revenue based financing

All this time, debt and equity financing have been the only options for startups. However, several new classes of capital have been brought to the forefront today. And upon careful analysis, it has been found that both investors and entrepreneurs have chosen revenue-based financing to be one of the best solutions.

What is Revenue-Based Finance?

Revenue-based financing (RBF) refers to the strategy to raise capital for a firm. It is generally taken from investors who are compensated with a portion of the company’s ongoing gross revenues in return for their investment.

In an investment using revenue-based financing, investors get a recurring cut of the company’s profits up until a preset sum is paid. This fixed sum is often a multiple of the principal investment and typically varies between three and five times the initial investment.

It is a logical progression for early-stage venture investment and private equity financing. However, as RBI is a new concept, little information is available to the general public.

How Revenue-Based Financing Works?

Revenue-based financing refers to securing borrowing (credit) by utilising projected profits. The investor or lender gets a certain percentage of the borrower’s income, commonly known as the revenue share. The lender then receives payment for the principal amount plus the revenue share.

To understand how revenue-based financing works, let us take an example. Let’s say, firm A makes an average of Rs 30 lakh every month. As a result, they expect to make Rs. 3.6 crore a year. It offers this estimate to an RBF supplier and suggests that they pay for it with Rs 30 lakh.

This lender lends the money following an evaluation for a 12% revenue share. As a result, firm A must pay back Rs. 336,000, or Rs. 300 000 + Rs. 360 000. (finance cost or revenue share).

Revenue-based financing considers several parameters like revenues, cash flow, scalability, growth capital, etc., when it comes to auditing. They will lend the agreed amount to the borrower’s account if convinced.

When do Companies Seek Revenue-Based Financing Options?

Revenue-based financing is attractive to:

  • Businesses that are currently releasing a new product.
  • Growth stage of businesses seeking to add more salespeople.
  • A business that has a sizeable market but not one that attracts venture capital firms.
  • Owners don’t want to sell stock or pledge guarantees on loans.
  • Organisations to launch a significant marketing initiative.

1. Evaluate Financing Terms Carefully

You must consider the loan’s structure carefully because it will impact the future expansion of your business. You must consider your alternatives for future growth, the loan’s quantity, and your capacity to repay it. The factors to consider are:

a. Analyse debt financing

Follow “The 33% Rule,” which states that your company’s debt should never exceed 33% of your yearly income while seeking funding. More debt than this might put your company in a serious liquidity bind.

b. Take into account your capacity for payback and periods

As you will be paying a portion of your future revenue as repayment for revenue-based loans, expanding your business will easily enable you to pay off your debt. Loan repayment is manageable if your gross profit exceeds your monthly debt financing.

c. Search for attached warrants attached

There may be warrant requests from some RBF financiers. In your firm’s case, warrants represent the right to purchase shares at a price set today in the future. You should retain equity financing for greater firm management and potential future investment rounds.

You should retain greater equity financing for greater management of your firm and potential future investment rounds.

d. Future options

Make sure the funding conditions allow you to pursue future choices. Think about things like whether you’ll be able to receive more money from them in the future as you weigh your alternatives. Ensure that the terms for prepayment are reasonable.

2. Choose the Right Financier

A long-term and occasionally complex relationship exists between an investor and a borrower. It’s essential to have reliable investors. Check the fund balance and current clientele of your revenue-based financing partner.

You should inquire around your networks and give suggestions from other D2C brand founders the weight they deserve. This is because it might be difficult to discern their perspective from their websites.

Pros and Cons of Revenue-Based Financing

Revenue-based financing has its own set of benefits and drawbacks.

Pros

  1. It is more affordable than alternatives: Compared to options that entail equity financing, revenue-based financing is less costly. Alternative sources of finance, like angel investors and venture capitalists, demand 10 to 20 times more in returns. Additionally, companies that offer revenue-based financing have an interest in your success.
  2. You can possess authority: With revenue-based financing, you’ll preserve your company’s equity financing and ownership and management.
  3. Flexible monthly payments: Slow months won’t impact your capacity to pay because monthly payments are dependent on revenue. Your cost is correlated with your revenue and, with careful preparation, should stay manageable.
  4. No personal guarantee is required on loan: All assets are at risk when you choose financing choices like bank loans, which require you to guarantee a loan. That commitment is not necessary for revenue-based financing.
  5. You’ll raise funds rapidly: You will only have to make a few pitches to get the funding you need with revenue-based financing. Most lenders will decide and issue a credit to ensure good future revenue.

Cons

  1. You have to generate revenue: A startup can only use this type of funding with a steady source of income since a firm must generate revenue to qualify.
  2. Availability of less money: Revenue-based financing covers around three to four months of a business’s monthly recurring revenue. In comparison, other funding options offer heavy investing.
  3. Mandatory monthly payments: Businesses have to make monthly payments in this arrangement.
  4. Minimal regulation: You must conduct a thorough study before signing any agreements since there is no regulation of revenue-based financing. It makes it difficult to avoid taking out a predatory loan.

Advantages of Revenue-Based Financing

Revenue-based financing has many advantages compared to venture capital firms’ loans. Here is the list of the advantages that you should know:

Non-dilutive

As a company owner, you retain complete control over your enterprise. You are not required to give up any equity financing interests in exchange for the funding you obtain. It is crucial for firms that are expanding quickly and require finance for it.

No Personal Guarantee Needed

Some revenue-based financing lenders might not require a personal guarantee or security during the application process, making it a less risky and quicker choice for borrowing funds.

Loan Repayments are Flexible

Revenue-based financing has payback terms that depend on how well your company performs. When sales are brisk, you pay more; when they’re sluggish, you pay less. This also implies that you will always have adequate growth capital to get through your post-holiday sales downturn.

Fast-Growing Companies Settle Quicker

Companies with rapid growth and an expected high future revenue make quick repayments. As a result, they end up giving low revenue.

Cheaper than Equity

Repayments are often far less expensive than interest, making it a much more cost-effective choice than getting your first investment from angel investors or venture capital organisations.

Fast Funding

Compared to venture capital firms’ funds and bank loans, you get revenue-based financing within a week. On the other hand, the other forms of bank loans take months for the funds to be released.

Works well with other Funding Sources

Early-stage firms benefit from revenue-based financing by gaining momentum, making other investment sources more available and affordable.

Who can Benefit from Revenue Based Finance?

Revenue-based financing is advantageous for many different company models, but some industries stand out to gain the most.

E-commerce Businesses

Online retailers are particularly well-suited to revenue-based financing since it gives them the flexibility to invest in marketing or inventory to fulfil demand swiftly.

Due to their internet sales, these companies make it simple for lenders to predict their success using information from their marketing and accounting accounts.

Companies with Seasonal Performance

Online retailers are particularly well-suited to revenue-based financing since it gives them the flexibility to invest in marketing or inventory to fulfil demand swiftly.

Due to their internet sales, these companies make it simple for lenders to predict their success using information from their marketing and accounting accounts.

‍SaaS and Subscription Businesses

Businesses with predictable and steady monthly incomes are more likely to benefit from revenue-based financing. This is because revenue-based repayments are based on MRR.

SaaS and subscription firms get payments every month. They know exactly how much income to anticipate each month. They can make their monthly payments better with reduced administrative costs and this consistency.

Revenue-Based Financing is the Way to grow your Business!

Suppose you don’t want to dilute stock or waste time obtaining money for investments in initiatives that are almost certain to generate revenue. In that case, revenue-based financing is the best financing choice.

However, it is imperative to team up with the ideal revenue-based financier to support the expansion of your company.

overview-co-lending

Co-lending Industry and Product Insights

YubiCo.lend Annual Report FY 21-22

Download

Finance that takes
you further