What Is Revenue-Based Financing
RBF is an opportunity for businesses and investors to pair up to generate shared wealth. It occurs when an investor injects capital into a business in exchange for a fixed percentage of the business’ ongoing gross revenues.
Here’s what you need to know about RBF:
- Payments increase and decrease, depending on business revenues. As a business makes more money, the investor also makes more money. When the business earns less money, the investor earns less money. Both the business and the investor want the same thing: for the business to turn a profit.
- Investor returns continue until the principal amount of the loan is repaid plus a multiple. While not set in stone because this is an RBF model, investors typically seek to recoup their investment within a three- to five-year period.
What Revenue-Based Financing Is Not
It's easy to mistake RBF for a traditional bank loan or a situation in which an angel investor or venture capital firm injects money into a business for a return of the profit. Those aren’t the same thing as RBF.
- RBF is not a bank loan. Businesses may decide against pursuing a traditional bank loan because banks may require upfront collateral. In most cases, a bank will require a business owner to sign an agreement that allows the bank to come after the business owner’s personal assets should the business default on the loan. This doesn’t happen with RBF.
- RBF is not venture capital or angel investing. There’s no selling of equity in exchange for the capital infusion with RBF. Instead of providing an equity share, the RBF model provides equity warrants. In finance, a warrant is a security that entitles the holder to buy company stock at a fixed price or “exercise” price. This warrant stays in effect until the expiry date passes.
Advantages of Revenue-Based Financing
RBF has several advantages you must understand in order to determine if it’s right for your business. These include:
- Both parties benefit when the business generates lots of revenue. Both the business owner and the RBF firm benefit when business revenue increases. Both have aligned goals in this sense — when the business does well, both parties do well. When the business suffers, both parties suffer.
- It helps during rough times. When a business has a hard time staying afloat due to an economic or market downturn, RBF can prove especially helpful for ensuring its success. Sometimes, a business needs an injection of cash to survive and keep growing. RBF allows this to happen.
- The cost of capital is usually less than some other finance options. In general, it costs considerably less to borrow money through RBF than other alternative finance routes. This is true in the case of angel investing, merchant cash advances, and even invoice financing.
Here are several factors contributing to RBF’s lower capital cost:
- Interest Rates: The reason capital costs much less with this option has a lot to do with interest rates. Interest rates for RBF generally run lower than those for other loan types.
- Legal Fees: Legal fees also tend to run lower with RBF.
- Tax Breaks: Businesses also can take advantage of tax breaks because the RBF investment is a loan with tax-deductible interest.
Here’s why RBF is preferable to a traditional bank loan:
- An RBF firm won't go after a business owner’s personal assets like a traditional bank would. This can take a lot of pressure off a small business owner.
- It’s easier to get financing. A bank will require a lot of paperwork. An RBF firm just cares that a business is in good health and can maintain strong margins.
How To Qualify for Revenue-Based Financing
To qualify for an RBF loan, a business must meet two key requirements. But, to do so, a business will first need sufficient operational history and a record of sustained growth.
Here are the two key requirements to qualify for RBF:
- The business must currently generate revenue. An RBF firm makes its money based on revenues generated by the business. For this reason, an RBF firm won’t inject capital into a business that doesn’t already have a steady revenue stream.
- The business must have strong gross margins. An RBF firm also won’t inject capital into a business that lacks strong gross margins. Why? Because RBF firms take a percentage of a company's gross margins as repayment. The stronger the gross margins, the sooner a business can repay the loan to the RBF firm.
RBF attracts businesses seeking an injection of capital. If a business wants to remain its own separate entity without taking on partners, the RBF model allows this to happen. In contrast, angel investors and venture capital firms take an ownership stake in the company and sometimes have input into the business’ daily operations. RBF allows a business owner to retain control of their business without the input and control that comes with venture capital money and angel investing.
With RBF, a business agrees to give up a percentage of its gross revenues in exchange for an infusion of cash from an RBF firm. Both parties have a mutual interest in the success of the business. As such, the business owner and RBF firm may collaborate to ensure the business makes the best use of its capital. When the business thrives, both the business owner and the RBF firm thrive. The sooner the business can repay the RBF firm, the better the rate of return on the RBF firm’s investment.