What is Revenue-Based Financing?
Revenue-based financing, also known as royalty-based financing, is a type of capital-raising method in which investors agree to provide capital to a company in exchange for a certain percentage of the company’s ongoing total gross revenues. It is an alternative investment model to more conventional equity-based investments, such as venture capital and angel investing, as well as debt financing.
Revenue-based financing, sometimes referred to as royalty-based financing (or RBF), is a type of business funding in which a company secures capital from investors and these investors receive a certain percentage of the business’s future monthly revenues in exchange for their initial investment.
The investor or financing firm will claim the agreed-upon monthly revenue percentage until a predetermined amount has been paid.
How does Revenue-Based Financing work?
There are firms that specialise in revenue-based financing. To start with, these companies look at parameters like revenues, cash flows, operating margins, scalability and growth potential among other things as part of their due diligence. Once convinced with the potential borrower’s prospects, they lend the required capital at a mutually decided rate of interest or fee. Interestingly, this is quite similar to how an angel investor or even a VC would function, but what makes revenue-based financing different is the manner in which the funds are repaid by the borrower. The borrower commits to sharing a part of the business revenue with the lender. In other words, both the principal and the fee or interest that the lender charges, is returned from the revenues that the company earns during the normal course of the business.
Here are the characteristics of typical revenue-based financing,
- Structured as a loan with a principal amount, a fixed fee of 4 to 8% and no interest
- As the financing is provided against future revenue, it does not require any collateral or equity dilution
- The monthly repayment is made as a percentage of future revenue (usually 5% to 20%) based on your requirements
- The maturity period of RBF is a function of your actual revenue trajectory, typically modelled for less than 6 months
6 Steps to Get Revenue-Based Financing to Start a Business
- Know The Reason And Amount for the Revenue-Based Financing
- Decide the Type Of Structure You Need
- Compare Financing Firms
- Check Your Qualifications
- Gather the Necessary Documents
- Apply For RBF
Benefits of Revenue Based Financing
Here are the top five benefits of revenue based financing:
- Minimal Credit Requirements – A business owner’s requires a minimum CIBIL score of 550 to qualify for this type of funding. This enables the un-bankable business owner to acquire the funding needed even with having personal credit challenges.
- No Collateral Required – While many conventional business loans require some form of collateral, revenue based financing doesn’t. Although rates are slightly higher than traditional bank rates the fact that no collateral is required makes it an attractive funding program for many business owners.
- Short Financing Terms – With this type of financing terms range from 4-18 months enabling a business to pay off the loan in a much shorter period of time.
- Simple Application Process – Unlike the long and excessive amounts of information required with a traditional bank application; a revenue based financing app is a simple one page application. The only other documentation required is the company’s past 3 month’s bank and merchant services statements.
- Quick to Fund – Once the application is submitted funding can take as little as 7-10 days making it an extremely fast and convenient way for a business owner to get access to funds in a hurry.
Pros of Revenue-Based Financing
1. Cheaper than Equity
With expectations for 10X-20X returns, Angel and VC funding are the most expensive sources of capital possible if your startup is successful.
2. Retain more Ownership & Control
When it comes to revenue-based financing (RBF), investors generally do not take equity. As a result, there is no ownership dilution to founders and early equity investors. In addition, RBF investors do not take board seats or place difficult financial covenants on a company. Founders are able to maintain control and direct the company towards their vision.
3. No Personal Guarantees
Bank loans require personal guarantees from founders based on the high-risk nature of startups. This requires founders to put their personal assets, such as a house or car, on the line. Founders can breathe easier under RBF knowing that no personal guarantees are required.
4. No Large Payments
Monthly payments are based on a percentage of your monthly revenue. This means if you experience a bad month, your monthly payment will reflect that and you are not burdened with a large payment you can’t afford.
5. Faster Funding Timeline
Pitching to venture capitalists can take anywhere from months to years before securing a deal. Since RBF investors do not require companies to achieve hyper-growth or large equity exits, lenders can provide funding in as little as four weeks.
Cons of Revenue-Based Financing
1. Revenue Required
Because this form of financing is revenue-based, pre-revenue startups are generally not a fit. A revenue-based investor uses metrics such as MRR/ARR and growth projections to determine eligibility for a loan.
2. Smaller Check Sizes than VCs
Venture Capital is known for shoveling out enormous amounts of cash for companies, even if they are pre-revenue. Investors in RBF deals will not provide capital that is worth more than 3 to 4 months of a company’s MRR. However, RBF investors may choose to provide follow-on rounds as a company grow, providing entrepreneurs access to more capital over time.
3. Required Monthly Payments
RBF requires monthly payments unlike equity financing. Startups may find themselves tight on cash, so it is crucial to take on a healthy amount of revenue-based financing that aligns with the company’s financial status and plans.
Revenue-based Financing vs. Venture Debt, Venture Capital & Bank Financing
RBF seems similar to venture debt as investors are entitled to regular repayments of their initially invested capital. However, RBF does not involve interest payments. Instead, the repayments are calculated using a particular multiple of the startups revenues that results in returns that are higher than the initial investment. In addition, unlike venture debt which only invests in companies that have raised capital and relies on an equity cushion for underwriting, RBF can be used for bootstrapped companies as well since the underwriting process is more comprehensive and data driven. More importantly, venture debt, can at times, creates equity dilution while RBF is non-dilutive for the companies.
As compared to equity-based venture capital, there is no transfer of an ownership stake to the investors in RBF. Also, in this type of a financing model, entrepreneurs are not required to provide investors with a seat on their board. More importantly, unlike venture capital which only funds companies with a potential of a high return at least 10x of the invested amount, RBF can be applied to a much broader universe of companies.
In the case of bank/NBFC lending, there are a significant number of regulatory constraints. Whereas in the case of RBF, a company is typically not required to provide any collateral to investors as compared to traditional debt financing by a bank/NBFC where collateral in most cases shall be required by the lending institution. For businesses with seasonal revenue profile, RBF gives them the flexibility to pay as a share of their revenue instead of a fixed amount every month in case of bank/NBFC lending.
Revenue-based Financing vs. Debt and Equity-based Financing
Revenue-based financing seems similar to debt financing because investors are entitled to regular repayments of their initially invested capital. However, revenue-based funding does not involve interest payments. Instead, the repayments are calculated using a particular multiple that results in returns that are higher than the initial investment. Also, in revenue-based financing, a company is not required to provide collateral to investors.
Unlike equity-based investment models, there is no transfer of an ownership stake in a company to investors. However, it is common that some equity warrants may be issued to investors. Finally, in such an investment model, a company is not required to provide investors with seats on the board of directors.
Top 3 Financial Institutions offering Revenue Financing
1. Bank of Baroda
Bank of Baroda (BOB) is a renowned public sector bank that offers business loans and MSME loans to self-employed professionals, MSMEs (Micro, Small and Medium Enterprises), corporates and business owners. Various other types of business loans offered by the Bank of Baroda are Working Capital, Term loans, MSME loans, Bill discounting, Overdraft, etc.
Omozing helps make Smart Money Moves for a Lifetime. They strive to get lowest interest rates and best terms for your Online Applications at www.Omozing.com . We’ve made business lending smarter, faster and easier by transforming the approval process from stumbling blocks to stepping-stones. This enables borrowers to not just get access to capital, but also understand what areas they need to work on in order to enhance their credit profile. Omozing ensures that Borrowers get a secure, safe and reliable application process that be tracked online.
3. ICICI Bank
ICICI Bank is a leading private sector bank in India. It caters to individuals, startups, as well as existing businesses and offers business loan interest rate from 18% onwards per annum.
Revenue Based Financers in India
- Klub takes a marketplace approach to RBF by working with both institutions (banks/NBFCs) as well as individuals to provide capital to loved consumer brands. Klub is India’s leading RBF player and provides capital in the range of Rs. 5 lakhs to Rs. 5 cr. to consumer brands for a tenure of 3 months to 18 months.
- Since its launch post-Covid in July, Klub has evaluated over 400 brands and has built a capital base of multiple million dollars from its patrons and partners
- 40% of the brands funded by Klub have availed or are in discussions for their 2nd or 3rd investment from Klub
- 40% of the brands funded by Klub have at least one women co-founder
- One of the first revenue based financing platforms in India, Getvantage facilitates growth stage businesses to fund their digital spends for a fraction of future revenues. They cater to companies with a digital-first approach.
- Capital advances between ₹20 lakh to ₹2 crore
- No interest %, no equity dilution, and no hidden charges
- Just one flat fee that’s recovered as a small share of future revenues