How Is Revenue Based Financing Different From Other Financing Options?

For every early and mid-stage business, financial growth is crucial to ascertain profitability. To obtain that financial stability and growth, these companies need to take their business to the next level through an influx of capital.  Most start-ups are cautious while choosing the right financing option because one wrong decision can lead their business into multiple problems, such as debt trap, strict repayment schedules, and impractical growth expectations.  To diverge from such complications, many businesses are inclining towards non-dilutive options like revenue-based financing. Such financing offers increased flexibility and allows businesses to grow at their own pace.

Why Choose Revenue Based Financing?

Revenue-based financing offers a more realistic approach to meet a flourishing company’s financing goals. Certainly, those at the beginning of their financial journey might question the credibility of this funding option and would consider traditional funding options like bank loans.  Although, banks have become increasingly hesitant to lend to small businesses due to more stringent federal regulations. In the same way, companies with insufficient collateral, poor profit generation, inconsistent cash flow, and a negative debt-to-income ratio cannot qualify as a credible borrower for banks. This is the reason why most entrepreneurs are turning towards alternative funding options. And revenue-based financing is one such ‘safe’ option.  Revenue-based financing is adherent to non-dilutive funding, meaning that the borrower here is not required to give up the enterprise's ownership. Moreover, new companies can scale up their business with uninterrupted cash flow by choosing KredX’s revenue-based financing. 

How Does Revenue Based Financing Work?

Below is the process through which the funding option works:
  • Initially, a company approaches a revenue-based loan from a lender, like a BDC (Business Development Company) or a private equity firm. 
  • After that, both the borrower and the lender agree upon a principal investment amount.
  • The company then repays the loan through a fixed percentage of its monthly revenue.
Important Points To Note
  • Unlike other types of loans, a target repayment date is not set for revenue-based financing. This is because the monthly repayment depends upon the amount of revenue generated by the borrower. In case a company experiences slower profit generation, the instalments will be less. Similarly, when the revenues are more, a company will make quick repayments.
  • Before loan approval, investors assess all related expenses associated with the purpose that a business is trying to fund. They also consider the revenue a company will most likely generate to reach a fair repayment percentage.

How Is Revenue Based Financing Different?

Revenue-based loans are different from both equity and debt financing. Debt financing involves higher risk as the borrower needs to repay the loan within a fixed date. Meanwhile, equity financing needs no set repayment date, but it dilutes its shares to lenders. Conversely, revenue-based financing entails the most favourable features of both debt and equity funding. Here, owners do not need to sacrifice their ownership, and there is also a lower risk as the repayment date is not fixed.  It is now evident that the revenue-based funding option is particularly beneficial for SaaS companies. Such enterprises can explore new markets, formulate growth techniques, and improve their services as a whole. Further, flexible funding can significantly help these companies establish a market presence without the outsized growth for venture capital.

Benefits Of Revenue Based Financing

This attractive method of capital generation entails several benefits, including:
  • No Collateral
RBF requires no personal collateral against the loan, unlike traditional bank loans. This saves borrowers from risking any of their assets.
  • Quick Capital Generation
Revenue based funding loan approval depends upon a company's monthly recurring revenue (MRR). Additionally, revenue-based financing entails lenient requirements, with no credit score or experience required from the borrower’s end. 
  • Offers Mutual Incentive
Investors in RBF have a mutual incentive for companies producing early revenue in investment, unlike VC investors. VC investors invest a large amount of cash up-front but fail to see any returns until the end. In the case of RBF investors, the incentive totally lies upon the revenue of the company. Meaning, the more the revenue, the higher their monthly percentage. 
  • Payments Also Reflect Revenues
Since the repayment schedule is based on monthly revenues, the payments directly reflect a company's revenue. A borrower may witness a month where debt payment will exceed monthly income.

Bottom Line

The alternative lending space has widened during the past few decades for small and mid-sized businesses. Since revenue-based financing requires no ownership control of the company, more and more start-ups are finding this funding option appealing.  With this alternative funding option, companies can look out for growth opportunities at a commendable pace and are not held back by venture capital firms. Start-ups can also approach online platforms like KredX for revenue-based financing without diluting their equity. In addition, entrepreneurs must note that this financing option is not an ideal choice for all companies. The model works effectively with companies generating steady revenue. Moreover, companies aiming to rely on revenue-based financing should have strong gross margins to secure their repayment capacity.