18 Nov Is Revenue-Based Financing Right For Your Company?
Moving away from traditional loans for revenue-based financing (RBF) can be exciting and overwhelming. You may be ready for a solution that works with the ebb and flow of your income, but still want to be sure that it’s the right option for your business. We get it. That’s why this guide breaks it down so you can make a fully informed decision before jumping in.
What Is Revenue-Based Financing?
With revenue-based or royalty-based financing, you receive a lump sum of capital in exchange for a percentage of your future revenues. You make payments until you reach a pre-agreed total amount. Instead of paying fixed monthly installments, you repay a small percentage, 2-10%, of your monthly revenue.
Revenue-based means your payments rise and fall in line with your income. Say you pay 10% of your earnings to your business cash advance loan. If you only earn $25,000 in your slow months, your payment will shrink to $2,500. When business picks up and you make $85,000 a month, your repayment increases to $8,500.
Instead of traditional interest, RBF uses a fixed repayment multiple to calculate your borrowing cost. This factor rate is usually between 1.2 and 1.6 times your funding amount. So if you receive $100,000 in funding with a 1.4 repayment cap, you’ll repay $140,000 through a percentage of your revenue.
Revenue-based financing companies usually offer a variety of products, such as merchant cash advances, invoice factoring, variable collection financing, and short-term working capital loans. Each option has slightly different terms and uses, but follows the same general guidelines as all revenue-based loans.
What Are the Benefits?
You might have been looking for something different than a traditional loan when your business grows or has seasonally fluctuating revenue. Revenue-based financing stands out from other funding options in several ways. Here are some of the benefits of RBF:
1. Cash Flow Flexibility:
Flexibility is the number one draw to revenue-based financing. Since repayments increase and decrease with your revenue, you avoid overcommitting during slow seasons. You can preserve working capital and give yourself breathing room.
2. No Equity Dilution:
Unlike venture capital or angel investment, RBF doesn’t require giving up ownership. It’s a form of debt financing. You retain complete control over your business while accessing necessary capital.
3. Simple Qualification Criteria:
Rather than collateral or credit scores, lenders usually focus on a predictable and significant revenue history for RBF products. That means you can access funding even if you’re a newer business or have limited hard assets.
4. No Fixed Repayment Schedule:
You can close your revenue-based financing once you have paid back the set repayment cap, even if that’s months sooner than expected. Without a rigid repayment schedule or prepayment penalties, this funding option makes it easier to reinvest in your businesses when sales are up and you’re ready to scale.
5. Fast Access to Capital:
RBF providers typically use simpler applications and underwriting processes to approve and fund your business in a few days. It’s ideal funding for a time-sensitive opportunity or unexpected challenge.
What Are the Drawbacks?
Nothing is perfect, and RBF comes with its own challenges. You can avoid any long-term strain on your business by going into a revenue-based loan with your eyes open. Here are some of the key downsides to keep in mind:
1. Higher Annual Borrowing Cost:
Because you’re paying back a fixed multiple regardless of how fast or slow the repayment happens, you may pay a higher borrowing cost per year with RBF than you would on a traditional loan. It might not save you money if you plan on repaying the financing in 12 months or less.
2. Limited Use Cases:
Depending on your industry and the lender, you may only be able to use RBF to fund projects that impact the specific revenue streams contributing toward repayment.
3. Repayment Caps Can Hurt Cash Flow:
Even though payments flex with your revenue, you still spend 2-10% of your income on your financing. That repayment can hurt your cash flow when margins are tight, or even limit your available capital to reinvest in your business. After all, your payments increase to match your income even when sales are up.
4. End Date Clauses:
Most RBF comes without a set repayment period, but some lenders and products have end dates. That means you must have repaid the total amount before the two to five years are up, or you default on the loan. Before agreeing to the terms, you should know if you’re dealing with one of the few RBF products with an end date.
5. Revenue-Based Qualifications:
Providers prefer predictability and may deny funding—or offer less favorable terms—if your sales history is erratic. RBF might not be a good fit if your revenue is inconsistent, highly project-based, or tied to large, infrequent contracts.
When Does Revenue-Based Financing Work Best?
Revenue-based financing works well for any enterprise with recurring, predictable income. Industries like e-commerce, SaaS, food and beverage manufacturing, health and wellness brands, and education platforms increasingly rely on RBF for capital.1>
Consider revenue-based financing if:
- You generate consistent monthly revenue
- Your profit margins could handle a 10% dip
- You expect steady growth or seasonal spikes in income
- You want fast, non-dilutive capital to grow your business
- You’re unwilling to pursue traditional loans or equity rounds
- You have limited collateral or credit history
Go into RBF with your eyes open. Based on your current financials, model repayments to determine if you can afford to pay a regular percentage of your revenue toward a loan. Run optimistic, conservative, and worst-case scenarios to see how long it will take to reach the repayment cap and your annual borrowing cost.
Take the time to vet your revenue-based financing provider, too. Finding a reputable RBF company specializing in your industry and region is an excellent step toward securing the right funding. For example, a farm-to-table restaurant in Illinois will likely secure a workable revenue-based loan and professional insight through nonbank lending experts in Chicagoland who understand local businesses.
You get the most out of RBF by knowing how this structure fits your revenue cycle and working with a professional who understands financing for your business model.
Look Before You Dive In
Revenue-based financing offers a refreshing alternative to traditional loans and equity fundraising, like a cool body of water. And, like with diving into a pool, you want to look carefully at the RBF. Evaluate the expenses, compare multiple offers, find a fitting lender, and ask the right questions. Then you can confidently jump into fast, flexible funding to refresh your business for new growth.
1https://techcrunch.com/2021/01/06/revenue-based-financing-the-next-step-for-private-equity-and-early-stage-investment/