When you're looking for funding, where do you go first?
Debt and equity-based funding have traditionally been the go-to options for most start-ups, but they aren’t necessarily best-suited for founders that want to avoid making personal guarantees or giving away equity.
That’s why in the last few years, revenue based financing has become one of the more popular funding options.
But what is revenue based finance, how does it work, and is it right for your business?
What is Revenue Based Finance?
Revenue based financing gives companies capital in exchange for a percentage of their future revenue.
Advances are approved on the assumption that companies will repay a certain percentage of their revenue every month. For example, if a company takes out a $500,000 loan, they might agree to pay back 6% of their revenue per month.
Higher-revenue months will result in a larger monthly repayment and a shorter repayment term overall, while lower-revenue months will see a smaller monthly repayment and a longer repayment term overall.
Revenue based finance lenders will take a look at your business's financial history to determine how much they are willing to lend you. However, unlike other forms of startup funding, you don’t have to present a pitch deck or an intricately detailed business plan - in fact, there’s often very little paperwork involved.
Instead, lenders connect to your back-end systems to make decisions based on your projected revenue. This means that lenders can make funding decisions within days, not months.
How does Revenue Based Financing work?
Revenue Based Financing works in three easy steps:
1. Sign up with an RBF provider
First, you'll sign up with a revenue based finance provider and connect your business's financial accounts (think Xero, Stripe, etc). This allows the provider to see your business's financial history and decide whether you’re eligible.
If your forecasted revenue is high enough, you’ll be approved for an advance. Usually you’ll be given a mix of offers with varied repayment terms.
2. Choose an offer
As part of the offer, the provider charges a flat fee and agrees to a monthly revenue-share. Here’s is an example of what that could look like:
Funding amount: $90,000
Monthly revenue-share: %6
Avg. Monthly revenue: $500,000
Approx. repayment term: 3 months
3. Repay the advance
Repayments are made as a percentage of monthly revenue, which fluctuates regularly. If a company takes more, it'll repay the loan more quickly.
Meanwhile, slow months will slow down your repayment so you never pay back more than you can afford.
How much Revenue Based Financing can you secure?
Finance providers will look at your recurring revenue to determine how much they’re willing to lend you.
Most set maximum loan amounts up to a third of the company’s annual recurring revenue (ARR) or four to seven times their monthly recurring revenue (MRR). At Uncapped, we loan between $10k - $5m.
Repayment fees are usually between 6-12% of revenue, based on whether you plan to invest the funds in predictable revenue-generating activities like advertising or higher-risk activities like hiring.
The Types of Revenue Based Finance
There are two common types of Revenue Based Financing agreements:
Variable collection is the most popular type of revenue based funding. Businesses take out a loan for a certain amount and repay it each month based on their gross profits.
Flat fee funding looks a little different to the variable collection model. With this funding, you commit to paying a fixed percentage of your future revenues every month for up to five years - usually at a rate of 1-3%.
Monthly repayments tend to be much lower than those in the variable collection model making it a good option for some early stage companies, but if you grow and scale quickly, you’ll end up paying far more over the term of the loan.
Revenue Based Financing in Action
Let’s say, for example, you’ve been loaned $50,000 on the condition that you pay back 10% of your monthly sales until the advance is repaid.
With variable collection, your repayments may look something like this:
- Month 1: sales of $30,000 mean you pay back $3,000 of the advance
- Month 2: sales of $60,000 mean you pay back $6,000 of the loan
- Month 3: sales of of $15,000 means you pay back $1,500 of the loan
This continues until you have completely paid the loan in full. If your sales drop for a month or two, your repayments will decrease too, so you're not struggling to repay a loan your business can no longer afford.
On the other hand, if your revenue shoots up one month, you pay a larger percentage and, therefore, a larger chunk of the loan. This significantly reduces your repayment term.
Revenue Based Financing vs Other Options
Understanding the difference between debt, equity financing, and revenue based finance is the key to choosing the right funding option.
Debt funding models (like loans) require businesses to pay back a fixed amount with interest over an agreed period of time. Unlike revenue based financing, the repayments are for a set amount each month and must be met in full.
For loans, startups are often required to provide a personal guarantee in case they can’t meet the repayment terms. There are other debt models, like venture debt, with more complex terms for repayment and in case of default on payment.
While debt financing can be a useful way to secure a large cash injection, it can also be high risk if your turnover isn’t consistent or if you’re selling in a fluctuating market.
Revenue based financing does not require a personal guarantee, years' of financial statements, or a long lead time, so it’s an increasingly popular choice for business owners.
Equity financing requires startups to hand over a portion of their ownership to lenders in exchange for growth capital. There’s a lower risk involved with this financing model, but founders and directors dilute their ownership with this approach.
Depending on how equity is structured, you may lose influence over major decisions. Either way, you’ll lose access to at least a portion of your future profits.
That’s in contrast to revenue based financing, which does not require founders to give up equity in their business. For this reason, equity finance isn’t an appealing option for founders looking to drive predictable revenue (through Facebook ads, for example).
Advantages of Revenue Based Financing
We’ve already covered a lot of the benefits of using revenue based financing for raising capital compared to debt and equity financing, but here's a full round-up of its advantages.
Founders and directors keep full control over the company. That’s crucial for startups who have the potential for rapid growth but need a cash injection to help get them there.
No personal guarantee needed
Founders and directors don’t need to put forward personal collateral against the loan, making it a less risky option than traditional debt financing.
Loan repayments are flexible
Repayments are based on the performance of your business. If you do well, you pay more. If you don’t do well, you pay less.
That means if you're an ecommerce business you don’t need to worry about a post-holiday sales slump and if you’re a service-based business you’re in better shape to weather lockdowns or whatever else the pandemic throws at you.
Fast-growing companies settle quicker
Companies that grow quicker than expected make repayments quicker too, so they end up giving up less revenue overall.
Cheaper than equity
Repayments aren’t usually as high as interest so it's often a far cheaper option than securing your initial investment from angel investors or Venture Capital firms.
Startups can secure revenue based financing within 24 hours. Meanwhile raising VC funding takes months...
Works well with other funding sources
Revenue based financing helps early-stage startups build traction, which makes other forms of funding more accessible, and less costly.
UK-based fitness app GRNDHOUSE took revenue based finance to invest in growing subscribers ahead of a seed round. The capital meant they were able to negotiate better terms and give away less equity when they raised €1.5m from investors.
Disadvantages of Revenue Based Financing
Although revenue based financing has a lot to offer, it doesn’t suit every business. There are a couple of things to consider before partnering with a revenue based financing provider.
Lenders will actively look at your business's ability to generate revenue. If you’re pre-revenue, you might not be able to secure the funds you were hoping for. If your financial history is inconsistent, you may have the same issue.
Smaller loan amounts
Lenders generally cap loans based on your business's MRR. If you’re a relatively small company, that probably means you’re only eligible for a loan that’s much smaller than what you might raise with angel investment. But as your company’s MRR grows you can often secure follow-on rounds from revenue based finance investors.
Doesn’t suit long repayment periods
Founders looking for repayment periods of more than a year might be better off with a standard bank loan than revenue based finance.
Revenue based finance is great for funding short-term initiatives that drive revenue that can be used to repay the advance. However, when these repayments drag out for longer than a year, for example, a fixed term bank loan becomes more economical.
Who can Benefit from Revenue Based Finance?
Many types of business benefit from revenue based financing, but there are a few industries that have the most to benefit.
Businesses that sell products online are well-suited to revenue based finance, because this funding type allows them to quickly invest in marketing or inventory to meet demand.
Because these businesses sell online, it’s easy for lenders to forecast their performance based on data from their business accounting and marketing accounts.
Companies with seasonal performance
Startups that do better at certain times of the year (such as ecommerce brands at Black Friday) benefit from the performance-based nature of revenue based financing.
They'll be able to stock up on inventory and shore up ad spend for the peak season, then quickly pay off their loan with the revenue they make.
SaaS and subscription businesses
Revenue based repayments are dependent on MRR, so companies that have predictable and consistent monthly revenue are more likely to reap the rewards of this type of funding.
For example, SaaS and subscription businesses receive monthly payments, so have a clear idea of how much revenue to expect each month. This predictability, paired with low overheads, puts them in a better position to make monthly repayments.
Is Revenue Based Financing right for you?
Revenue based financing is the perfect funding option if you don’t want to dilute equity or spend time raising capital to invest in initiatives that are very likely to drive revenue.
The ability to make repayments based on your monthly revenue means you can keep growing without worrying about whether you’ll meet the cost of a fixed loan.
So whether or not you plan to use other funding sources, any business owner looking to retain equity and grow quickly can benefit from using revenue based financing as part of their funding strategy.