Revenue based financing is an alternative financing option that bridges the gap between equity investing and obtaining bank debt. Traditionally, startups use angel investors or venture capital financing for the first few years until they can ‘prove’ their profitability and qualify for debt. While this works for many businesses, certain startups or business models sometimes don’t meet traditional lending requirements - and therefore lose out on this jumping off point into debt to allow their growth to continue.
Revenue based financing, also known as RBF, is particularly useful for startups and for recurring revenue businesses or SaaS companies.
So how does a revenue loan work, and when should you consider applying for one?
We normally picture financing as falling into two buckets: equity funding where payment is a stake in the business, and debt funding where interest needs to be repaid at a set amount over a set time frame.
But revenue based financing works differently. The lender, usually an investor or financing firm, provides capital in return for payments based on your incoming sales revenue. They do not take ownership in any part of your business, and you also do not pay them interest on the outstanding balance of your revenue loan.
It therefore brings elements of both equity and debt financing into play.
Most importantly, it allows businesses to move to non-dilutive financing at an earlier stage than has traditionally been assumed with bank loans. A revenue based financing firm will have different requirements in order to agree to lend capital, and these usually tie in to how well your business can create consistent recurring sales over the anticipated term of the loan.
The terms of revenue loans vary depending on the financing firm and the business, but there is usually a repayment cap of anywhere from 1.35% to 3% of the initial loan amount. And the amount to be repaid every month is not set, but is a percentage of the revenue brought in the month before; anywhere from 1% to 8%.
That means that if your business grows over time, then you will be paying a higher amount each month and will pay of your loan faster. If you experience some months where your revenue unexpectedly dips, then the amount you repay drops accordingly. This allows you the flexibility to plan for and aim for growth, without increasing your risk of affecting your runway to the point where your business is no longer sustainable due to loan payments.
Revenue based financing allows companies who don’t have many assets or a good credit score to find non-dilutive financing. While debt financing requirements often make sense for a bank, they leave startups and SaaS businesses behind. If you can prove that you have consistent monthly revenue (and even better if you can show that revenue is growing over time), then many revenue based financing firms will be confident to lend based on that. If you’re a startup that has only been in business for a year or two, but you have a solid recurring revenue and a plan to continue that and grow, then revenue-based financiers will likely be happy to lend to you.
Another benefit is that you don’t have to sacrifice part of your business in return for capital. This can be especially valuable for bootstrapped startups who realize that an injection of capital is necessary for further and faster growth, but who have worked so far to get where they are and don’t want to give up a portion of their business to do so. For those who have already given away a large proportion of their business to venture capital firms or angel investors, and are watching their company grow and realizing how much of that growth belongs to others, the thought of giving away yet more of the company just to grow it further can also be frustrating.
Because revenue based financing comes from investors or financing firms and not banks, the regulations surrounding this type of financing are fewer and as a result lenders can be more flexible on what businesses provide in return for funding.
While many revenue loans are provided as one payment of the full amount of capital agreed in a similar way to a bank loan, other options are available.
Many revenue based financing firms will agree to loan a set amount, with the business being able to drawdown amounts from that as and when needed. The benefit of this, obviously, is that companies only have to pay back on the funds they actually use, keeping the amounts to be repaid as low as possible. It also means companies can negotiate a large sum (revenue based financing is often for larger amounts than traditional bank loans) without having to know how they will spend every penny. With debt financing, companies are paying interest on the entire sum from the moment it is paid out, even if they don’t need that money for several months. With revenue financing, startups can be in control of drawing down funds at the specific time they are required, and feeling confident agreeing to costs that may not happen immediately, knowing that the money will be available at that point.
Revenue loans can allow recurring revenue based companies to ensure their working capital is always healthy and sustainable, especially as they grow and take on more clients, where accounts are not always paid immediately. As that gap in the working capital widens as the business scales, revenue based financing can plug the gap comfortably.
If the amount you agree to borrow is based on a percentage of your ARR, then some financing firms will offer you the option to continue to draw down on that based on your ARR at the time. That means the amount available extends and your funding capacity grows as you do, without having to constantly negotiate new bank loans or terms with your venture capital firm or angel investor.
Equity financing, which involves giving away a share in your business, can involve weeks or months of negotiations and so much paperwork. Terms need to be negotiated and agreed, with every venture capital firm or angel investor having different terms and requirements.
Debt financing involves a similarly large amount of red tape and time spent providing data and documentation.
With newer forms of financing, the paperwork and data monitoring can be reduced drastically. Capchase, for example, integrates with the biggest banks and accounting services so that you can sync your data seamlessly. This allows Capchase to analyze your information and provide an offer within hours or days, rather than weeks. Once you’re approved, first drawdown can happen immediately thus making your financing strategy more efficient and optimized for your needs.
For businesses that are growing fast, have consistent recurring monthly revenue, and don’t have the traditional assets that a bank likes to see to allow for debt financing, revenue-based financing can be a great option. It removes the need to give away a share of the company, removes much of the regulations and red tape required in both equity or debt negotiations, and if the financing company is able, can connect to your data and provide terms within hours or days. The flexibility that a revenue based financing company can offer can empower founders of startups and SaaS businesses to grow in the most efficient way, rather than hindering them or slowing their potential growth.
Try out our our runway calculator to see how Capchase can help accelerate your growth today.