Is Revenue Based Financing The Best Fit For Your Business?

  • Lates_blog
  • 03 Nov 21
  • Revenue Based Financing
Revenue based financing has emerged as a popular alternative financing option for start-ups and small businesses. The global market for revenue-based finance is growing at a CAGR (compound annual growth rate) of 6.18% between 2020 and 2027. Valued at $901.41 million in 2019, its market size is projected to reach $42 billion by 2027.  Revenue based financing provides small businesses with an easy and quick way to raise funds. Companies can also use the MANDII app to get funds online in just 30 minutes. MSME Atma Nirbhar and Development Initiative of India (MANDII) is a marketplace platform made by companies like KredX to provide collateral-free financing for MSME and start-ups. 

A Brief Overview Of Revenue Based Financing

Revenue-based financing (RBF) is a type of capital raising process where investors agree to provide funds in exchange for a certain percentage of a company's gross profits. The company raising funds via RBF needs to make periodic payments to these investors until a predetermined sum is compensated.  Sometimes called royalty-based financing, RBF allows founders to raise funds without diluting their equity holdings or placing assets as collateral. Moreover, it provides them with an easy and quick method of raising funds to maintain cash flow requirements and make expansions.  Unlike most debt financing options where one has to make regular repayments, repayments in RBF happen as a percentage of monthly revenue. This ensures that a company has sufficient capital to deal with its short-term needs.  Unlike equity-based investment methods, RBF does not require owners to transfer their stake. They also do not have to provide investors seats on the board of directors. This allows them to keep full ownership of their company and be free to make independent decisions.

How Does Revenue Based Financing Work?

Suppose the CEO of a company (say ABC) requires around Rs. 1 crore of funds for an expansion. If ABC already has pending debts, it will not be able to acquire these funds from banks. Moreover, if the shareholders of ABC do not agree to dilute their stakes, the company will not be able to get equity-based financing. That is when ABC will turn to a financial institution (say XYZ) for revenue-based financing. XYZ will check past revenue statements and do a thorough credit analysis to project ABC’s future earnings and decide the terms based on this data. Let us say they make an offer to lend Rs. 1 crore funds upfront, with a 20% revenue share and total fees of 10%.  This means that ABC will have to repay 20% of its revenue (monthly/quarterly) till it repays a total of (Rs. 1 crore + 10% of Rs. 1 crore) Rs. 1,10,000. 

Benefits of Revenue Based Financing

The following are some of the main advantages of revenue-based financing:
    • Owners Can Retain Control: RBF may be similar to equity-based financing in that it lets outside investors provide funds. However, unlike VC (Venture Capitalist) funds, the investors don’t get a stake in the company or a seat on the board of directors. 
    • Quick Access To Capital: RBF comes with lenient requirements such as no need for a high personal credit score or business experience. Lenders like KredX only require proof of ownership and past balance sheets to quickly process these funds
    • Payment As Per Revenue: RBF has the most flexible repayment option as the company has to make repayments as a percentage of revenue. This means that its debt payment is always less than its monthly income.
    • A Desire For Steady Growth: Unlike VC funds, RBF investors have an interest in the early success and steady growth of a company. As it will receive higher repayments for higher monthly revenue, these investors will provide genuine help and advice.

The Right Time To Apply For Revenue Based Financing?

Revenue based financing is ideal for businesses in the following situations:
  • Confirmed Demand For Product:
Steady sales and growth in profits is a good situation where one can take the risk of high-value financing. It is advisable to look at six months of revenue data for consistent growth before making this decision; otherwise, one may not be able to make the large repayments.
  • Need For Additional Funds
Foie Gras effect refers to using jumbo-sized funds and still not being able to gain success. Only companies who have good reasons to get mega-funding and plans for long-term growth should opt for RBF. 
  • Fast Track Growth
Companies on a fast track to success can opt for revenue-based financing. This lets them raise enough working capital to continue expansion without selling its highly valuable shares to outside investors.

Bottom Line

Revenue based financing provides a middle-ground option between debt funds and equity-based funds. Its accessibility and flexible repayment features make it an effective finance tool for entrepreneurs to grow their companies without diluting their stakes. However, CEOs should remember that RBF is not suitable for every company. It works best for companies that earn sufficient revenues and have strong growth margins as it ensures their repayment capacity.