How Revenue-Based Financing Works

As a business reaches the expansion stage, it may need extra funding to support future growth.

Two popular options for financing your plans are raising debt or equity capital.

While both have pros and cons, many are unaware of a third option: revenue-based financing (RBF).

This type of funding offers lower levels of risk than other lending arrangements. As a result, businesses can tap into capital without giving up equity or taking on debt.

Before deciding if RBF is right for you, it’s essential to understand how it works and the risks that come with it.

What is revenue-based financing?

Revenue-based funding is raising finance for a business in exchange for a share of its future sales. In exchange for the investment, you give a set percentage of the company’s gross revenues to the investor until you pay the money back in full.

Three things are usually agreed upfront:

1. The total amount to be repaid over time. Usually, this equals the investment plus a flat fee.
2. The percentage of revenue shared with the RBF lender.
3. The payment frequency - usually monthly, weekly or daily.

How does revenue-based financing work?

RBF gives businesses immediate access to funding in return for future revenue shares. It follows a pre-agreed percentage of shares up to a specific amount, known as the repayment cap.

First, you decide on the percentage of sales to share and the maximum amount to repay. Then, the investor receives a portion of your sales each month. This will depend on how well your business performs.

What is an example of a revenue-based loan?

Say you borrow £25,000:

• Your monthly turnover determines your loan term.
• Your payments will align with an agreed share of your monthly sales.

So, if your turnover is £50,000 one month and you've agreed to repay 10% of your monthly sales, 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, UK revenue-based financing is like merchant cash advance. It adapts to benefit a business’s cash flow.

Revenue-based finance vs debt or equity finance

At a glance, revenue-based finance appears similar to debt financing, however:

• Debt finance is repaid with interest over a set term.
• RBF repayments are a percentage of revenue each month until you reach the repayment cap.

Before you compare it to debt or equity financing, here are the key differences:

Debt vs equity finance

Raising debt has the advantage of not diluting existing business ownership and control. Issuing equity does.

Debt comes at a higher risk to the business and the owners. You must repay the debt by some fixed date. If not, the owners may lose their business and more if they have personal guarantees or collateral to support the loan.

Equity, in contrast, doesn't need to be repaid. If the business is struggling, you don't need to make regular payments to the shareholders. In good times, you share profits 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 a hybrid form of lending.

It combines the best parts of debt and equity finance while minimising the negatives.

Unlike debt or equity financing, RBF offers performance-linked repayments without needing to sell shares in your business.

Why use revenue-based financing instead of debt financing?

You should think about four factors before applying for alternative finance:

• ownership and control
• flexibility and risk

The pros of UK revenue-based financing include:

1. Retaining 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.

2. Fixed percentages and repayment caps

Similarly to debt, there’s a fixed amount to repay. Once reached, it discharges you of any further obligations.

However, unlike interest rates charged on loans, RBF finance payments are based on a fixed percentage of revenue. This 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. Your finance is therefore a variable cost rather than a fixed cost to your firm.

If your sales temporarily slow down, so do your repayments. This is a good option if you experience fluctuating sales, such as hotels and restaurants.

4. Potential for short repayment periods

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

5. No need to provide collateral

Certain finance products ask for assets as collateral to reduce the risk to the lender.

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

The disadvantages of revenue-based loans

1. Assesses historical revenue

The application process looks at how much your business makes based on past and expected sales.

For startups, this can make it hard to get revenue-based financing. 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 large amount, the lender’s 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 must be returned to the provider in cash repayments.

What are the risks of revenue-based financing?

Revenue-based finance is often less risky than debt financing or bank loans. This is because revenue-based loan agreements may not need personal guarantees or collateral.

Why use revenue-based financing?

The structure has been used for years by large businesses in industries from oil and gas to media and biotech.

RBF emerged in the US in the 1980s, with Arthur Fox bringing revenue-based loans to SMEs for the first time.

Offering several benefits to both investors and business owners, 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 funding

When applying, tools like RBF calculators can help you understand the costs.

With so much information available online, you may prefer to discuss your options with professionals over the phone. Here at Fleximize, we can support you in finding the right funding for your UK business.

Our dedicated relationship managers are on hand to discuss any questions you have about alternative finance options.

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Your common questions answered

Why choose revenue-based financing instead of debt financing?

Revenue-based financing is often preferred over traditional loans because repayments are based on a percentage of your monthly sales.

This means you pay more when your business does well, and when sales slow down, your payments decrease. It’s flexible and doesn’t require you to pledge your assets as collateral, reducing your risk.

What are the criteria for revenue-based financing?

To qualify for revenue-based financing, lenders typically look at your:

• monthly revenue
• growth potential
• business' financial performance in the past

These factors help them decide how much funding you can get and the repayment terms.

What’s the difference between revenue-based financing and equity financing?

Revenue-based financing gives you money in exchange for a share of your future sales, but you don’t permanently lose ownership of your business.

Equity finance, on the other hand, means selling part of your business to investors in return for funding.

How do you structure revenue-based financing?

Revenue-based financing works by agreeing upfront to pay a fixed percentage of your monthly sales to the investor until you’ve paid back a set amount.

This percentage and the total repayment amount are decided before you get the money.

What is the repayment cap in revenue-based financing?

The repayment cap is the maximum amount of money you’ll pay back to the investor, which includes the initial funding plus a fee. Once you reach this cap, your payment obligations end, no matter how much time has passed.

What is the accounting treatment for revenue-based financing?

In accounting terms, revenue-based financing is treated like a loan.

The payments you make to the investor are recorded as expenses on your financial statements, similar to how interest payments on a loan are handled. This helps keep your financial reporting clear and accurate.

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