Disclaimer: Information in the Business Financing Blog is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the Business Financing Blog often covers financial products that Biz2Credit does not currently offer.
We all know that small businesses form the crux of the American economy. As foot soldiers of the economy, they carve out a path to economic resilience and prosperity, ensuring that America’s financial future always remains solid and stable. Yet, their path to success is riddled with challenges – right from funding to planning to hiring. They struggle to get the financing they need for their growth, as traditional banks are not always flexible enough to come to their aid. Hence, a lot of small businesses fail to grow and thrive, unlike their big-name competitors.
But not everything is lost! In the last few years, alternative funding options have been tailored for small businesses. One such option is revenue-based financing, which has become popular with entrepreneurs and startups.
It allows borrowers to raise money by repaying investors with a percentage of their future revenue rather than fixed monthly payments or equity stakes. It also ensures that businesses do not run out of working capital when they need it the most.
Sounds interesting, doesn’t it? No wonder there has been an increase in the application of revenue-based financing in recent years. But before you get excited, let’s understand exactly what revenue-based funding is, how it works, what it can be used for, and finally, whether it is the right kind of financing for you.
3 Key Takeaways
- Revenue-based funding provides flexible financing options to small businesses and startups without sacrificing equity. The repayment is linked to a company’s monthly revenue.
- With faster and less stringent application and approval processes, they provide access to speedier cash without requiring collateral.
- This financing model suits businesses with variable or fluctuating revenue streams such as e-commerce, SaaS companies, media, etc.
How Does Revenue-Based Financing Work
A truly revolutionizing funding option, revenue-based financing (RBF) offers small businesses and startups an attractive alternative to traditional financing methods. RBF’s adaptable repayment structure suits businesses with fluctuating revenues by allowing companies to raise money instead of a percentage of their future income rather than fixed monthly payments or equity stakes. Since this financing type is often processed faster than traditional bank loans, working capital can be made available more quickly, making it perfect for businesses with urgent capital needs. Another feature of RBF is that it does not require collateral or personal guarantees, making it easier for businesses without significant assets to seek necessary funds.
Mechanics of Revenue-Based Financing
With this type of financing (also known as royalty-based funding), after deciding on the initial investment amount, the lender charges a fixed fee on the principal amount, calculated as a percentage of future revenue, to be repaid by the borrower. This percentage is usually between 3%-8%, depending on the agreement. RBF stands apart from traditional business loans because it adapts to the company’s revenue cycle – increasing during peak periods and decreasing during slower ones. In short, the payments are directly proportional to the company’s monthly revenue growth.
This funding is also different from other alternative financing options. Unlike Merchant Cash Advance (MCA) loans, which are paid back from credit/debit card sales, RBF considers total sales and offers a more flexible repayment term. It is also different from a line of credit loan, which allows borrowers funding up to a certain limit with repayment based on usage. With RBF, the focus remains on the revenue rather than credit scores, making it easier for the borrower to qualify for the loan. But keep in mind that interest rates are typically higher with revenue-based loans. So, while selecting a funding option, businesses must consider the trade-offs between flexibility, accessibility, and overall expense.
Understanding Revenue-Based Financing (RBF)
Before we talk about the best use of revenue-based financing, it is important to understand what underwriters look for in candidates and businesses when assessing RBF.
Who Should Apply for Revenue-Based Financing?
As mentioned before, revenue-based funding is suitable for businesses with high-profit margins, certain startups, and businesses experiencing cash flow problems yet maintaining a steady recurring revenue. Borrowers who are unable to apply for traditional business loans due to poor credit history or lack of significant assets can also qualify for this type of financing. As RBF depends on immediate revenue, any company just starting out or in the pre-revenue stage of the business should skip this funding option.
What Can Revenue-Based Financing Be Used for?
The capital from RBF can be used to drive growth and innovation in small businesses and startups. From scaling operations to purchasing inventory to hiring additional staff, RBF can act as a catalyst to drive business growth to the next level. Here are some more ways to use funding from RBF:
- Scaling Operations – By providing the capital to expand the operations quickly, RBF helps businesses grab market opportunities and increase their customer base.
- Fostering Growth-Oriented Mindset – As RBF repayment is linked to revenue, it encourages small businesses and startups to focus on revenue-generating activities, resulting in a growth-oriented mindset.
- Effective Cash Flow Management – The flexibility offered by this type of funding helps businesses handle their cash flow more efficiently, ensuring they do not experience financial strain during slow periods.
Industries That Benefit from Revenue-Based Financing
This alternative form of funding benefits many businesses, but a few still flourish.
- Technology and SaaS:
With fluctuating revenues and a frequent need for capital for rapid scaling, technology and SaaS companies require the flexible funding that RBF offers. This form of financing allows the companies to invest in growth without giving up equity or facing fixed repayment schedules.
- E-commerce:
This loan works well for online retailers as the capital can be used to manage their revenue fluctuations during the off-season and investment in growth opportunities during the peak ones. They can stock up on inventory and save up on ad spend for the peak season, then quickly pay off their loan with the revenue they make.
- Subscription-Based Services:
As these companies receive monthly or periodic payments, they know exactly how much revenue they will make each month. This pattern and low overheads make it easier for them to make monthly payments.
- Healthcare and Biotechnology:
A lot of companies in these sectors need quite a heavy upfront investment for their R&D. Here, RBF comes into play by providing them with the required amount without sacrificing equity and linking repayments with future revenue from product sales or partnerships.
Step-by-Step Revenue-Based Financing Process
RBF works in four key steps and borrowers must pay attention while completing all these stages to ensure they get their funding without any hitch:
- Eligibility: A proven track record of steady revenue, with at least six months of operational history, is required to be eligible for revenue-based financing. Most lenders online financing providers like Biz2Credit look for annual income greater than $250,000, but some settle for revenue around $100,000 annually.
- Assessment: Financial and bank statements, as well as revenue reports, allow lenders to assess the creditworthiness of the borrower and decide whether the applicant is eligible or not. They may analyze future revenue trends to determine whether the business can meet the repayment obligations.
- Quote and Agreement: Post review, an initial investment amount or quote will be shared by the lender – outlining the capital amount, repayment percentage, duration, and total repayment cap. Once both parties sign the agreement – the loan amount will get dispatched quickly – often within a week.
While negotiating the agreement for this type of business loan, keep in mind the following components that are very important to understand:
- Revenue Share Percentage
This means that a percentage of the business’s monthly revenue will be set aside for the repayments. The rate of monthly income that will be allocated to repayments. This is typically between 3% and 8%.
- Repayment Cap
This implies the total amount to be repaid at the end of the term. It is usually a multiple of the initial funding amount.
- Term Length
It is the expected duration of the repayment period. It can differ based on revenue performance.
Things to Keep in Mind When Applying for Revenue-Based Financing
Choosing funding is not an easy task. As it may affect a business’s financial health, business owners must carefully consider every aspect related to financing needs. Here are a few things to keep in mind while applying for RBF:
- Select the Right Lender
Not all RBF lenders are the same. It is necessary to conduct in-depth research and choose a reputable lender with transparent terms and supportive customer service. You can consider looking at platforms like Biz2Credit, which specializes in RBF.
- Understand Your Revenue Patterns
Most lenders advise borrowers to understand their business’s revenue patterns thoroughly. It is of utmost importance as it will determine whether they can manage the flexible repayment amounts. For example, seasonal businesses must be ready to pay high repayment amounts during peak sale periods.
- Assess Creditworthiness
A lot of lenders look for certain annual revenue generation, credit scores, type of business, and usage of funds while trying to assess the creditworthiness of the borrower. It may vary depending on lenders, but it is better to maintain a score of 650+ to make this a seamless process. Any business that has not generated revenue yet or will not be generating income soon should steer clear of RBF.
- Prepare Documentation
It is important to ensure that proper documentation is in place while applying for funding. It includes financial statements, bank and legal statements, tax returns, and revenue reports. Having all this information in one place can expedite the approval process.
Conclusion
RBF works best for those businesses who are in the market for a flexible and non-dilutive funding option. Since the repayment is linked to monthly revenue, the company’s cash flow will not be under pressure. However, while these aspects make RBF very useful financially, the drawbacks are also hard to ignore. Non-dilution and flexibility come with a higher rate of interest that might make repayment difficult for some small businesses in the long run. It might put a strain on the company’s financial future. That’s why its borrowers must understand all the aspects of revenue-based financing clearly before making any decision.
FAQ Questions
RBF is an intelligent alternative funding option for small businesses and startups, where upfront funds are provided for a percentage of the business’s monthly revenue instead of a fixed interest or equity. It helps small businesses, especially those with variable monthly income, to maintain a steady cash flow to meet their business needs.
This type of funding allows companies to raise capital in exchange for a percentage of their monthly revenue. It will help those companies with fluctuating monthly revenue as they can avoid paying a fixed amount of interest. Instead, as their repayment is linked with their monthly income, they will have to pay a higher repayment amount during peak seasons and lower during off-seasons.
Any small business with steady annual revenue, even if their monthly income fluctuates, can apply for RBF. Moreover, a credit score must be above 650, though some lenders are willing to accept a marginally lower score. They need to have an annual income of $250,000 and should have been in business for at least six months.
There are many advantages of revenue-based funding. It includes flexible repayment terms, non-equity funding by avoiding equity dilution, and enhancing business performance since the repayment is tied to the revenue.
Several platforms offer revenue-based funding options, but it is always advised to go with a reputable lender with transparent terms and notable customer service. Because any funding has long-term implications, starting with someone trustworthy like Biz2Credit is best.
