Today’s dynamic market has proffered several advantages to companies, making it easier to run a business with minimum hindrances. Perhaps the most significant advantage in this regard has been the availability of finances. It is now easier than ever to access external capital, all credits to the flourishing financial ecosystem.
Alongside traditional alternatives like stocks, enterprises today have recourse to options like revenue-based financing as well. Hence, it is essential for businesses to learn how these facilities differ. They can make a better decision that way and optimise their financial position.
Revenue-based financing allows companies to acquire capital based on their current monthly or annual revenues. Also known as royalty-based financing, investors who pour their capital, receive a share of the company’s profit until it has repaid a specific sum.
It is a relatively new mode of financing that has emerged in different parts of the world and is widely prevalent among start-ups, because of its non-dilutive nature. It may seem similar to debt financing in some ways but is distinct in that, since companies do not need to pay a fixed sum. Rather, payments are made based on how well a company is performing.
In this mode of financing, companies dilute a portion of their equity and issue stocks. Primarily, these equity shares are traded on stock exchanges, but institutional investors can also buy these stocks. Usually, companies that opt for equity financing are public limited companies, but private businesses can also sell their shares to external investors.
There are several types of instruments that enterprises can use to avail capital via equity financing, including –
Enterprises that issue stocks provide dividends to their shareholders. However, they’re not bound to disburse dividends regularly in the case of common stockholders and can do so, when they make sufficient profits. The incentive enjoyed by the investors is usually the change in stock prices, which denotes their income.
The following table lists the points where these two financing options differ.
|
Basis Of Difference |
Revenue Based Financing |
Equity-Based Financing |
|
How it is availed |
A company raises capital against its future earnings. Investors base their decision on the business’s current revenues. |
Companies issue stocks, which represent a part of its equity, to the investors. Each stock unit is priced at a certain amount, typically determined by market fluctuations. |
|
Ownership dilution |
Businesses do not need to dilute their ownership in this mode of financing. |
Companies need to dilute their equity every time they issue new shares. |
|
Investor rights |
Investors are only eligible to receive a return on their capital. |
Common stockholders are owners of a company, and hence, enjoy voting rights. |
|
Returns |
Companies disburse monthly pay-outs to investors, which is usually a percentage of its revenues. The repayment amount is a multiple of the invested sum. This additional amount compensates investors for the risk they have shouldered. |
Businesses need to pay dividends on stockholding. Such dividends can be disbursed yearly or in-between as well. Returns from common stocks primarily comprise an increase in share prices. |
|
Liability |
Companies are usually liable to pay instalments every month. This liability ends when it repays the due amount in full. |
Companies are not liable to pay dividends to their shareholders. However, they shall share profits as per holdings to improve the appeal of such shares. |
It entirely depends on a company’s capital requirements, and preference of its owners. A major downside to equity financing that deters companies from it is, they have to give up a portion of ownership, which means agreeing to relinquish a share of profits and voting rights.
Revenue-based financing also comes with a similar clause of repayment from the business’s earnings. However, it’s not for a lifetime and does not involve sharing any ownership rights.
Hence, owners of a company often prefer revenue-based financing to keep their stakes intact. Another advantage of this financing option is lesser tax outgo, and therefore, a higher margin in EPS.
That’s because repayments made for revenue-based financing are deducted from an enterprise’s net profit, before taxation. Thus, the tax paid by a company is lower, which leaves a higher yield to be shared among stakeholders.
Businesses can regulate their costs by mixing both options to strike an optimal balance between interest outgo and tax liability. Companies can opt for KredX’s Revenue-based financing to get access to growth capital.
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