If you’re new to the world of business, you may have come across the term revenue-based financing (RBF). This type of financing is sometimes preferred by startups because it helps them raise non-dilutive capital.
But how do revenue-based financing firms work, and what are the pros and cons of this financing method?
In this article, we’ll provide you with an in-depth introduction about this topic.
What Is Revenue-Based Financing?
Revenue-based financing is a way of getting funds for any business from certain investors. In exchange for the money they’ve invested, the investors will receive a percentage of the company’s ongoing gross revenues.
The investors keep getting a share of the enterprise’s revenues until a predetermined amount of money has been paid. Usually, this predetermined amount is three to five times the original amount that has been invested.
Revenue-based financing (RBF) started as a source of debt financing in the oil, gas, and mineral industries. These days, it’s a popular funding method that you can find in both technology and non-technology fields.
How Revenue-Based Financing Works
There are many ways that RBF can be structured, and they're all based on the agreement between the investors and the business that needs funding. Yet, the most common structure is called a term loan.
Simply enough, the whole amount of invested money isn’t advanced upfront. Instead, the company keeps drawing down from this amount over multiple years when it's needed, which helps lower interest expenses.
As for the payment that the investors receive, it’s based on a fixed percentage of revenue from the prior month or quarter. Therefore, the share itself isn’t fixed, and it’s linked to how well the company is doing each month.
For instance, if the sales are a bit off one month, the investor’s payment will be reduced. But, an increase in sales in another month will lead to a corresponding increase in the investor’s share in that same month.
As you can see, the relationship between the business’s performance and investor’s payment is proportional.
This exchange keeps on going until one of the following scenarios happens:
- A terminal date is reached
- The investor receives a predetermined multiple of the original loan
- The investor achieves a predetermined internal rate of return
After reaching one of these milestones, no more payment will be made to the lender.
Comparing Revenue-Based Financing to Other Funding Methods
In this section, we’ll help you understand how revenue-based financing differs from debt and equity investment.
RBF vs. Traditional Debt
Revenue-based financing may sound a lot like debt, but it only includes a few elements that are similar to bank loans.
What RBF has over traditional debt is that revenue-based financing firms can provide much larger loans to earlier-stage businesses than banks ever will. Plus, banks are usually subject to loads of regulatory constraints, unlike RBF firms.
Still, you need to consider that traditional debt is less expensive than revenue-based financing.
RBF vs. Equity Investment
Unlike equity investment, RBF lets a company’s management keep control of their equity and ownership. In other words, RBF doesn’t allow the lender to have direct ownership of the business.
Therefore, lenders don’t expect to have board seats or any involvement in the operations of the funded company.
The Advantages of Revenue-Based Financing
Now, it’s time to explore the numerous upsides of dealing with a revenue-based financing firm.
RBF is similar to equity financing in that a business receives the funds through investors or firms. However, one of the major downsides of equity financing is that the lender ends up with a share of the company.
This isn’t the case with revenue-based financing, which we’ve pointed out previously. Once you resort to this method, you’ll still have control over your business, leaving all the decisions entirely to you.
Payments Are Linked to Revenue
This is another upside that makes RBF popular. It’s the most flexible method in investor financing because the payment is a fixed percentage of each month’s revenue.
This way, you’ll never have to fear that the monthly payment is more than your monthly income.
No Personal Collateral
Unlike regular bank loans, revenue-based financing may not require a personal guarantee as collateral against the loan.
Therefore, depending on the firm you work with and the nature of your loan, you may have no risk of losing any of your personal assets in the future if you choose to go for RBF.
One of the best things about revenue-based financing is that it’s perfect for startups because it has lenient requirements.
For instance, its approval is based on the company’s monthly recurring revenue, and it doesn’t require a specific personal credit.
Therefore, if you’re ready to kickstart your small business, RBF is a good option to consider.
Revenue-based financing aligns investors' incentives with your incentives because when your monthly revenue is higher, the lender receives a higher monthly payment.
As a result, the investors will likely be genuinely excited to grow your monthly revenue. They’ll give you advice and tips you could benefit from to improve your business and grow your income.
The Disadvantages of Revenue-Based Financing
Like anything in life, revenue-based financing has a few downsides that you’ll need to consider before giving it a shot.
Sure, RBF can be the boost that every startup company hopes to get. However, it won’t be effective when trying to make drastic changes to a business’s income.
This is because the funds secured through revenue-based financing tend to be much lower than funds from equity investment.
Not Suitable for Brand New Companies
Even though revenue-based financing doesn’t have strict rules for approval, it still uses the MRR as an indicator of a company’s eligibility.
Thus, the business must have a history of bringing in relatively steady income every month. This makes RBF unsuitable for businesses that are just starting down their path without having sold any products yet.
The Burden of Monthly Payments
Of course, monthly payments are part of the deal, but that doesn’t mean you can't complain about them. If you wish to go down the RBF path, remember that the monthly gross margin will also be affected.
A New Financing Approach
When compared to other funding methods, revenue-based financing is a relatively new invention. Of course, this isn’t a bad thing, since innovation is the way into the future.
Still, because RBF is fairly new to the world of financing, it still lacks a lot of regulation. So, you’ll have to do plenty of research before settling on a trustworthy revenue-based financing firm.
You don’t want to fall into the hands of scammers and predatory offers.
What Are Some of the Best Revenue-Based Financing Firms on the Market?
Speaking of reputable revenue-based financing firms, here’s a list of the top candidates that you may want to consider.
A lot of people in the business world recommend Corl because it's fast to deal with. You can get approval for your RBF loan in as little as ten minutes.
Plus, this firm is a favorite of E-commerce, SaaS, and other digital businesses. Here are the numbers that you should keep in mind:
- Financing amounts of up to $1,000,000
- Payments of 2% to 10% of your monthly revenue
Decathlon Capital is a reputable RBF firm, and it’s the largest in the US. The reason behind its popularity is that it doesn’t require warrants, governance involvements, etc.
If you like this option, keep in mind the following numbers:
- Decathlon Capital invests out of a $500M fund
- Payments are 1% to 4% of your monthly revenue
Lighter Capital is a revenue-based financing firm that funds tech companies all over the US. You’ll just need to ensure that you’ve averaged at least $15,000 a month in revenue for the past three months, and you’ll be one step closer to approval.
Here are the details that you need to know about:
- Financing amounts of up to $3,000,000
- Payments are 2% to 8% of your monthly revenue
Starting a business is no easy task, but keeping it running smoothly is the bigger challenge. To give you a much-needed boost, you may want to consider using the help of revenue-based financing firms.
Unlike other types of loans, RBF gives you full control over your business. Besides that, it promises quick capital with minimal requirements that you’ll need to fulfill.