What the Fund is Revenue-Based Financing? (With Examples)
Once upon a time, the paradox, “it takes money to make money” was accepted by all; however, there is another way. You just need other people's money to make money.
Enter: financing. From ancient times to the contemporary digital era, funding businesses has been a practice intertwined with entrepreneurial pursuits. However, it isn’t easy. From subpar credit scores to the cursed prospect of equity dilution, traditional investment is a hard game for early-stage businesses to play. Luckily, there’s another option. Hellooo, revenue-based financing.
In this article, I’ll explore the nature of revenue-based financing, the context behind it, and all the details you should consider when looking at it as the next step in your business plan.
What Is Revenue-Based Financing?
Revenue-based financing (RBF) - also known as revenue-based lending or revenue-based investment - emerged in the early 2010s as an innovative funding alternative for startups and small businesses. During this time, traditional investment options were running the scene and early-stage businesses saw their potential become a tiny factor in a sea of requirements they didn’t have.
Faced with the challenges of accessing traditional funding avenues like bank loans or venture capital, early-stage companies were fighting for opportunities to get a chance to grow.
Following Philip Sidney's timeless quote, "Either I will find a way, or I will make one," revenue-based investing entered the scene to break some of the barriers between start-ups and the investment market, providing a new model where potential was the main asset of value.
As the name suggests, this investment model allows companies to secure funding in exchange for a percentage of their future expected revenue. Investors take a long-term approach to get back their money, and they receive a percentage of the company’s revenue until the original deal is repaid. Unlike traditional debt or equity financing models, RBF meets businesses and investors halfway by avoiding the upfront debt that standard financing represents for entrepreneurs while giving investors the opportunity to make an expected return without needing to wait for an exit event.
Who is RBF for?
If you’re a business operator growing an early-stage startup and you have a great income opportunity without the means to capitalize on it, revenue-based financing metal could be the solution you need to upscale your current systems and take that success to the next level.
However, that large income potential is pretty much a requirement: RBF may not be suitable for early-stage startups without significant revenue or businesses in industries with irregular or seasonal revenue patterns (as many RBF providers see this as a challenge for the long term).
How Much Money Can You Secure with RBF?
The amount of funding you can secure through revenue-based financing depends on various factors such as your revenue history, ARR, growth potential, and the specific terms offered by the provider.
RBF providers may offer a loan amount ranging from tens of thousands to several million dollars. It's essential to explore multiple forms of financing and negotiate terms that align with your company's needs.
How Does Revenue-Based Financing Work?
Revenue-based financing is facilitated by a diverse array of entities, including specialized RBF funds, forward-thinking venture capital firms, and innovative alternative lenders.
The organization receiving the funds outlines its expected future revenue and the strategic growth initiatives that underpin its enterprise. This documentation serves as a roadmap for potential RBF investors, giving them the chance to assess the viability of the business and gauge the potential return on their investment.
Crucial components such as the proposed revenue share percentage, repayment timeline, and other specific terms of the RBF agreement provide clarity and transparency, serving to fuel investors' confidence in the operators’ abilities.
Once the financing is secured, repayment goes to the lender based on the schedule and structure that you agreed to. The repayment period is typically predetermined and limited within a specified timeframe, while the payment structure may differ among providers or individual arrangements. Make sure to consider the average repayment terms and take note of any specific clauses or conditions associated with the financing agreement.
To illustrate the dynamic nature of revenue-based financing, let's consider a hypothetical scenario: A burgeoning software start-up, Examplify, secures $200,000 in revenue-based financing, containing a mutually agreed-upon revenue share percentage of 6% and a repayment cap of $400,000. As Examplify grows, monthly revenue totals $50,000. Following the RBF agreement, the investor is entitled to receive $3,000 (6% of $50,000) each month, until the lender earns a total of $400k.
Types of Revenue-Based Financing
Flat Fee
The flat fee model operates on the principle that the business agrees to pay a fixed percentage of its monthly revenue until the agreed-upon amount is fully repaid. This financing structure is particularly suitable for businesses with stable revenue streams and consistent cash flow. By committing to a predetermined percentage, companies can accurately forecast their repayment obligations, thereby facilitating effective financial planning.
Variable Collection
On the opposite side of the road, we find the variable collection model, which offers a more flexible approach to revenue-based financing. In this model, the repayment percentage varies by the company's revenue performance. When the business experiences a period of lower revenue, the repayment amount decreases proportionally, relieving some financial burden during challenging times.
In both the flat fee and variable collection models, the repayment process is contingent upon the business's monthly revenue. By linking repayment to monthly revenue, these financing models provide a more tailored and adaptable solution compared to traditional fixed-term loans.
RBF In The Wild
To those new to the concept of revenue-based financing, it may be hard to differentiate it from traditional debt financing. In order to make it clearer, here are a couple of examples:
A rental company that needed a capital boost
Idoneo.com, a car rental company, faced a critical challenge in obtaining capital for its marketing campaigns without diluting its equity. Despite successfully closing two funding rounds and raising over €550,000, a significant portion of their funds was already allocated to prior marketing efforts. To drive their growth, they needed additional capital but couldn't rely on traditional banks and business loans due to their risk profile. In search of a solution, Idoneo.com turned to RITMO, a revenue-based funding provider.
Partnering with RITMO proved to be a fruitful experience for Idoneo.com. Through RITMO's Growth Capital RBF, they secured the much-needed funding to invest in their marketing campaigns. This injection of capital empowered them to accelerate their growth through highly profitable marketing investments that would have been challenging to finance otherwise.
RBF to support UX education
Love Circular, a technology course provider based in Manchester, embarked on a mission to empower individuals with digital education and foster diversity in the tech industry. Founded by Zaire Allen, Love Circular aimed to create opportunities for 1 million UX and UI beginners to pursue in-demand careers. However, the team behind this SaaS startup encountered a challenge when trying to finance their business.
In the early stages, Love Circular consisted of Allen and a small team of instructors. They needed capital to hire operational staff and marketers to drive growth but traditional financing options were not well-suited for their business model. Bank loans proved difficult to secure, and the grant application process was too time-consuming, so the team recognized the need for innovative funding options to fuel their growth without compromising their mission. With Pipe’s support, they were able to scale their boot camp initiative, make strategic hires, and launch a flagship course. The flexibility and cash flow provided by Pipe empowered Love Circular to fuel its growth trajectory.
Advantages Of Revenue-Based Financing
Non-Dilutive
RBF enables startups to secure the funding they need without sacrificing ownership or control of their business. This is a significant advantage for entrepreneurs who want to maintain their equity stake and strategic decision-making power. By avoiding equity dilution, entrepreneurs can preserve their vision and retain the upside of future value creation.
No Personal Guarantees
Unlike traditional financing options, RBF providers typically do not require personal guarantees from founders or the management team. This means that entrepreneurs are not personally liable for the repayment of the funding. This aspect reduces personal risk and provides a level of financial protection for the individuals involved, allowing them to focus on business growth without the burden of personal liability.
Flexible Repayment Structure
One of the standout features of RBF is its repayment flexibility. Unlike the fixed monthly payments associated with traditional loans, RBF repayment is tied directly to the company's revenue. This dynamic structure allows businesses to navigate periods of fluctuating revenue without being burdened by fixed repayment amounts. As revenue increases, the repayment amount adjusts accordingly, ensuring that entrepreneurs can manage their financial obligations in a way that aligns with their business's performance.
Disadvantages Of Revenue-Based Financing
Revenue Required
One significant drawback of revenue-based financing is, of course, its need for revenue (and revenue history). If you’re unable to secure debt financing, it’s not guaranteed that you’ll be able to qualify for RBF, depending on your business’ stage of its lifecycle. Therefore, RBF is typically better suited for companies with a bit more of a track record (or an extremely clear revenue plan & the right operating team to get them there).
Long-term Commitment
When opting for revenue-based financing, businesses often find themselves making a substantial commitment that spans several years. While this commitment brings the benefits of stability and predictability in repayment, it also means that the business becomes tied to the financing arrangement for an extended period. Unfortunately, this lack of flexibility can hinder the company's ability to swiftly adapt to changing market conditions or pivot its strategy as needed.
Smaller Check Sizes
Compared to traditional venture capital or bank loans, revenue-based financing often involves smaller funding amounts. This is because the repayment is based on a percentage of the company's revenue. As a result, businesses may find it difficult to secure larger capital injections required for substantial growth or significant expansions. If a company needs significant funding, it may be necessary to explore alternative financing options.
Other Funding Options
Revenue-based financing can be game-changing for many entrepreneurs, but it’s not the only option out there. For some businesses that meet specific requirements, traditional funding options can be more suitable for achieving their business goals. Also, after learning the specifications behind all the funding options out there, you can be certain that RBF is, or isn’t, the best option for you.
Debt Financing
Debt financing is a traditional method that involves borrowing funds from a lender and repaying them with interest on their money, over a specified period at a specified interest rate. While it provides more flexibility than equity financing, it often requires collateral and may involve personal guarantees. Compared to RBF, debt financing is blind to an ailing business, which can result in increased financial risk for the business if conditions change for the worse.
Equity Financing
Equity financing involves selling shares of your company in exchange for capital - typically to friends & family, venture capitalists, or angel investors. While it can provide a significant infusion of funds, it also means diluting ownership and giving up a portion of control. Unlike RBF, which is a non-dilutive option, equity financing involves long-term implications for the company's ownership (and potentially decision-making) structure.
If you’re looking into equity financing, I get it. I’ve put together a list of the SaaS investors writing checks in 2023.
In Conclusion, Money = Money
As it turns out, sometimes, it does take money to make money. However, RBF is one way to use your money to get other people’s money, in order to make everyone a lot more money.
Easy enough to understand, right?
Assess all of your options, make sure there’s alignment with your company’s goals, and reach out to me if you ever find yourself stuck with different concepts. Remember, the best thing you can do when running your business is to keep helpful resources at the tip of your fingers (or even better, directly in your inbox).