What Is Revenue Based Financing?
Revenue Based Financing, also known as royalty-based financing, is a method of raising capital for a business from investors who receive a percentage of the enterprise’s ongoing gross revenues in exchange for the money they invested.
In a revenue-based financing investment, investors receive a regular share of the businesses income until a predetermined amount has been paid. Typically, this predetermined amount is a multiple of the principal investment and usually ranges between three to five times the original amount invested.
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How does Revenue Based Financing work?
Revenue Based Financing works in three easy steps:
1. Sign up with an RBF provider
First, you’ll sign up with a revenue based finance provider and connect your business’s financial accounts (think Xero, Stripe, etc). This allows the provider to see your business’s financial history and decide whether you’re eligible.
If your forecasted revenue is high enough, you’ll be approved for an advance. Usually you’ll be given a mix of offers with varied repayment terms.
2. Choose an offer
As part of the offer, the provider charges a flat fee and agrees to a monthly revenue-share. Here’s is an example of what that could look like:
Funding amount: $90,000
Monthly revenue-share: %6
Avg. Monthly revenue: $500,000
Approx. repayment term: 3 months
3. Repay the advance
Repayments are made as a percentage of monthly revenue, which fluctuates regularly. If a company takes more, it’ll repay the loan more quickly.
Meanwhile, slow months will slow down your repayment so you never pay back more than you can afford.
Why Should I Take Revenue Based Financing?
The revenue-based financing model is a pioneering asset class in India that took off during the pandemic as start-ups struggled drastically to raise funds. Revenue-based financing is a hybrid capital instrument that combines the best of both equity- and debt-based financing options.
When opting for a revenue-based financing model, borrowers must remember a few things, including-
- RBF is a debt offered to start-ups and SMEs but is not as structured as a loan.
- In this, investors get a fixed share of the business’ revenues on a monthly basis. This signifies that if a company earns higher income a month, the investor simultaneously gets back a greater share. This repayment is inclusive of the principal and returns decided upon during the investment time.
- To access revenue-based financing, a company does not have to dilute equity to meet working capital requirements.
- There is no need to pledge collateral as securities for revenue-based financing, making it a less risky proposition for borrowers.
- For businesses that can carefully assess and predict their revenue flow, revenue-based financing is highly attractive. Though a start-up may not be absolutely profitable, they do have a regular stream of income.
- With RBF, entrepreneurs can raise funds anywhere between Rs 5 lakh and Rs 15 crore. Borrowers will have to repay the debt with a profit share ranging between 2% and 15% instead of paying EMIs or equity dilution.
- RBF usually comes with a repayment tenure of up to 12 months. Companies can repay the borrowed sum + revenue share within this period or earlier, depending on their revenue scale.
Thus far, growth capital has been an exclusive concept in India because of the extensive cost and time required. Revenue-based financing mitigates these issues to provide fledgling businesses, especially SaaS-based and D2C, with a quicker and easier means to fund their investments. Companies can opt for a revenue-based financing solution from KredX, which offers to finance against nominal, 100% digitised documentation, and within just a few working days.
Benefits of Revenue Based Financing
RBF offers several benefits for businesses seeking funding –
No dilution of equity
Unlike traditional financing methods, RBF does not require business owners to give up ownership stakes in their company. This means that entrepreneurs can secure capital without relinquishing control or sacrificing future potential.
Flexible repayment structure
RBF payments are directly tied to a business’s revenue. During slow periods, the payments adjust accordingly, alleviating the pressure of fixed monthly payments that can strain cash flow. This flexibility allows businesses to manage their finances more effectively.
Fast and accessible funding
Revenue based financing can be obtained relatively quickly compared to traditional loans, which often involve lengthy application processes. This speed can be crucial for businesses in need of immediate capital to seize growth opportunities or overcome financial challenges.
Support for growth initiatives
RBF investors often provide additional value beyond capital. They may offer strategic advice, industry connections, and expertise to help businesses grow and succeed.
RBF vs. Traditional Financing
While revenue based financing offers unique advantages, it’s important to understand how it compares to traditional financing methods –
Equity financing
RBF allows businesses to raise capital without giving up ownership. In contrast, equity financing involves selling shares of the company, which dilutes the founder’s ownership stake.
Debt financing
Unlike traditional loans, RBF does not require fixed monthly payments or collateral. Instead, repayments are directly tied to revenue, providing more flexibility during lean periods.
Venture capital
RBF is an alternative to venture capital funding, offering a less risky and more accessible option for businesses that don’t fit the typical venture capital profile.
Revenue-based Financing vs. Debt and Equity-based Financing
Revenue-based financing seems similar to debt financing because investors are entitled to regular repayments of their initially invested capital. However, revenue-based funding does not involve interest payments. Instead, the repayments are calculated using a particular multiple that results in returns that are higher than the initial investment. Also, in revenue-based financing, a company is not required to provide collateral to investors.
Unlike equity-based investment models, there is no transfer of an ownership stake in a company to investors. However, it is common that some equity warrants may be issued to investors. Finally, in such an investment model, a company is not required to provide investors with seats on the board of directors.
The Types of Revenue Based Finance
There are two common types of Revenue Based Financing agreements:
Variable collection
Variable collection is the most popular type of revenue based funding. Businesses take out a loan for a certain amount and repay it each month based on their gross profits.
Flat fee
Flat fee funding looks a little different to the variable collection model. With this funding, you commit to paying a fixed percentage of your future revenues every month for up to five years – usually at a rate of 1-3%.
Monthly repayments tend to be much lower than those in the variable collection model making it a good option for some early stage companies, but if you grow and scale quickly, you’ll end up paying far more over the term of the loan.
How much Revenue Based Financing can you secure?
Finance providers will look at your recurring revenue to determine how much they’re willing to lend you.
Most set maximum loan amounts up to a third of the company’s annual recurring revenue (ARR) or four to seven times their monthly recurring revenue (MRR). At Uncapped, we loan between $10k – $5m.
Repayment fees are usually between 6-12% of revenue, based on whether you plan to invest the funds in predictable revenue-generating activities like advertising or higher-risk activities like hiring.
Revenue-Based Financing and Revenue Bonds
Although separate forms of financing and different in their technical details, revenue-based financing is similar to the cash flow structures common to revenue bonds. Instead of using general obligation (GO) bonds, many municipal projects will issue revenue bonds to finance specific projects, such as infrastructure. A toll-road would be a good example. These projects retire debt obligations with secured income generated by the project or asset. Hence the name revenue bond.
Revenue Based Financing vs Other Options
Understanding the difference between debt, equity financing, and revenue based finance is the key to choosing the right funding option.
Debt financing
Debt funding models (like loans) require businesses to pay back a fixed amount with interest over an agreed period of time. Unlike revenue based financing, the repayments are for a set amount each month and must be met in full.
For loans, startups are often required to provide a personal guarantee in case they can’t meet the repayment terms. There are other debt models, like venture debt, with more complex terms for repayment and in case of default on payment.
While debt financing can be a useful way to secure a large cash injection, it can also be high risk if your turnover isn’t consistent or if you’re selling in a fluctuating market.
Revenue based financing does not require a personal guarantee, years’ of financial statements, or a long lead time, so it’s an increasingly popular choice for business owners.
Equity financing
Equity financing requires startups to hand over a portion of their ownership to lenders in exchange for growth capital. There’s a lower risk involved with this financing model, but founders and directors dilute their ownership with this approach.
Depending on how equity is structured, you may lose influence over major decisions. Either way, you’ll lose access to at least a portion of your future profits.
That’s in contrast to revenue based financing, which does not require founders to give up equity in their business. For this reason, equity finance isn’t an appealing option for founders looking to drive predictable revenue (through Facebook ads, for example).
Advantages of Revenue Based Financing
We’ve already covered a lot of the benefits of using revenue based financing for raising capital compared to debt and equity financing, but here’s a full round-up of its advantages.
Non-dilutive
Founders and directors keep full control over the company. That’s crucial for startups who have the potential for rapid growth but need a cash injection to help get them there.
No personal guarantee needed
Founders and directors don’t need to put forward personal collateral against the loan, making it a less risky option than traditional debt financing.
Loan repayments are flexible
Repayments are based on the performance of your business. If you do well, you pay more. If you don’t do well, you pay less.
That means if you’re an ecommerce business you don’t need to worry about a post-holiday sales slump and if you’re a service-based business you’re in better shape to weather lockdowns or whatever else the pandemic throws at you.
Fast-growing companies settle quicker
Companies that grow quicker than expected make repayments quicker too, so they end up giving up less revenue overall.
Cheaper than equity
Repayments aren’t usually as high as interest so it’s often a far cheaper option than securing your initial investment from angel investors or Venture Capital firms.
Fast funding
Startups can secure revenue based financing within 24 hours. Meanwhile raising VC funding takes months…
Works well with other funding sources
Revenue based financing helps early-stage startups build traction, which makes other forms of funding more accessible, and less costly.
Disadvantages of Revenue Based Financing
Although revenue based financing has a lot to offer, it doesn’t suit every business. There are a couple of things to consider before partnering with a revenue based financing provider.
Revenue required
Lenders will actively look at your business’s ability to generate revenue. If you’re pre-revenue, you might not be able to secure the funds you were hoping for. If your financial history is inconsistent, you may have the same issue.
Smaller loan amounts
Lenders generally cap loans based on your business’s MRR. If you’re a relatively small company, that probably means you’re only eligible for a loan that’s much smaller than what you might raise with angel investment. But as your company’s MRR grows you can often secure follow-on rounds from revenue based finance investors.
Doesn’t suit long repayment periods
Founders looking for repayment periods of more than a year might be better off with a standard bank loan than revenue based finance.
Revenue based finance is great for funding short-term initiatives that drive revenue that can be used to repay the advance. However, when these repayments drag out for longer than a year, for example, a fixed term bank loan becomes more economical.
Who can Benefit from Revenue Based Finance?
Many types of business benefit from revenue based financing, but there are a few industries that have the most to benefit.
Ecommerce businesses
Businesses that sell products online are well-suited to revenue based finance, because this funding type allows them to quickly invest in marketing or inventory to meet demand.
Because these businesses sell online, it’s easy for lenders to forecast their performance based on data from their business accounting and marketing accounts.
Companies with seasonal performance
Startups that do better at certain times of the year (such as ecommerce brands at Black Friday) benefit from the performance-based nature of revenue based financing.
They’ll be able to stock up on inventory and shore up ad spend for the peak season, then quickly pay off their loan with the revenue they make.
SaaS and subscription businesses
Revenue based repayments are dependent on MRR, so companies that have predictable and consistent monthly revenue are more likely to reap the rewards of this type of funding.
For example, SaaS and subscription businesses receive monthly payments, so have a clear idea of how much revenue to expect each month. This predictability, paired with low overheads, puts them in a better position to make monthly repayments.
Is Revenue Based Financing right for you?
Revenue based financing is the perfect funding option if you don’t want to dilute equity or spend time raising capital to invest in initiatives that are very likely to drive revenue.
The ability to make repayments based on your monthly revenue means you can keep growing without worrying about whether you’ll meet the cost of a fixed loan.
So whether or not you plan to use other funding sources, any business owner looking to retain equity and grow quickly can benefit from using revenue based financing as part of their funding strategy.
FAQ on Revenue-Based Financing
1. What is Revenue-Based Financing (RBF)? Revenue-Based Financing (RBF) is a method of raising capital where investors provide funding to a business in exchange for a percentage of the business’s future gross revenues until a predetermined amount, typically a multiple of the initial investment, has been repaid.
2. How does RBF work? RBF involves three main steps:
- Signing up with an RBF provider and connecting business financial accounts for evaluation.
- Choosing an offer with specific repayment terms.
- Repaying the advance through a percentage of monthly revenue until the agreed amount is fully paid.
3. What are the benefits of RBF?
- No equity dilution: Owners retain full control of their company.
- Flexible repayment structure: Payments are tied to revenue, adjusting with business performance.
- Fast and accessible funding: RBF can be obtained quickly compared to traditional loans.
- Additional support: RBF investors often provide strategic advice and industry connections.
4. What are the disadvantages of RBF?
- Requires consistent revenue: Pre-revenue or inconsistent revenue businesses may struggle to secure RBF.
- Smaller loan amounts: Loan amounts are often capped based on monthly recurring revenue.
- Unsuitable for long-term repayment: Better suited for short-term initiatives rather than long-term investments.
5. Who can benefit the most from RBF?
- Ecommerce businesses needing quick inventory or marketing funding.
- Seasonal businesses that perform better during certain times of the year.
- SaaS and subscription businesses with predictable monthly revenue.
Conclusion
Revenue-Based Financing (RBF) offers a flexible, non-dilutive alternative to traditional financing options for businesses with predictable revenue streams. By tying repayments to revenue, RBF provides a safety net during slow periods and accelerates repayment during prosperous times.
This funding method is especially beneficial for fast-growing companies, ecommerce businesses, and those with seasonal or subscription-based revenue. However, it may not be suitable for businesses without consistent revenue or those needing long-term repayment periods. Overall, RBF can be a strategic addition to a business’s funding strategy, helping to drive growth without sacrificing equity or facing the rigidity of traditional debt financing.