A firm owner chooses revenue-based financing when he cannot secure loans from every finance company or when the company’s shareholders are unwilling to dilute their holdings by enlisting new investors through equity-based financing. Assume a company must expand further and obtain $1 million in financing; there are no other options. In some cases, the firm must raise funds through revenue-based financing.
This is how the firm must function. The corporation contracts with XYZ Capital, a company specialising in this type of financial transaction. According to the agreement, XYZ Capital will supply the firm with one crore in return for a portion of the company’s total gross income. Following that, the firm must make monthly installments to XYZ Capital (say, 2.5% of total gross income). Furthermore, the corporation may be required to pay an additional sum in addition to the original sum to cover any liabilities.
Revenue based financing, or royalty-based financing, is a capital-raising mechanism in which investors supply cash to a corporation for a share of the organisation’s continuous total gross income. While investors have widely employed other traditional equity-based investments, revenue-based financing remains an appealing capital-raising approach for businesses since it provides additional benefits.
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Benefits of Revenue Based Financing
1. Less expensive than equity
With 10X-20X returns expected, Angel and VC investments are the most costly forms of money available if your firm is successful.
2. Maintain Greater Ownership and Control
When something relates to revenue-based financing, lenders seldom accept shares. As an outcome, there’s no ownership loss for founders and early equity investors. Moreover, RBF investors don’t assume board seats or impose stringent financial limitations on a firm. Entrepreneurs can keep control and steer the firm towards their goals.
3. There are no personal guarantees
Because of the significant risk of startups, bank loans need personal guarantees from founders. This necessitates entrepreneurs risking their assets, like their homes or cars. Founders can rest assured that no individual guarantees are required under RBF.
4. There will be no large payments
Monthly payments are calculated as a proportion of monthly income. If you have a terrible month, your monthly bill will reflect it, and you will not be saddled with a hefty amount you cannot afford.
5. Shorter funding cycle
Pitching to venture investors might take months or years to secure a contract. Since RBF investors don’t expect firms to achieve high energy or big equity exits, lenders can give the money within as few as four weeks.
6. Both the investors and the founders have a shared purpose
Because RBF uses a flexible payment mechanism, investors’ profits improve as the firm expands. As a result, both the investors and the creators want the firm to flourish. As a result, each would put in extra effort to help the firm flourish.
Large payments are no longer made
Unlike traditional financing techniques, where you must pay a specific sum to the investors, RBF does not need you to give a predetermined amount to the investors. The monthly payment arrangements in RBF are based on a proportion of the company’s monthly income. As a result, if your revenue is low in certain months, your monthly payout will reflect this. The more revenue produced, the higher the number of monthly installments. Consequently, even if a company loses money, it is not burdened with significant payments.
The cons of revenue financing
Every financing technique has inherent disadvantages, so revenue-based financing is optional. Some disadvantages of revenue-based financing include the following:
- This strategy is not appropriate for pre-revenue businesses. To persuade an RBF investor, a firm must demonstrate revenue. An RBF investor utilises ARR or MRR indicators to assess the company’s growth and loan eligibility.
- Revenue-based funding will provide only a portion of the sum to businesses. While Venture Capital includes a significant amount of money for the firms, even if they are in the pre-revenue stage, RBF agreements do not involve a large quantity of capital. Specifically, at most, the capital will be three to four months of the company’s MRR.
- In the first few months, startups may need help paying monthly payment installments to investors. As a result, while presenting, businesses must be cautious regarding their financial situation and future ambitions.
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Revenue based funding might be quite advantageous to an investor. Investors can make a significant return if the firm expands and becomes successful since it has a variable payment structure depending on the total revenue received. The greater the profit, the greater the salary! An investor, however, must be conscious of the risks connected with RBF. While investing in a company using the RBF model, investors must understand the firm’s future objectives and evaluate the company’s growth using appropriate criteria.
Companies may effectively acquire finance with revenue-based financing without putting a piece of their assets as security or surrendering a percentage of their stock. Furthermore, as compared to debt and equity financing, revenue-based financing is significantly simpler and requires far less documentation.
1. Is revenue-based financing considered a loan?
Not at all. Revenue-based financing systems, unlike traditional loans, do not charge interest or need warrants, collateral, or personal guarantees. Instead, your revenue is the sole asset traded.
2. What is the process of revenue-based financing?
In a nutshell, revenue-based financing assumes that businesses may acquire finance by promising to return a specific proportion of their future income. The investor will get the principal amount and an additional revenue share depending on the adjustable monthly income.
3. Is revenue-based finance a viable substitute for private equity?
Revenue-based financing is predicated on allowing entrepreneurs to expand at a personal pace without requiring them to give up too much ownership too quickly. This also allows them to negotiate greater pricing in subsequent rounds.
4. Is revenue-based funding appropriate for SaaS businesses?
SaaS businesses operate on a subscription model with recurring income, making them a great choice for revenue-based financing. Moreover, direct-to-consumer and e-commerce businesses are ideal candidates for revenue-based loans.