As an entrepreneur trying to raise capital, you are probably facing multiple options. Startups indeed have many different instruments to choose from.
Whilst equity and debt have their pros and cons, a number of hybrid solutions exist and might be suitable for your business. Among them, revenue-based financing provides many advantages you should know about, before your make a decision on which funding option you should use. Let’s dive in.
Considering RBF? Make sure to check our ranking of the best 14 revenue-based financing firms for startups.
What is revenue-based financing?
Revenue-based financing is a form of debt instrument whereby investors receive a share of the business’ revenues in exchange for the money invested.
It is different from a standard loan. Indeed, payments are not calculated on an outstanding balance but a function of revenues instead.
In a revenue-based financing agreement, there 3 main parameters:
- The amount of capital invested
- The amount to be reimbursed (usually the capital invested – the principal – plus a flat fee percentage)
- The percentage of revenues which will paid to the lender
After lending the amount of capital to the company, investors receive the agreed share of its revenues until the amount to be reimbursed has been met.
Let’s assume you raise $100k from a RBF provider and agree to repay the principal plus 12% flat fee with a 10% revenue share agreement on a monthly basis. This means that, as soon as you have revenues (unless there is a minimum revenue threshold below which revenue share does not apply), you will need to pay 10% of it to investors.
The total amount to be reimbursed is therefore $112k. If you make $40k sales in month 1, you will need to pay $4k to investors, reducing the total amount to be reimbursed by the same amount. The same logic goes on every month until you have fully repaid the 112k.
Note: revenue-based financing is, in some ways, comparable to working capital financing. For more information about working capital financing and why is it especially useful for ecommerce businesses, read our article here.
Revenue-based financing: Pros
Revenue-based financing is very attractive for many businesses as it shares some of the advantages of equity and debt. These are:
- No equity dilution: most revenue-based financing providers charge a cash fee on top of the principal. As such, RBF isn’t like any equity instrument: there is no dilution.
- Flexible repayments: unlike standard debt instruments which come with fixed payments, RBF is a form of debt whereby repayment is a function of revenues. Repayments depend on the growth of your business. If your revenues are by nature volatile, you will never be in a position whereby you cannot meet your repayment schedule.
- Cost-effective: like any form of debt, and unlike equity, RBF is attractive from a price perspective. Because you do not sell some of your shares to investors, you keep all the upside to yourself.
- Ease of access to funds: typically, obtaining a RBF is a matter of a few days, if not shorter. New companies are using efficient credit scoring solutions so you can obtain funds in your bank account as soon as possible. Equity, in comparison, usually takes several weeks to raise. Indeed, equity investors are taking on more risks vs. debt investors and need to perform due diligence before they can release funds.
Revenue-based financing: Cons
Whilst RBF is an attractive financing option for a number of reasons as we explained above, there are few disadvantages:
- RBF is more expensive than standard debt. Because RBF investors give you the freedom to repay the loan whenever your revenues allow it, they also take a risk. That’s why RBF typically is more expensive than other forms of debt. Still, if you are a startup, good chances are that you will not find a better deal vs. RBF terms. Indeed, most standard debt instruments are not suitable for startups (e.g. bank loans).
- Minimum revenue threshold required. Because repayment is a function of revenues, the higher your revenues the more you can raise. Unfortunately, if you do not have any or limited revenues, most RBF investors will refuse to lend you any capital. For any capital amount investors will typically require to see a minimum level of revenues (existing and future). If you are raising for your startup and do not have any past revenues, good chances are that revenue-based financing isn’t an option for you (yet).
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Should you use it?
RBF is not for any business. As explained above, there are a number of factors to consider when judging whether you should opt for a revenue-based financing. RBF is suitable for any businesses sharing one or multiple of the following characteristics:
- Existing revenues: businesses with no or limited revenues will not be suitable for RBF. Indeed, they cannot show any historical performance to investors for them to judge their level of risk.
- Predictable revenues: whilst your business might have volatile or cyclical revenues, the more predictable they are, the better it is when applying for RBF. Indeed, investors will try and predict your revenues over time as their repayments depend on it. Logically, if you have recurring revenues, for instance, such as SaaS businesses, investors will be more comfortable giving you money knowing you will repay them on time.
- You are not yet profitable. If you are profitable and generate positive free cash flow, you might want to opt for a standard bank loan instead. Indeed, bank loan is cheaper vs. RBF, and banks may be willing to lend you that money. In comparison, revenue-based financing is attractive for businesses with a minimum level of revenues, yet not profitable yet. RBF investors and lenders do not judge on your profitability, but whether you have positive unit economics, sufficient growth and revenues instead.
Revenue-based financing is an attractive form of debt for any high-growth business which generates sufficient and predictable revenues. That’s why many subscription and SaaS businesses especially decide to opt for RBF instead of straight equity.
Ease and fast access to funds, no equity dilution and flexible and cost effective repayments are amongst the key advantages of RBF. With revenue-based financing gaining a lot of interest recently, many providers now offer highly attractive financing within a few days only.