Fundraising has always been critical for companies in order to address their working capital requirements and accelerate growth. Historically, company owners have relied on investors and banks to raise capital through issuing shares or securing debt. However, this is no longer the case; with revenue-based financing, firms may now access the collateral-free capital they want for future expansion without diluting their ownership or increasing debt associated risk. 

Let’s go further in the sections below to learn more about this innovative, founder-friendly method of funding your firm.

The Revenue-Based Finance

Revenue-based finance (RBF) is an alternative option instead of equity-based (venture capital or angel) and debt-based financing, which are most commonly used for fundraising. RBF allows entrepreneurs to obtain financing without sacrificing ownership or producing collateral, and repayments are based on monthly income, on a pro-rata basis. This ensures that the startup has enough funds for business activities while it is also able to uphold its obligation with investors.

To estimate growth and make financing choices, revenue-based financiers will ask for particular data points about the startup. The investor will evaluate the growth of the startup by monitoring their key business metrics. To understand the business growth, the investors will look into their historical growth, the business margins, scope of establishing moat with increasing customer base, and many other essential business factors. As long as the company’s growth estimates are realistic and have proof with previous track record, The investor will immediately disclose the financing conditions and distribute the funds as early as possible.

Here are some common features of revenue-based financing:

• A loan with a principle, a fixed charge of 4–8%, and no floating interest
• Because the funding is based on future income, no collateral or equity dilution is required.
• The monthly payments done is a proportion of future earnings (typically 5-20%).
• RBF maturity is based on your real revenue trend and is often shorter than 6 months.

Why RBF?

Before any money can be generated, a company must invest in its growth. Most of the money goes towards inventory, vendor payments, and marketing, creating a significant shortfall of three to six months for working capital. Moreover, the quicker the brand expands, the more money it requires. Even reinvesting most generated money into the start-up will result in a growing cash flow deficit.

Imagine getting a modest percentage of future income upfront from a revenue-based funder like Velocity. You may now utilise this money to grow your firm. Not only that, but the repayments are based on your sales, so you pay more when you make more and less when you earn less, and retain the extra earnings (no strings attached). Such terms of financing offer a huge advantage to startups.

Still, if you are wondering whether obtaining funds from investors is better than revenue-based financing, our next sections will provide more insight. Let’s review different aspects in detail below.

How is RBF different from VC financing and bank loans?

There are several methods to generate financing for your company, but each has a drawback. Most firms start by raising funding from friends and family and then search for angel and VC investors as they expand.

Angel and VC investors are hard to come by since they want high-growth companies with ~10X or more return on investment. Getting VC money makes sense for firms that need to spend heavily in R&D, promotional activities, and technological development. Getting cash from investors early in your firm might leave you with smaller ownership and hence lowers your decision making power. For bank loans, you must be profitable and provide collateral and personal guarantees. Not to mention the tedious process of pitching to VC investors and obtaining bank credit.

If you want a better deal on VC based financing, you will need to grow your company. Having constant revenues allows the startup to grow its business without losing equity.

Getting funded by a revenue-based financer does not exclude subsequent fundraising. Instead, some RBF investors (like Velocity Insights) supply sophisticated tools to assist you to measure key KPIs. So when you approach VC founders, your prospective investors will be more confident.

How can a startup secure revenue-based financing?

In general, if a start-up wishes to secure revenue-based financing, it should satisfy all or most of the criteria listed below:

1. The startup should have a proven track record of revenue growth. It should have a stable income stream from which it can repay debt.
2. KPIs (Key Performance Indicators) are quantitative measures against which a company measures its performance. Having good KPIs is crucial to secure RBF.
3. The startup’s finances must be sound. Make sure the business has a summary of debt, revenues, expenses, and future projections, and that they are all accurate.
4. Startup’s priorities to be aligned with investors: In general, revenue based financing enables consistent and stable growth multiples for investors instead of high returns in equity based fundraising, i.e. 2x-5x in revenue based vs ~10x to even more in equity based financing. In such cases, an investor should be comfortable with the multiple, and the startup should be able to guarantee the returns without compromising on its growth. 
5. Though this is not necessary, it might be an advantage if the startup operates in a well-established and generally stable market. This ensures that the investor will get a portion of the revenues consistently.

How to assess revenue-based financing?

When analysing your revenue-based financing, take these aspects into consideration:

1. Assess compatibility with the investor: An investor-borrower relationship is long-term and complex in nature. It’s better to get involved with investors who you can trust. Examine your RBF partner’s portfolio and their investment terms. Beyond online sources like websites, get referrals from other startups too.
2. Examine loan conditions carefully: Consider how the loan is structured since it will impact future development. Consider your future growth possibilities, not just the amount and your capacity to pay. Considerations include:
   1. Calculate debt %: When seeking external financing, adhere to the “33 percent Rule,” which states that debt should never exceed 33% of yearly sales. A debt greater than this might put your company in a liquidity dilemma.
   2. Repayment capacity and timeline: Because RBF is based on future revenues, your company’s development may quickly repay your debt. If your gross earnings exceed your debt payment, you may simply return the loan.
3. Check for warrants (if any): Others may seek Warrants. Warrants are the rights to acquire your company’s stock at a future date. For example, a revenue-based financier may ask for 2% ownership in your company at the current price/share valuation. Sometimes lenders hold a “put option” with warrants; you may purchase these shares back from them, but at a high price (again, not a good idea). For long-term control of your firm and future fundraising rounds, preserve as much stock as possible. Also, make sure your investor doesn’t provide warrant-based funds. With no warrants, collateral, personal guarantees, or equity, you will get the best deal ever.

These are some of the primary aspects a startup should consider while evaluating a deal. However, many other factors may come into play based on the situation in context. 

Conclusion

Revenue-based financing offers investors the possibility to earn attractive returns at low risk. However, an investor should be mindful of the dangers inherent in the financing arrangement, since the payback rate is directly proportional to income. If a business’s sales diminish significantly, the payback rate will decrease proportionately. Additionally, revenue-based financing is not appropriate for every startup. The approach is only applicable to startups that generate a considerable amount of revenues. Moreover, a startup seeking revenue-based financing must have good gross margins to secure repayment of the investment. Both investors and startups need to evaluate the scope of executing the deal profitably and decide accordingly.