What is Revenue-Based Financing?
Revenue-based financing, (RBF), is a mix of equity and debt financing that places a limit on the equity portion of the financial agreement. In an RBF agreement, a company receives capital from investors with an agreement to pay a percentage of monthly revenue until a predetermined amount has been paid. This method is popular for startup companies because it can be one of the only options to obtain financing, while also not giving away a high percentage of equity. This form of financing is very popular in technology related industries.
RBF, however, is distinct from equity or debt financing. Some say it’s a hybrid between the two. Because investors do not have direct ownership in the company, RBF is different to equity financing. And even though revenue-based financing does mean making regular payments to pay back investors, there are no fixed payments and interest is not paid on an outstanding balance, as you would with debt financing. This is because payments to investors are directly proportional to how well the company is doing, so if sales are above or below average one month, this will be reflected in the investor’s payment.
The different types of revenue-based financing
RBF can be structured in a few ways. The most common type of structure you’ll come across is one that is similar to the structure of a term loan. You receive a set sum of capital and repay that capital, with interest, over time. However, you may also come across RBF with a structure similar to that of a business line of credit. The full amount of capital is not given up front, but drawn upon over a number of years, so that no interest is accrued until the money is needed.
You may also have RBF that involves making payments to investors in different ways. This is dependent on the terms of the agreement with the investor, but you might make payments until:
- The investor receives a pre-determined payment of the initial loan amount.
- The investor reaches a pre-determined internal rate of return.
- A pre-determined, final date is reached.
Revenue-based financing may differ in structure, but they’re all based on regular payments based on your company’s sales, and the time it takes for you to repay the investment will vary too. However, typically, repayment of the initial investment will range from three to five years.
Pros and cons of revenue-based financing
Revenue-based financing comes with its advantages and disadvantages, and weighing up both sides will allow you to decide whether RBF might be a good fit for your capital needs.
Maintain control of your company – Unlike equity financing, investors do not have direct ownership in stock or shares in your company, so key decisions and governance is still solely in your own hands. This is one of the main benefits of this type of financing for businesses.
No valuation is required – RBF is relatively popular amongst startups due to the maintenance of control in the company but also because it doesn’t require companies to be valued, which can trip up a lot of businesses who may just be starting out.
Large sums of capital – Because revenue-based financing is based on longer-term repayment terms and timings, companies will be able to access a lot more capital, when compared to other forms of funding. RBF is often available in minimum amounts of $100,000 to $2 million, with no real maximum amounts.
Longer repayment terms – Revenue-based financing gives you more breathing space to repay the investment, with longer repayment schedules. And for businesses where capital and profits may be relatively limited to begin with, this funding option is ideal as the stress of paying back large debts in a small time frame is removed. And so, RBF could be a lot more manageable for your company, when compared to other funding options.
Expensive debt – Longer repayment schedules may be a great plus point for revenue-based financing, but it’s worth remembering that the longer it takes you to repay the debt, the more interest you accrue on that debt. This can end up adding up to a lot more than the initial investment amount, potentially leaving your business in a worse off position in the long term.
No pre-payment incentives – The usual practice when businesses borrow large amounts of money is that lenders will also provide pre-payment incentives. These could be discounts or minimal interest rates to encourage businesses to pay back their debt ahead of the proposed schedule. But this is not the case with revenue-based financing. RBF doesn’t have specific schedules for repayments, so financers don’t provide pre-payment incentives.
Only suited to specific businesses – Revenue-based financing requires businesses to meet very specific requirements in order to be eligible for this type of funding. Your company will need to have strong growth projections, which for small or new businesses, isn’t always a possibility. On top of this, many investors and firms will only work with companies in particular sectors, mainly the tech industry, because of how fast growing it is.
What do RBF financiers look for?
As alluded to in the last point, businesses looking to access this type of funding have to meet specific criteria. To be eligible for revenue-based financing, you’ll likely need:
- An annual revenue of $200,000 or above.
- Consistent revenue with high growth margins of at least 50%.
- A defined path to profitability or positive projected growth.
- Little to no existing debt obligations.
Top 5 revenue-based financing companies
There are a number of RBF financers available but we’ve pulled together our top five companies that we recommend to those wishing to pursue this type of financing:
To find out more about the terms of each financer, you can have a look at our detailed resource that outlines the ins and outs of each recommended company.
Wondering if revenue-based financing is a good fit for you and your company? Simple Startup is able to help you prepare for seeking financing, determine how much financing you need, and make sure your business model is set up properly to maximize these influxes of cash. We look at your metrics as part of our accounting, controller, and fractional support services to determine the full financial picture for your company and the options available to you. So, why not grab some time on our calendar and see how we can support you in your financial roadmap.