Revenue-based financing: What is it? More importantly, is it right for your company? Deciding how to raise capital is among the most complex questions entrepreneurs face. Equity financing requires handing over control, traditional business loans are hard to get, and debt financing is limited to low sums and short terms. In this challenging financial environment, it’s no wonder business owners want to explore their options.
Here’s more information from Bridges Consulting, LLC.
What Is Revenue-Based Financing?
Revenue-based financing exchanges current funding for future revenue. Unlike equity financing, which gives investors equity in exchange for funding, revenue-based financing provides investors with a percentage of the company’s revenue. It’s a flexible funding option that lets founders retain full control of their company. Not only that but with payments proportional to revenue, you don’t have to worry about getting suffocated by debt during slowdowns.
In a revenue-based financing agreement, terms are set including:
- Principal: The amount borrowed, paid as a lump sum.
- Payment terms: This establishes the percentage of monthly revenue to be applied toward repayment.
- Repayment cap: Set as a multiple of the principal loan amount, this is the total amount repaid to the investor.
Pros and Cons of Revenue-Based Financing
Flexible payments and no loss of equity are the obvious perks of revenue-based financing, but what other pros and cons should entrepreneurs eyeballing this financing method consider?
- Can be obtained quickly compared to other financing methods.
- Longer repayment terms and larger financing amounts compared to other debt financing.
- No equity dilution — borrowers retain control of their company.
- Personal collateral is not required.
- Flexible eligibility requirements are well-suited to startups.
- Payments are scaled to revenue — you can never owe more than you earn.
- Lower funding limits than equity financing.
- It can take a long time to pay off debt.
- It may tie up capital if your company is more successful than anticipated.
- Not well-suited to brand new businesses, businesses with low profit margins, or those operating at a deficit.
Who Should Use Revenue-Based Financing?
Revenue-based financing is best suited to startups with strong revenue and growth projections. While you don’t need high credit or years of business history as traditional business lenders require, RBF investors do want to see consistently high revenue and a plan for profitability. Businesses need to have their story and documentation in order before applying for revenue-based financing.
As a result of these requirements, revenue-based financing firms tend to focus their attention on tech and e-commerce companies. SaaS companies and other startups with subscription-based revenue models are a good fit for revenue-based financing since subscriptions generate reliable cash flow.
This also means you won’t be able to apply for revenue-based financing the day after incorporating or forming an LLC and designating your registered agent on LLC paperwork. Generally, founders turn to revenue-based financing when they’re ready to accelerate growth after a period of bootstrapping. Instead of relinquishing equity to a venture capital firm or angel investor, founders can use revenue-based financing to scale up the recurring parts of their business.
While revenue-based financing is unlikely to replace traditional bank lending and venture capital in the fundraising process, it’s a flexible alternative at a time when founders need options. Not only is traditional debt financing hard to secure for early-stage startups, but founders are starting to push back against the expectation that they have to give up equity in exchange for growth capital.
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