Ask @StartupCFO: When should I ask for annual prepayment?

When I am talking with SaaS founders the discussion frequently turns to the pros and cons of asking customers to prepay their subscription annually. Often the decision to do this is driven by a desire to improve conversion rates. I think this is mistaken.

As far as I’m concerned a customer that is willing to prepay for an entire year was going to convert anyway. And in terms of renewals, offering a prepay discount to a renewing customer won’t keep them if they were planning to leave anyway.

So, annual prepayments should not be done to improve conversion and retention rates.

If that’s the case, then when should you offer annual prepayments?

At the very early stages, a successful annual prepayment offer is a great way to test product-market fit. If you have not built the right product for the right customer, they won’t prepay.

At all stages, annual prepayments fill the cash void. With a SaaS business model, you pay to acquire the customer on day 1 and only recover that acquisition cost over time as you collect subscriptions. So, your ability to grow is limited by your ability to fund that cash gap.

When you get paid upfront, there is no cash gap unless your acquisition cost is greater than one year’s subscription revenue. I don’t usually recommend such aggressive customer acquisition spend until a company is in to the growth stage and is presumably well funded and has enough history in its unit economics and acquisition channels to be confident about investing aggressively in growth.

This article was syndicated with permission from Mark MacLeod’s @StartupCFO blog

Mark MacLeod

Mark MacLeod

Since 1999, Mark MacLeod has been helping fund, grow and exit venture-backed startups. Mark has over 14 years experience as a CFO for leading companies such as FreshBooks, Shopify, Tungle and many others. Mark’s deep experience and passion for startups led him to found SurePath Capital Partners in order to guide and advise founders on how to fund, grow and ultimately exit their companies.