Revenue-based financing (RBF), also known as royalty-based financing, is a method of raising capital for a business from investors who receive a percentage of the enterprise’s ongoing gross revenues in exchange for the money they have invested. Revenue-based financing is an alternative to Debt financing and Private Equity Financing.
In an RBF arrangement, investors receive a regular share of the entity’s gross revenue until a predetermined amount has been repaid. Generally, this amount is a multiple of the principal investment and usually ranges between three to five times the original amount invested. Municipal bonds are a hybrid example of revenue-based debt financing.
Working Of Revenue Based Financing
- A start-up approaches a leading financier to avail a loan against the recurring revenue.
- The financier scrutinises the recurring revenue expenses to estimate their future earnings and subsequently, decide on a specific percentage of revenue.
- The firm uses the funds availed by the facility to meet specific business-related requirements.
- To repay the borrowed sum, a fixed percentage of the company’s revenue is paid out to the financier.
Typically, when a company generates higher revenues, the borrowed sum is paid off quicker. However, during the seasonal lows of the business cycle, when the income generated is marginal, it may take a little longer to pay off the debt.
Pros and Cons of Revenue Based Financing
- No Equity: The fact that revenue-based funding does not require businesses to give up a portion of their ownership, appeals more to the start-up owners. It must be noted that revenue-based funding is a blend of debt and equity financing. Also, no interest is generated on the unpaid balance since interest is collected by lender in 1st instalment as a processing fee.
- Flexibility in repayments: Since monthly payments are based on revenue, slow months won’t hinder your ability to pay. The repayment amount is directly related to the revenue.
- Collateral Free: Financing options such as bank loans require you to guarantee a loan, putting your personal assets in jeopardy. Revenue-based financing doesn’t need that commitment.
- You’ll raise funding more quickly: With revenue-based financing, you won’t have to make several pitches to attain the money you need. Most lenders will make their decisions and offer financing within a month.
- You must produce revenue: A business must generate revenue to use this financing option, so it’s not suitable for startups without a significant income stream.
- Less money is available than with other financing options: Some funding options, such as VCs, are known for heavily investing in a business. Revenue-based financing provides about three to four months of a business’s monthly recurring revenue.
- Monthly payments are a compulsion: Irrespective of your revenue, you must make the minimum contracted monthly repayment.
- No Regulation: Lastly, Revenue-Based Financing is relatively new to the world of Financing. Innovation is great, but this also means that there is not a lot of regulation involved yet. This aspect has the potential to lead to predatory offers and higher scam rates.
Future of Revenue Based Startup
The idea of Swiggy and Zomato has revolutionized the world. Following these giants, several small startups or other kitchens have come into existence. But the only issue with them is the lack of funds.
Similarly, several startups have been identified particularly in SaaS, Direct 2 Consumer (D2C), and education niche which needs funding. The people behind these startups are not looking forward to taking bank loans because they have almost nothing to keep as security among banks. Here comes the need for revenue-based financing, which seems the future of these small startups.
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