What to Know About Revenue-Based Financing

In this article:

• Understanding revenue-based financing
• Benefits of revenue-based financing
• Does revenue-based financing work?
• Is revenue-based financing right for your business?

For small businesses that have grown tired of the old process of raising venture capital or who have been turned down by lenders when trying to get financing to grow, revenue-based financing (RBF) is a great alternative financing option to keep in mind.

Different from conventional loans and debt financing or equity investment, revenue-based financing (sometimes referred to as revenue-based funding or merchant cash advance) offers a dynamic approach to funding, aligned closely with a business’s revenue trends. This financing model is non-dilutive, which means it doesn’t take your equity. It’s also flexible to your company’s natural ups and downs. That’s why RBF is gaining traction with business owners who want financing that is flexible and easy.

This article will explain the important details of revenue-based financing. We guide business owners through the way RBF works, why it could be right for businesses in different situations, and benefits and drawbacks of this type of financing. Hopefully you’ll walk away with the information you need to decide if revenue-based financing is right for your business.

Understanding Revenue-Based Financing

Revenue-based financing is a novel approach to funding where businesses receive capital in exchange for a percentage of their ongoing gross revenues. In this model, the repayment amount fluctuates in tandem with the company’s sales performance, providing a flexible repayment structure.

How Revenue-Based Financing is Different:

Under revenue-based business funding, a company agrees to pay back the principal amount plus a fixed fee, calculated as a percentage of future revenues. This percentage is typically between 3% and 8% of the company’s ongoing sales, varying based on the terms of the financing agreement. Unlike traditional loans with fixed monthly payments and interest rates, RBF adapts to the company’s revenue cycles, increasing during high-sales periods and decreasing during slower times. And unlike venture debt and royalty-based financing, the obligation between the business and the funding company stops exclusively at actual received revenues and does not extend into the company’s equity or other assets.

Ideal Candidates for RBF:

This financing model is particularly well-suited for businesses with high gross margins and predictable revenue streams. It’s a popular choice among SaaS companies, e-commerce platforms, and other digital businesses where revenue patterns are more easily forecastable. Additionally, RBF is attractive to companies looking to preserve equity and control, as it doesn’t require giving up company shares or board seats.

RBF’s suitability extends to businesses seeking capital to fund growth initiatives like marketing campaigns, inventory expansion, or product development, without the pressure of fixed repayments that traditional loans impose.

It should not be confused with revenue-based business loans, which are traditional loans that are underwritten using a company’s revnue instead of its assets. Instead, RBF is not a loan.

Benefits of Revenue-Based Financing

Revenue-Based Financing is a form of financing that offers several distinctive advantages. RBF can be particularly beneficial for certain types of businesses that have high working capital needs, or that often need to convert their recurring revenue into short-term liquidity.

Here are some of the major benefits that business owners typically find with revenue-based financing when comparing it to traditional debt financing or raising capital from investors:

1. Flexible Repayment Terms: One of the most significant benefits of RBF is its flexible repayment structure. Payments adjust based on monthly revenue that the business is making, so you don’t have to worry about a fixed debt payment and can focus on growth. This can be particularly good for businesses with fluctuating sales. This flexibility makes it easier to manage cash flow, especially during slower business periods.
2. No Equity Dilution: Unlike equity financing, RBF does not require business owners to give up a share of their company. This aspect is particularly appealing to owners who wish to retain full control of their business or who are expecting the company’s valuation to grow significantly over time.
3. Quick Access to Capital: RBF processes are often faster than traditional bank loans. Since the focus is more on the business’s revenue potential rather than extensive creditworthiness audits, funds can be made available more quickly. This is crucial for businesses needing immediate capital for growth opportunities.
4. Alignment with Business Growth: Since repayments are based on revenue, they align closely with the business’s growth trajectory. This means that companies that seek funding to take advantage of market opportunities can do so without being crippled by high payments up front.
5. Convenience of Applying: Applying for RBF is also very convenient these days: business owners usually only need to complete a simple online application and provide 3-6 months of bank statements from their business bank account upfront in order to be qualified. There is usually no need for extensive documentation to prove personal assets or waiting on the IRS to issue a tax transcript. That’s because the financing is based on the company’s monthly revenue and its future receivables (the money that it is expected to make once it has received the financing).
6. Easy Eligibility Criteria: Unlike the process with the financing products that are offered by traditional financial institutions, revenue-based financing or merchant cash advances typically have simpler eligibility requirements. As long as the business can show that its annual revenue will meet or exceed the funder’s requirement, other factors in the financing decision like credit scores and personal assets, such as a home or a car, are less likely to get in the way.

Does Revenue-Based Financing Work?

Revenue-based financing companies are growing in popularity with many small business owners because of these benefits. When a business is looking for revenue growth and has opportunities that can’t wait until next month, revenue-based financing is fast becoming one of the preferred types of growth capital that entrepreneurs are using to super charge their growth.

So let’s take a closer look at how it works.

Small business revenue financing always starts with a financing application that specifies the business’s current revenue and details about the business such as the industry.

A financing company then reviews a small business’s recent revenue performance and they identify the common revenue patterns and amounts that a business can expect to generate. Then they take into account the additional financing that they will provide to the business and calculate how much the business’s revenues are expected to grow.

Because revenue-based financing is based primarily on the performance of the underlying business, this means that startups and other pre-revenue businesses are not able to qualify until they can start showing that they have cash flow coming in.

Somewhere between the first number (the recent revenue generated by the business) and the second number (the expected future revenue of the business) is the financing amount that the funder will provide to the business.

Sounds like VC funding, right? Actually, because the funding company is technically buying a stake in the future revenue created by the business, it’s pretty different from VC money. The financing company doesn’t own any equity or take control of the business in the event that the financing is not being paid back, but they will have some of the same rights as other contract holders with the business, such as customers or vendors owed payment if a business were to go bankrupt.

Evaluating If Revenue-Based Financing Is Right for Your Business

OK, so you know what it is and you know how it works. But is revenue-based financing right for your business?

Deciding whether RBF is suitable for your business involves careful consideration of several factors:

• Understanding Revenue Patterns: Small business revenue financing is most effective for businesses with predictable and regular revenue streams. Companies should evaluate their revenue predictability and ensure it aligns with the nature of RBF.
• Assessing Margins: Given that repayments are a percentage of revenue, businesses with higher profit margins are better positioned to handle this repayment style. It’s important to analyze whether your profit margins can comfortably accommodate the RBF repayment model.
• Growth Stage and Future Projections: RBF can be an excellent tool for businesses in growth phases with clear plans for revenue increase. Businesses should have a solid plan for how they will use the capital to generate increased revenue, ensuring the financing helps propel growth rather than becoming a burden.
• Cost-Benefit Analysis: Evaluate the total cost of RBF compared to other financing options. While RBF does not dilute equity, the total repayment amount may be higher than traditional loans when accounting for the fixed fee. Businesses need to weigh the cost against the benefits of flexibility and speed.

Key Considerations and Potential Downsides

While Revenue-Based Financing offers unique advantages, it’s crucial for businesses to be aware of its potential downsides and key considerations:

Higher Overall Repayment Amounts: As noted already, the total repayment amount can be higher than traditional loans, depending on the revenue share percentage and business performance.

Impact on Cash Flow: Although the flexible repayment structure is beneficial, consistently dedicating a portion of revenue to loan repayments can impact cash flow, particularly if the business encounters unexpected expenses or downturns.

Contract Terms Clarity: The terms of RBF agreements can be complex. Businesses must thoroughly understand all aspects of the contract, including the cap (the maximum amount to be paid), the percentage of revenue dedicated to repayments, how this may vary in response to different events in the business, and the obligations of any owners of the business through the agreement.

Potential for Misalignment: While RBF aligns with business revenue, there’s a potential misalignment if the business’s growth strategy changes or if revenue projections are not met. Usually the business owner will be responsible for a personal guarantee of performance, which means that they must agree that they will not undermine the revenue of the business while their financing obligations are still open. Businesses need to ensure that RBF fits into their long-term strategic plan and that it will actually help them achieve growth.

Wrapping It Up

Revenue-Based Financing stands out as a flexible and innovative funding option for small businesses, particularly those with steady revenue streams and high growth potential.

Its key benefits, such as alignment with business growth, flexibility in repayments, and preservation of equity, make it an attractive choice for business owners looking to expand without the constraints of traditional financing methods.

But, as with any financial decision, business owners need to weigh the benefits against the potential downsides. The higher overall cost, possible impact on cash flow, and need for careful contract scrutiny are important considerations.

Make sure you conduct a thorough analysis of your company’s financial health, revenue predictability, and growth plans to determine if revenue-based financing aligns with your objectives.

Considering financing with Biz2Credit? You’re in good company. Thousands of business owners have come here and found the right solution for their needs.

FAQ

1. What is an example of revenue-based financing?

   Imagine a small business that makes a good amount of money each month but the owner never seems to have cash to buy things they need to help the business keep growing. For example, a restaurant in a popular tourist town might always be a few dollars short of being able to stay open to serve its customers and actually renovate their patio space. Revenue-based financing would provide this business with cash up front in exchange for the future revenue that the business is expected to create, allowing the business owner to make those upgrades now without having to close down and lose out on business.

2. Is revenue-based financing risky?

   There are always risks involved in every financial product, and revenue-based financing is no exception. Business owners should carefully understand the terms of their revenue-based financing agreement to understand what their obligations are in case the business is not able to generate its expected revenue. However, one of the key benefits of revenue-based financing is that there is no fixed repayment period, so if revenues are lower for a short period the financing is paid back slower also.

3. How does revenue-based financing work?

   Basically, a business owner tells the funding company how much revenue they are currently making. The funding provider calculates how much revenue they are expected to make in the future thanks to the financing and determines how much funding the company can afford to pay in order to get financing up front. Then, once the business receives funding it will continue to pay back a portion of its revenues on a regular timeframe until the full financing amount has been paid off. This is different from revenue-based lending because there is no fixed payment schedule: instead the business pays a percentage of the revenue it is making, whether that goes up or down.

4. What are the advantages of revenue-based financing?

   There are quite a few advantages to choosing revenue-based financing. These include a convenient application process with minimal paperwork and limited personal information revealed to the financing company, a flexible payment structure, faster funding process and easier eligibility rules than other types of financing like loans.

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