How Does Revenue-Based Financing Work?

At some point, every business owner needs to access capital for one reason or another.

Whether you choose to finance through a bank or an alternative funder, the type of financing you pick depends on several factors, including how long you have been in business, what you plan to invest in, and the financial health of your company. In this article, you will learn about revenue-based financing, its benefits, and how it compares to other forms of financing. 

What Is Revenue-Based Financing?

Revenue-based financing (RBF) is a type of capital source used by small businesses that tie repayment structure to your business’s revenue. The appeal of RBF is that the borrower can access capital for their business without pledging a part of its assets as collateral or giving over a portion of its equity. The terms typically appeal most to small and growing businesses with fewer assets, and funders usually specialize in RBF.

How Does It Work?

There are many ways to structure revenue-based financing, and the specific terms are situational, relating to the state of your business and the discretion of the funder. However, all revenue-based financial agreements contain three basic components: 

• the total amount to be repaid by the borrower,
• the percentage of revenue to be paid,
• and the payment schedule, which is usually weekly, but can also be daily or monthly. 

If approved, you can expect funding amounts between $2,500 and $3 million depending upon your gross revenue. The predetermined monthly percentage of revenue to be paid varies from 1 to 20 percent on average, and the total cost of capital, also known as the purchase amount minus the purchase price, will be determined by the advance agreement. The cost of funds generally ranges between 1 to 3 percent per month on average. 

The structure is often flexible, with a variety of features to meet your business needs. Typically, the term of the advance is variable, based on the performance of the company. 

What are the Requirements?

Providers require a minimum monthly revenue of $15,000 to $100,000 and a gross margin of at least 50 percent. Before applying for revenue financing, you will need to have a thorough, documented business plan, including a strategy to increase your current revenue. Since revenue is the deciding factor in this type of financing, funders want to see the potential for monthly growth. You have to prove that your revenue will be able to support the funding.

What Are the Benefits of Revenue-Based Financing?

There are several factors that make revenue-based financing a viable and favorable option.

• Payments are linked to performance. If you have a terrible month or are affected by outside circumstances, you do not have to worry about how to make a fixed payment. Since payments are a percentage of monthly revenue, they fluctuate with the ups and downs of your business’s performance.
• You can pay off the funding faster than anticipated. If your business starts to grow faster than you projected, your monthly payment will increase and the repayment cap can be reached early.
• Revenue-based financing is non-dilutive. You do not lose a stake in your company. This means that you remain in complete control of all operational decisions.
• You do not need to provide collateral. Your assets are not at risk if you have a bad quarter or year.

The flexibility of revenue-based financing is what makes it so appealing to small businesses. You will need to adjust how you budget because the payments are not fixed amounts, but that is a small con in a mountain of pros. 

How Does Revenue-Based Financing Compare?

Two common types of financing used by entrepreneurs are Venture Capital and SBA loans. Comparable to revenue-based financing, there are several fundamental differences between the three. Each is more suitable for certain business conditions.

Venture Capital requires no payments. Instead, the borrower will give an equity stake in the business. They may also take a portion of control in the business. They demand high returns and take anywhere from three to six months to decide on approval.

SBA loans have fixed payments and typically require collateral. The term is longer than RBF, ranging from 5 to 25 years. They can also charge prepayment penalties, making it difficult and costly to pay the loan off early. The cost of capital is usually cheaper, but the borrower can expect heavy documentation and anywhere from 4 to 13 weeks before receiving funding.

When Is Revenue-Based Financing Right?

Funders prefer businesses with high gross margins or revenue models based on subscriptions. Steady revenue is a must to receive RBF. There are a few reasons that you might be interested in revenue financing. 

• You want to retain control. Even if you are eligible for other types of financing, you may be drawn to RBF because you do not have to release an equity stake in your business.
• Your business is too small for venture capital investments. Even if your business is sustainable and showing growth potential, it may be too small to attract venture capital (VC) investors. RBF funders are typically not expecting the level of returns that VCs expect.
• You may have no other option. Most forms of financing require an extended period of time in business to even be considered. If your business is new, you may struggle to qualify. RBF is a great option for startups. 

You will need to assess your level of comfort with the options available to you. Put together a business plan and ask yourself if revenue-based financing is a viable option. If you need assistance along the way, talk to the experts at Platform Funding and get the capital your business needs. 

Sources:

1. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/revenue-based-financing/
2. https://www.investopedia.com/terms/r/revenuebased-financing.asp#:~:text=Revenue%2Dbased%20financing%20is%20a,original%20investment%20has%20been%20repaid.
3. https://www.businessnewsdaily.com/6659-revenue-based-financing-tips.html