3 min read

Bruce Stuart: How much capital is required for cloud computing

Cloud

We encourage you to do your own financial modeling of your recurring revenue driven cloud or SaaS venture.  The 30-DAY RISK FREE PILOT offer of LivePlan brought to you by Channelcorp and CDN is provided to help you do just that. https://app.liveplan.com/promo?pm=CDN30_ANNUAL.

The modeling shows that a successful entry-level business will likely need unencumbered investment capital in the range of $100,000 to $200,000 per dedicated fulltime equivalent.  The required amount of capital will peak approximately eight quarters (two years) after you start your investment cycle.

How long is it at risk

Some business models we have seen indicate that the investment in the business will be at risk for up to twelve quarters.  This is often when the partner or reseller holds the hosting assets.  The financial models and experiential evidence suggests that with proper execution the total amount invested in the business could be paid back in three years or less.  We also note that by quarter fourteen or fifteen the total amount originally invested will be equal to the positive cash flow balance…and the positive cash flow continues to expand from there.

What is the return on invested capital?

Return on invested capital (ROIC) is a measure of how well companies are investing their money.  When the return on invested capital exceeds the cost of the capital to the business, then the business is increasing the value of their business as a result of the investments that they are making.

ROIC equals   EBIT x (1-tax rate)

                     ——————————–

                     (Current assets-current liabilities) + fixed assets

Your modeling will show you that the first two years of the cloud or SaaS investment do not show a positive ROIC because the expenses lead, and exceed the revenues.  However by the third year of the investment, your modeling will show profitability begins to emerge as revenue streams begin to overtake expense streams.

Due to the nature of the cloud/SaaS business there are very few fixed assets in the equation, current liabilities are equal to normal trade payables and current assets are mostly made up of cash (excess cash levels are generally removed for the ROIC equation) and accounts receivable.  Your financial modeling calculations will indicate that by year three the ROIC on the investment is approximately 25 per cent.  In subsequent years your models will show this rate continues to rise up over 100 per cent, driven by rapid increases in EBIT that exceed increases in invested capital.  Obviously results from various businesses will differ but certainly the modeling and experience to date should get you and your team interested enough in recurring revenue driven cloud and SaaS business to contact your chosen vendors and distributors for an in-depth discussion about the business.

Contemplation points

What would Channelcorp like you to be thinking about as a result of reading what you just read?

Firstly there is no need to guess as to what the cash flow and working capital impacts of investing in the recurring revenue business might be.  Palo Alto Software has invested extensively in LivePlan, a financial modeling tool to help you and your team build a quantitative and financial picture of your cloud or SaaS business.  It is obviously in everyone’s best interest to know the financial “truth”.

Secondly we are confident that in order to realistically be an investor in a cloud or SaaS business your organization will require $100,000 to $200,000 per dedicated employee of investable capital that you can afford to have invested for up to twelve quarters.   What does this mean?  If you have 10 per cent or more of last year’s revenue in cash or near cash (investable funds) then you need to be a business with at least 1-2 million dollars of revenue in 2013 per dedicated cloud, SaaS or MPS employee, or have access to “outside” debt or equity capital.

Finally, if you have the capital to invest, and the organization that can execute the required business model in the required manner then your investment in a cloud or SaaS business may have a strong positive impact on the long-term value of your business.  Once again, your financial modeling is key. https://app.liveplan.com/promo?pm=CDN30_ANNUAL.

 

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About Channelcorp

Margaret and Bruce Stuart founded Channelcorp in 1989.  The firm is a global leader in the assistance of reseller, distributor and vendor clients. Channelcorp specializes in the business model transformation that is required in the face of the structural changes to recurring revenue driven business models in the worldwide IT business (www.channelcorp.com/services.php).  Channelcorp publishes and sells four industry- leading books and 12 white papers (www.channelcorp.com/publications.php).