Revenue-Based Financing: Compare the Best Options


If your business has significant recurring revenue, revenue-based financing can provide growth capital without requiring you to give up your equity. Find out if this is right for your business.

What is revenue-based financing?

Revenue-based financing, also known as revenue-based investing or revenue-sharing financing, is a form of financing that allows small businesses to obtain financing and repay it from future revenues. Payments are based on a weekly or monthly percentage of revenue, until the financing is repaid with fees, which are usually around 3 to 7 times the initial investment.

How revenue-based financing works

Revenue-based financing or revenue-based investing generally describes an arrangement in which investors provide funding to businesses with strong, ongoing revenues. Often, companies that provide these loans specialize in certain types of high-growth industries such as software as a service, i.e. saas companies. It can be an alternative to traditional venture capital or angel investment structures that require the company to give up some of its capital in exchange for funding.

Unlike a traditional small business loan that requires fixed monthly payments (or sometimes weekly payments), revenue-based financing offers more flexible repayment terms. Investors or the company providing the funding or finance will receive a percentage of future earnings until the total agreed upon on repayment is reached. When income is lower, payments will be lower, and when income is higher, payments will increase.

There will be a reimbursement cap which will determine the total cost of financing. It can be as low as 1.35% of the initial investment amount, or as high as 10%, although there is no legal limit that caps the amount these companies can charge.

Advantages and disadvantages of revenue-based financing

Benefits:

  • More flexible approval criteria than loans
  • The owner can avoid a personal guarantee
  • Payments fluctuate with income
  • No equity dilution
  • Quick funding

The inconvenients:

  • Higher cost of capital than traditional commercial loans
  • Requires significant recurring revenue
  • Not available for all industries

Revenue-based financing is generally more flexible than standard small business loans that require at least two years in business, good credit scores, and solid income. The contractor may also be able to avoid a personal guarantee.

This type of financing does not require the small business to give up business capital, but it is likely to be more expensive than a traditional small business loan, such as a commercial bank loan or even a secured loan. by the SBA.

Revenue-Based Financing vs. Debt and Equity Financing

Debt financing is another term to describe a business loan. With this type of financing, entrepreneurs borrow money and pay it back over time with interest, usually in monthly payments. The cost of financing can be described using an interest rate, fee, or other terminology. (In most cases, small business lenders are not required to disclose an annual percentage rate (APR).

Some small business loans come with very low interest rates. Traditional bank loans and SBA loans backed by the Small Business Administration often carry the lowest interest rates, although micro loans and some online loans are also relatively inexpensive.

The advantage of a small business loan over RBF is usually the cost. Borrowers who qualify for a low-interest small business loan will likely find this option cheaper than an income-based financing arrangement.

On the other hand, small business loans require regular payments which can be difficult to make, especially for a new and growing business, or one that experiences fluctuations in income.

Equity financing allows companies to obtain funds from investors, whether they are private investors, angel investors or venture capitalists. There is even a type of crowdfunding that allows companies to raise funds from a large number of investors.

The advantage of equity investments is that they can be structured without payment. Investors cash out when there is a liquidation event (like an IPO or an acquisition). However, the advantage of RBF over this type of financing is that it does not require giving up the company’s capital. The company does not cede control of the company

Revenue-Based Financing Rates and Terms

Revenue-based financing can be structured in a variety of ways, but the defining feature is that payments will be tied to gross revenue. When income decreases, payments also decrease. Higher revenues allow the business to repay financing more quickly, but it likely won’t reduce the total amount owed.

Here is an example of how this funding can be structured:

Lighter Capital, a leader in this type of financing, provides loan amounts of up to $3 million to technology companies with monthly recurring revenue (MRR) of at least $15,000 in the last three months and at least five customers receiving products or services. Borrowers may qualify for a loan of up to 33% of the annualized rate of income. (To illustrate, their website example shows that a business on track for $1 million in sales this year can receive a loan of approximately $330,000.) Payments are based on a fixed percentage of income ranging from 2% to 8% but not more than 10%.

How to qualify for revenue-based financing

True revenue-based financing has very specific requirements. The first and most important requirement for this type of financing is that the business has sufficient recurring revenue. As mentioned earlier, it is typical with this type of funding that companies (or investors) seek companies in certain industries such as technology companies with a history of generating recurring revenue and strong growth potential.

As part of the application process, the business must be able to confirm the source of income and may also need to document how it will use the new funds to grow the business. Minimum recurring revenue requirements of at least $10,000 to $20,000 or more per month would not be unusual. There may also be annual revenue requirements.

How to get revenue-based financing

Ideally, when you’re looking for a small business, you’ll want to research the financing options that best fit your business needs and that you qualify for. Since RBF is available through specialist finance companies, you may have very limited options. You can find potential investors from the investment community, or perhaps from a trade association or networking with other entrepreneurs in your industry.

If you don’t fit the rather narrow RBF criteria, you may want to consider other types of revenue-based financing. Businesses with strong monthly revenues may qualify for a merchant cash advance or a business cash advance, for example. Both of these products offer advances on future earnings and will rely heavily on recent earnings (often the last 6-12 months) to make an underwriting decision. MCAs and BCAs are widely available to many types of businesses, as long as they have sufficient revenue. Credit score requirements are generally very low.

Another type of financing that looks at revenue is accounts receivable financing or invoice financing (or factoring). With this type of funding, the company commits to earning revenue from sales that have already taken place, but for which it has not yet been paid.

Understanding what type of financing is right for your business can be confusing. One option is to work with a small business funding marketplace who can match your business with funding based on your qualifications.

This article was originally written on December 17, 2021 and updated on December 20, 2021.

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