How Revenue-Based Financing Supports Sustainable Start-Up Growth?
The pandemic has brought about a number of new trends in the Indian financial market. One of them is a new loan type embraced by young companies in the country amidst their struggle to acquire credit. A funding mode widely practised in the US, revenue-based financing (RBF) entered the Indian market in 2020 and has since been popular with start-ups due to their easy availability.
What Is Revenue-Based Financing?
It is a royalty-based funding method of raising capital from lending institutions to finance several business operations. These financiers generally advance a percentage of the business’ projected revenue, which is determined from previous sales records.
Although mostly similar to debt-based financing, the only way revenue-based financing differs is that borrowers do not need to pledge any collateral. Therefore, companies can avail funds without losing any ownership stake to investors. Also, revenue-based funding does not involve interest payments. Instead, investors/financiers continue to receive a periodic share of the company’s income till the pre-agreed amount is paid. This amount is generally a multiple of the original investment.
How Does Revenue-Based Financing Work?
Acquiring a traditional bank loan can be quite troublesome for start-ups without adequate turnover, necessary documents, and assets to pledge. Under these circumstances, these companies can approach revenue-based finance providers to enhance their working capital. Post application, the lending institution will examine the firm’s previous sales value as well as current expenses to decide on the borrowable amount, which is a percentage of its projected returns. The borrower can then utilise this acquired amount to finance business expansion and increase sales, using which they can clear the debt.
It is important to note here that the frequency of regular repayment depends upon the returns generated by a start-up periodically. In case revenue generation slows down for a period, repayment will also be delayed.
How Can Revenue-Based Financing Help Start-Ups Grow?
As already mentioned, the sole reason why revenue-based financing gained popularity in India was start-ups struggling to raise funds via traditional modes. That speaks a lot about why this type of funding is beneficial for new businesses. Here is a list detailing the reasons for validating this statement:
- Easy Eligibility: The primary issue faced by most start-ups while availing loans is the lack of a decent credit profile and necessary documents. Due to this, most lending institutions reject such loan applications. Revenue-based funding comes as a saviour under such circumstances since these financial products come against simple eligibility parameters.
- Risk-free Credit: Businesses do not need to pledge any asset or collateral to avail of revenue-based funding. Novice entrepreneurs lacking high-end tangible assets can easily avail such credit without risking any ownership percentage of their companies.
- Prompt Funding: Most loan providers sanction funds within as early as 3 working days. This makes revenue-based financing an excellent solution during emergency financial crises.
- Flexible Repayment: Start-ups can avail such financial products for long-term usage, which allows them to repay comfortably without straining their finances. Additionally, borrowers enjoy flexibility in terms of the periodic repayment quantum. Business returns can keep fluctuating over time. Since companies make repayments periodically from their returns, the former is directly proportional to the latter. In other words, the greater the revenue, the larger the repayment amount.
- Transparent Loan Terms: Financiers lay out all lending and repayment details in an agreement prior to sanctioning funds. This fine print gives borrowers a clear idea of such terms in advance and prevents discrepancies.
- Low Borrowing Cost: On calculating the actual interest rates charged against this mode of funding, borrowers will find them to be way lesser than those set by other debt-based funding options. The same goes for additional charges. Plus, these interest payments are tax-deductible.
However, to avail these benefits of revenue-based funding, applicants need to make sure their firms meet the basic eligibility requirements.
Who Can Avail Revenue-Based Funding?
Budding entrepreneurs opting for revenue-based financing must look out for the following requirements to avail their required loan amount.
- Previous sales records and projected earnings, both play a crucial role in determining the final sum sanctioned. Companies need to meet the specified minimum limits for both in order to qualify for a sizable loan amount.
- Businesses must have strong profit margins to ensure high and speedy loan repayment.
Once applicants meet the above requirements, they can apply for revenue-based financing with their choice of lender. Entrepreneurs can also turn to platforms like MANDII to that end. Digital marketplaces like that feature business financing options from different financial institutions. They can select one as per their suitability.
Revenue-based financing can be an excellent funding option for new businesses struggling to acquire secured or unsecured traditional business loans. However, as the name suggests, it is a viable means only for companies generating significant revenue to pay off their debts. This is why borrowers must take note of all applicable charges and their profit margins to meet these expenses.