How Revenue-Based Financing Works

As a business reaches the exciting expansion stage, it may require additional funding to support future growth.

Two popular avenues for financing a company’s development plans are raising debt or equity capital.

While both methods come with their advantages and disadvantages, many business owners are unaware of a third option that sits in between the two: revenue-based financing (RBF).

This type of funding offers lower levels of risk than other lending arrangements, helping businesses tap into capital without needing to leverage equity or take on debt.

Before deciding whether or not revenue based funding is right for your business, it’s important to understand how revenue-based finance works and the risks that come with it.

What is revenue-based financing?

Revenue-based financing is a process of raising finance for a business in exchange for a share of its future revenues. In exchange for the initial investment, a fixed percentage of the company’s gross revenues is given to the investor until the money is paid back in full.

Three parameters are usually agreed upfront besides the sum to be provided:

1. The total amount to be repaid over time (usually this amount equals the investment plus a flat fee)

2. The percentage of revenue shared with the provider of financing

3. The payment frequency - usually monthly, weekly or daily.

How does revenue-based financing work?

Revenue-based finance is structured to give businesses immediate access to capital investment in return for future revenue shares. This agreement works around a pre-agreed percentage of shares up to a specific amount - referred to as the repayment cap.

Once the share percentage and repayment cap have been determined, a proportion of the company’s gross revenues are paid to the investor in accordance with monthly business performance.

Revenue-based financing example:

For example, if you borrow £25,000, your monthly turnover determines your loan term and your payments will align to an agreed percentage of your monthly sales.

Therefore, if your turnover is £50,000 for one month, and you have agreed to repay 10% of your monthly sales each month, you would pay £5,000.

If your turnover then goes down to £45,000, you pay £4,500. These payments continue until the agreed repayment cap has been paid.

As the example shows, repayments are calculated as a percentage of monthly revenue. In this way, revenue based finance is similar to merchant cash advance funding, in that it adapts to benefit a business’s cash flow.

Revenue-based finance vs debt or equity finance:

At first glance, revenue based finance appears to be much the same as debt financing. However, while debt finance is repaid with interest over a set term, revenue-based repayments are calculated as a percentage of revenue month on month until the repayment cap has been fulfilled.

Before being able to compare revenue finance to debt or equity financing, you should be aware of the key differences between these two stems of funding:

Debt vs equity financing

A lot is written about the advantages and pitfalls of debt and equity financing. Essentially, raising debt has the advantage of not diluting existing business ownership and control, whereas issuing equity does.

Debt comes at the expense of a higher risk to the business and the owners; the debt must be paid back by some fixed date. If it isn't, the owners may lose their entire business and perhaps more if they provide personal guarantees or collateral to support the loan.

Equity, in contrast, doesn't need to be repaid, and if the business is struggling, there's no pressure to make regular payments to the shareholders. In good times profits are shared among the owners as dividends. This makes equity a much more flexible and less risky source of financing.

Is revenue-based financing debt or equity?

Revenue-based financing is essentially a hybrid form of lending that combines the best features of debt and equity finance, while minimizing the negatives. Unlike debt or equity financing, this flexible finance offers performance-linked repayments without requiring entrepreneurs to permanently give away shares in their businesses.

The benefits of revenue based finance

When considering benefits that revenue based finance can offer, it can be helpful to think about four parameters that should always be considered before applying for alternative finance - ownership and control vs. flexibility and risk. The pros of revenue-based financing include:

1. Retain business ownership

Like debt, revenue-based loans are non-dilutive; you don’t lose a stake in your business so you can maintain greater control over its destiny.

2. Fixed percentages and repayment caps

Similarly to debt, there’s a fixed amount to repay, which once reached, discharges you of any further obligations. However, unlike interest rates charged on loans, RBF finance payments are based on a predetermined fixed percentage of revenue, which typically falls between 1 - 3%.

3. Repayments in sync with cash flow

Your monthly repayments are directly linked to the performance of your business. They move up and down with your revenues, making your financing a variable cost rather than a fixed cost to your firm.

If your sales temporarily slow down, so do your repayments, making it a good option for businesses that experience fluctuating sales, such as hotels and restaurants located in seasonal destinations.

4. Potential for short repayment periods

Likewise if your sales grow quicker than expected, your monthly payments will be higher and you’ll end up repaying your revenue advance quicker.

5. No need to provide collateral

Certain finance products like secured business loans require corporate or personal assets to be put forward as collateral to reduce the risk to the lender.

Revenue based loans are unsecured and do not require the same type of guarantee, so there’s no need to worry about risking valuable assets.

The disadvantages of revenue based finance

1. Assesses historical revenue

The application will analyse a business’s revenue capabilities based on historical and predicted revenues. This can often make it difficult for pre-revenue stage companies to raise capital through revenue-based finance, alternative loans for startups may be better suited.

2. Investments are determined by financial health

The amount of money invested into a company is based on monthly recurring revenue. If you’re looking to borrow a substantial amount, the revenue-based lender’s investment offer may be limited by your business’s finances.

3. Requires monetary repayments

Unlike funding provided through small business grants or angel investments, revenue funding is required to be returned to the provider in the form of cash repayments.

Is revenue-based financing risky?

Revenue-based finance is often less risky than alternatives like debt financing or bank loans. This is because revenue based loan agreements don’t require personal guarantees or collateral to be put down against the loan.

Why use revenue based financing?

Revenue-based financing as a product has never been a poster-child of finance, but the structure has been used for years by large businesses in industries as diverse as oil and gas, mining, media, and biotech.

Years ago, revenue based financing companies emerged in the US, which brought revenue-based loans to SMEs for the first time.

This financing model has been gaining popularity ever since, and revenue based financing firms like Lighter Capital, Rock and Hammer Ventures have managed to build up multi-million dollar portfolios of revenue advances.

Offering several benefits to both investors and business owners in need of investment, revenue-based finance can help:

• Fulfil large order costs

• Maintain cash flow

• Support spending linked to business expansion

All without diluting equity in your business.

How to apply for revenue based finance:

When applying for revenue based finance online, tools like revenue based financing calculators can help to give you a better idea of the associated costs.

With so much information available online, many business owners prefer to discuss their options with professionals over the phone. Here at Fleximize, we can support you in finding the right revenue based agreement for your UK business.

Our dedicated relationship managers are on hand to discuss any questions you have about revenue funding, while helping you explore all alternative finance options available.