against. Cash flow does the work.

Which funding fits, and which doesn't

SBA 7(a) loans can be used for working capital, refinancing and changes of ownership, through a participating lender. For an acquisition of another firm's contracts, that's worth pricing alongside a conventional term loan.

Revenue-based financing (repaid as a share of revenue until a fixed total is paid) suits firms growing recurring revenue quickly, but with a fixed total, paying back faster raises the effective rate. A merchant cash advance rarely fits: little card income, and a price built for riskier businesses.

What it costs: a worked example

Say you borrow $100,000 to hire two engineers ahead of a signed managed-services contract, as a term loan at 18% APR over 24 months, paid monthly.

• The payment is $4,992.41 a month.
• You repay $119,817.84 in total.
• The interest is $19,817.84.

The test is whether the new contract's monthly gross margin comfortably covers $4,992.41 once it's fully billing. Now compare $100,000 as revenue-based money at a 1.20 factor repaid over 12 months, daily: $120,000 back, about 37.5% APR. Repaid over 6 months instead, the same factor is about 75%. The borrowing calculator on this page shows what your deposits can support.

In California, commercial financing providers must disclose the total cost as an annualized rate when they make you a specific offer.

Sterling's take: hire on signed contracts, not on a pipeline spreadsheet.

What funders typically ask an IT firm for

• Business bank statements for recent months.
• A list of recurring contracts with monthly values, start dates and terms.
• An accounts receivable aging report.
• Profit-and-loss statements and tax returns for larger amounts.
• Client concentration: what share of revenue your top few clients represent.
• A schedule of existing loans and advances.

Our funding partner's programs suit IT firms trading 12 months or more with about $80K a month in deposits, an owner credit score of 600+ and no more than two loans or advances running.

Red flags specific to IT services

1. Borrowing against unsigned pipeline. Hiring ahead of a deal that slips leaves you paying salaries and a loan with no new revenue.
2. Fronting hardware for slow payers. If a client takes weeks to pay for kit you bought, you're their lender. Ask for deposits on large hardware orders, or bill on delivery.
3. One client, most of the revenue. If your biggest client leaves, can you still make the payment? Funders ask that question; ask it first.

Before you sign

List your recurring contracts by renewal date. Make sure the loan's term doesn't outlast the contracts that are paying for it, unless you're confident they'll renew.