Why SaaS companies get it wrong when it comes to payment terms
In all the excitement it is easy to forget how that company intends to pay you
The day you secure that first big corporate deal as a SaaS CEO is phenomenal. You might have been running for a year, growing steadily, and this new deal is now taking you into the big league. Remember that feeling in your gut just before you get the handshake, the smile you’re trying to hold back when you get the agreement, and the little dance you do in your head as you’re walking out of the building?
In all the excitement it is easy to forget how that company intends to pay you. Many of your larger customers will want to structure their own supplier agreement. They will want you to raise purchase orders. They won’t pay you on the same payment terms as other customers, they’ll want to pay you on their own terms.
This is where SaaS companies get it wrong.
Most B2B SaaS companies will charge a monthly or annual subscription and take payment in advance of the system being used. They will then allow their customers to cancel at any point during that period to prevent the subscription payment from being taken at the next billing cycle.
When billing corporates, this all changes. For any larger size invoice, a corporate will want you to raise a purchase order, and bill them manually. They will then pay you on 30, 60, or increasingly 90-day terms.
If a corporation pays you on 90-day terms, they have enjoyed 3 months of service before you get paid. For a growing SaaS company that operates very close to the margin, this can create a serious cash flow issue — especially if corporates represent a significant portion of your revenue.
What many SaaS companies don’t understand is that you’re not just ‘getting the money later’, on 90-day terms your bank account is 3 months of revenue lower — forever. In ignoring payment terms, you not only creating yourself a cashflow problem, but you are also giving your customer a discount. You are loaning your customer cash for 0% interest.
Most SaaS companies understand the value to cash flow and business continuity of being paid annually versus monthly. Dropbox, for example, gives businesses a 20% discount on annual pricing vs monthly. However, no one gets it right when it comes to payment terms.
When I put together a proposal to corporates, I state pricing in the following way:
The price of the service will be £5,000 + VAT per month.
Fees are charged each month in advance. Prices increase by 5% for every 30 days you need in payment terms. Should you pay annually in advance, the price decreases by 20%.
Stating pricing in this manner serves a number of purposes:
- It establishes monthly pricing as the baseline for negotiating. Monthly pricing helps corporates understand the costs as operational expenditure instead of capital expenditure.
- It establishes a penalty for payment terms. 5% is about right. If you needed the cash and needed to use invoice financing, 5% per 30 days is likely to cover the charges and give you a bit of margin for the hassle of doing so.
- It establishes a potential discount if the corporate pay annually in advance. 20% is becoming the new normal as an annual discount.
The maths of this model mean that if corporate has a 90 payment term policy but can pay annually, they still get a 5% discount on the monthly pricing.
If you don’t state a reasonable size price differential for terms, you won’t have a leg to stand on when it comes to negotiation. When you state a price penalty for terms, it gives you an extra card to play. Want it cheaper? Reduce your terms.
We would go one step further than this with pricing pages. Show the effect of terms on pricing by including a payment term calculator on annual pricing options.
If a SaaS company is actively targeting corporate customers, then the conversation around payment terms should be preempted. If you know it’s coming, give yourself a leg to stand on.