REVENUE BASED FINANCING: Definition, Types & Methods

REVENUE BASED FINANCING

It’s not always easy to get financing based on income to pay for start-up costs or to grow a business. Banks are sometimes hesitant to lend or require a personal loan guarantee. If you can find them, venture capitalists (VCs) or angel investors are looking for high returns and a significant stake in the company. This creates a problematic situation for the entrepreneur. How can you get funding for your company without sacrificing equity or incurring crippling debt? Revenue-based financing may fill the hole for firms looking for a happy medium between the realm of traditional bank loans and the high-stakes game of private equity investments. We’ll look into revenue-based financing for startups and the best companies to see if it’s the best funding option for your business.

What is Revenue-Based Financing?

Startups can get money from investors in exchange for a share of the company’s ongoing gross profits through revenue-based financing.

In revenue-based financing, investors get a regular share of the business’s income until a certain amount is paid back. This set amount is usually a multiple of the initial investment, and it can be anywhere from three to five times the amount you put in.

How Revenue-Based Financing Works

Although an organization that raises capital through revenue-based financing must make regular payments to pay down an investor’s principal, it differs from debt financing in several ways. On the balance still owed, no interest is paid, and no payments are made as planned.

Payments to an investor are directly proportionate to how well the firm performs. This is because payments vary according to the level of the business’s income. If sales drop in a single month, an investor’s royalty payout will be cut. Similarly, if sales increase in the next month, payments to the investor will increase as well.

In revenue-based financing, the investor does not have a direct stake in the company, which is different from equity financing. Because of this, many people think of revenue-based financing as a mix of debt and equity financing.

In some ways, revenue-based financing is similar to accounts receivable-based financing. Accounts receivables-based financing is a type of asset-financing arrangement in which a company uses its receivables, bills, or money customers owe to get financing. The corporation receives an amount equal to the lowered value of the pledged receivables. The age of the receivables significantly impacts the amount of financing received by the company.

When do Companies Look for Revenue-Based Financing Options?

Startups that provide revenue-based financing are appealing to…

  • Early-stage companies want to hire more salespeople.
  • Companies are in the process of releasing a new product.
  • Companies are on the verge of launching a large-scale marketing campaign.
  • A corporation has a well-established market but not one large enough to attract venture capitalists.
  • Owners are unwilling to guarantee a loan or sell equity personally.

Revenue-based financing is an alternative to debt and private equity financing for startups.

  • Debt financing: While debt financing allows owners to retain total control of their enterprises, they must occasionally put up personal assets as collateral—and even then, only for a small amount.
  • Private equity financing: When it comes to financing, founders frequently object to ceding complete control of their company. In exchange, they have access to their financing partner’s resources, network, and experience.

Revenue-based financing falls somewhere in the middle of these two choices. While investors are unlikely to sit on the board of directors or intervene in operations, they have a vested interest in the company’s success and growth that banks do not.

Revenue-Based Financing Companies

Using these advantages and disadvantages, you should be able to decide whether revenue-based financing is a suitable kind of startup finance for your company. Revenue-based financing firms, often known as royalty-based financing firms, provide funding for startups with reliable revenue streams. Companies that provide revenue-based financing provide upfront funding in exchange for a proportion of top-line revenue or a predetermined percentage of each contract.

Revenue-based financing solutions are appropriate for organizations that generate regular, recurring revenue, such as SaaS companies, eCommerce shops, and subscription companies. Using the table below, compare the finest Revenue-Based Financing companies currently accessible.

#1. Lighter Capital

Lighter Capital is a revenue-based financing organization that provides funding to technology companies across the United States. You’ll be a good fit to work with this revenue-based commercial financing organization if you’ve averaged at least $15,000 in monthly revenue over the last three months with gross margins of at least 50%.

Here are the numbers on what you can expect from Lighter Capital’s revenue-based financing:

  • Financing for up to $3 million
  • Monthly payments ranging between 2% and 8% of monthly revenue
  • Repayment limitations range from 1.35 to 2

#2. GSD Capital

GSD Capital, another top revenue-based financing organization, works with early-stage SaaS companies in the United States’ mountain west region.

Granted, GSD deals only with a particular subset of borrowers but also provides some of the best revenue-based financing conditions. Furthermore, they may fund qualifying customers with revenue-based financing in as little as 30 days, which is quite speedy for this form of funding.

Despite their limited reach, GSD Capital is worth noting for the following terms on revenue-based financing:

  • Financing ranges from $200,000 to $1 million.
  • Monthly payments ranging between 3% and 8% of monthly revenue
  • Repayment caps ranging from 0.4 to 0.6 during three years

#3. SaaS Capital

SaaS Capital differs from Lighter and GSD in providing a line of credit based on monthly recurring revenue (MRR).

This means the revenue a company can borrow is determined by how much money it produces each month. Furthermore, SaaS Capital only works with a particular subset of businesses: B2B SaaS companies based in the United States, Canada, or the United Kingdom with at least $250,000 in monthly recurring software revenue.

If you meet these requirements, SaaS Capital can provide you with the following benefits:

  • Loan amounts ranging from $2 million to $12 million
  • Up to five-year repayment terms
  • Interest rates range from 12% to 14%

Revenue-Based Financing Example

As you can see, revenue-based financing for startups may be complicated, particularly when compared to more traditional sources of financing. To further understand how this form of financing works, consider the following example:

Assume you have a startup company that requires $100,000 in funding. Your monthly sales revenue averages around USD 25,000.
You find an investment company willing to give you this money through a revenue-financing contract with a maximum payback of 1.3x. This amounts to a total payment of $130,000 for this capital.

Your arrangement’s monthly revenue percentage is 5%; therefore, your average repayment will be 5% x $25,000—or $1,250 per month. In this example, we’ll suppose that your monthly sales remain at $25,000 and that it will take you nearly nine years to repay the money you borrowed.

Although this example illustrates how revenue-based financing works, it’s crucial to note that this business funding frequently requires significantly more significant sums of money and monthly income than the numbers we’ve used here.

Pros and Cons of Revenue-Based Financing

Like any other funding method, revenue-based financing for startups has advantages and disadvantages.

Pros

  • It is less priced than competing products. It is less expensive than equity-based options. Other finance methods, such as angel investors and venture capitalists, require 10 to 20 times the return. Furthermore, companies that provide revenue-based financing are engaged in your success because the monthly payments they receive grow as your firm grows.
  • You can keep control. You will retain ownership and management of your firm and your equity with financing. Investors will not gain influence through board seats, etc. Thus you must select the path of your company.
  • The monthly payments are adjustable. Slow months will not affect your ability to pay because monthly payments are based on revenue. Your costs are linked to your revenue and, with careful planning, should remain manageable.
  • You are not required to guarantee the loan personally. Bank loans, for example, require you to guarantee the loan, placing your assets at risk. That commitment is not required for revenue financing.
  • You’ll be able to raise funds more quickly. You won’t have to make multiple pitches to get the money you need with revenue financing. Most lenders make decisions and provide financing within a month.

Cons

  • You must generate revenue. Because a business must make money to use this financing option, it is not appropriate for startups that do not have a consistent income stream.
  • Less money is available than with other types of financing. Some funding choices, such as venture capitalists (VCs), are well-known for aggressively investing in enterprises. Revenue-based financing gives a business three to four months of recurring monthly revenue.
  • Monthly payments are required. You must make the monthly payment nonetheless. Businesses that are low on funds should think about this.
  • There is little regulation in this industry. Because it is poorly regulated, you must conduct thorough research before entering into any deal to avoid a predatory loan.

Is Revenue-Based Financing for Startups Right for You?

Revenue-based financing is not appropriate for every business. Consider the following before proceeding:

  • Your organization should have a consistent revenue stream from which to collect debt service payments.
  • Your company should operate in a substantial and well-established market.
  • Your financial situation should be in order. Check that your debt, revenue, operating expenses, and future predictions are all correct.

Before you give your business any financing, you need to figure out its long-term obligations. A loan is a loan, and repayment is required. When it comes to financing, it may appear like fewer strings are attached, but using it carelessly is a prescription for disaster.

“It’s flexible, but it’s still a loan,” Lackland explained. “You must be prepared to bear such responsibilities.” “We strive to be gentle on businesses, but we are a capital provider committed to our investors.”

Nonetheless, revenue-based financing is another tool in the entrepreneur’s toolbox, helping you build your organization, hit your stride, and reach the next level—without putting your assets at risk or selling off a portion of your business.

What are the three methods of financing?

When it comes to financing, many business owners still turn to known, traditional solutions, and there are three basic options.
It is possible to accomplish this by:

  • using internal funds
  • organizing debt finance
  • arranging equity finance.

What is a revenue-based program?

Revenue-based financing can assist businesses in obtaining cash without paying interest or losing equity. With this financing, a company commits to repaying the cash with a share of its future revenues up to a certain amount.

What is the revenue financial model?

A revenue model is a structure for creating monetary profit. It determines which revenue stream to pursue, what value to provide, how to price the value, and who pays for it. It is an essential part of a company’s business model.

What are the 3 main types of revenue models?

Subscription, licensing, and markup are all common revenue strategies. The revenue model assists firms in determining their revenue production strategy, such as which revenue sources to prioritize, target customer understanding, and how to price their products.

What are the 4 types of revenue?

Rental revenue. Dividend revenue. Interest revenue. Contra revenue (sales return and sales discount)

What are the 5 revenue models?

5 Effective Ecommerce Revenue Models:

  • Sales Revenue Model. 
  • Advertising Revenue Model.
  • Subscription Revenue Model. 
  • Transaction Fee Revenue Model. 
  • Affiliate Revenue Model.

What are the five benefits of revenue management?

The Benefits of Revenue Management: An Inside Look;

  • Understand your client’s expectations.
  • Divide the market into segments.
  • Set a competitive price.
  • Encourage collaboration.
  • Get rid of manual processes.

Conclusion

Revenue-based financing offers a possibility for investors to earn profitable returns. Nonetheless, because the payback rate is directly related to revenues, an investor should be mindful of the risks associated with the financing arrangement. If the company’s revenues fall significantly, the payback rate will fall accordingly.

Furthermore, the revenue-based financing model is not appropriate for every business. The approach only works with companies that generate a considerable amount of revenue. In general, revenue-based financing works well for SaaS companies.

References

0 Shares:
Leave a Reply

Your email address will not be published.

You May Also Like