Common Misconceptions around Revenue-Based Financing

Revenue-based financing (RBF) is a financial innovation that has been gaining traction among businesses in recent years. This innovative way of getting funds lets companies raise capital by committing a share of their future revenues. It offers a flexible repayment structure tied to the performance of the business. Despite its growing popularity, there are several myths and misconceptions surrounding RBF that may discourage business owners from exploring its potential as a viable financing option.

Understanding RBF is crucial for entrepreneurs and business owners, as it can provide distinct advantages and growth opportunities. In this blog post, we will dispel common misconceptions about RBF and shed light on its true potential as a financing solution for a wide range of businesses.

1. RBF is too costly

The first misperception about revenue-based financing is that it is an expensive form of funding. While the cost of RBF may sometimes be higher than that of traditional loans, it is essential to consider the unique benefits and flexibility it provides to businesses.

The cost of RBF generally includes a small fixed percentage of the investment amount, representing the total amount the business will repay over time. This multiple is typically negotiated based on the company’s risk profile and growth potential. Furthermore, businesses agree to repay a fixed percentage of their monthly revenue until they reach the agreed-upon multiple. This structure offers flexibility, as repayment amounts can vary depending on the company’s revenue performance.

Addressing another common misconception about revenue-based financing, let’s explore its cost compared to traditional debt financing and equity financing:

Traditional Debt Financing

• Requires collateral, personal guarantees, and a strong credit history.
• Can be challenging for some businesses to secure.
• Fixed loan payments can become burdensome during slow revenue growth.

Equity Financing

• Involves surrendering a portion of the company’s ownership 
• May lead to a dilution of control for the founders 
• As the company grows, the cost of shared equity increases indefinitely

Several factors can influence the cost of RBF:

• Business performance: Successful businesses with higher revenues can repay the investment faster, potentially reducing the overall cost.
• Risk profile: The perceived risk associated with a business can impact RBF costs, as investors may require a higher return on investment for riskier ventures.
• Percentage: The cost of RBF can be negotiated, allowing businesses to work with investors to establish a mutually agreeable repayment structure and percentage. 

When evaluating the cost of RBF, it is crucial to weigh its unique benefits and flexibility against the expenses associated with other financing options. In many instances, RBF can present a competitive and attractive funding solution for businesses in search of growth capital.

2. RBF Hinders Business Growth

The second misconception we’ll address is the notion that RBF hinders business growth. In reality, RBF can serve as a catalyst for growth when used strategically.

RBF offers a flexible repayment structure linked to a company’s revenues, freeing businesses from the constraints of fixed monthly payments that might impede growth. Instead, payments increase during high-revenue periods and decrease during slower periods. This structure can offer businesses the financial freedom needed to invest in growth initiatives, such as research and development, marketing, or hiring. 

For example, Noberto, an apparel brand that seamlessly blends style with budget-friendly options with diverse clothing line raised INR 35 lakhs. They were met with immediate success as they witnessed a 1.85x increase in the number of customers and a growth of 2.1x in revenue. They also had a 1.1x increment in average order value. Moreover, their liquidity increased by 1.64x.  

The adaptable repayment structure enabled the company to invest heavily in marketing without being burdened by fixed monthly loan repayments. 

Traditional debt financing can strain a company’s cash flow due to fixed monthly repayments, limiting its capacity to invest in growth initiatives. Equity financing might lead to pressure for rapid growth to satisfy shareholder expectations, potentially resulting in unsustainable business practices. In contrast, RBF can provide businesses with the capital and flexibility needed for sustainable and strategic growth.

3. RBF is only for startups

One prevalent misconception about revenue-based financing is that it is exclusively designed for startups. While RBF can indeed be a valuable funding source for early-stage companies, it is not limited to this particular segment.

RBF is a versatile financing option suitable for businesses across various industries, sizes, and stages of growth. Companies that demonstrate consistent revenue streams, scalable business models, and strong growth potential can be ideal candidates for RBF, irrespective of their position in the business lifecycle. These could be:

• Small and medium-sized enterprises (SMEs) seeking expansion or investment in new projects.
• Companies that have outgrown traditional bank loans but are not yet prepared for venture capital or private equity.
• Businesses facing seasonal revenue fluctuations, which can benefit from RBF’s adaptable repayment structure.

How RBF Compares to Other Financing Options:

RBF can complement or replace other financing options, such as bank loans, angel investments, or venture capital, depending on a business’s specific needs and objectives. The primary distinction between RBF and these other financing methods is that RBF centers on a company’s revenue-generating potential rather than the owner’s personal credit history or the company’s valuation. This makes RBF an attractive financing option for a wide range of businesses, not limited to startups.

4. Fear of Losing Business Control 

Another misconception is that RBF necessitates relinquishing control of the business. On the contrary, one of RBF’s primary advantages is that it allows entrepreneurs to maintain full control and ownership of their enterprise.

Unlike equity financing, where investors acquire a share of the company and can influence its direction, RBF is a non-dilutive form of financing. This means businesses receive capital without giving up any equity or control over their operations. The focus remains on the company’s revenue and growth potential, rather than ownership stakes.

In RBF, investors do not gain voting rights, board seats, or any control over the company’s decisions. Their involvement is primarily financial, not operational.

RBF is an excellent option for entrepreneurs who value retaining control of their business while securing the necessary funding for growth. The non-dilutive nature of RBF ensures that owners can continue to steer their business in their desired direction without external interference.

5. Only for Businesses with Poor Credit

Some people think that RBF is only for businesses that have bad credit. This might be because RBF doesn’t mainly look at credit scores when deciding to give money. However, this doesn’t mean RBF is only for businesses with really bad credit as a last option.

Unlike traditional loans that heavily consider credit history, RBF places greater emphasis on a company’s performance and growth potential. The key factors considered in RBF include revenue trends, profit margins, market size, and the viability of the business model.

While creditworthiness is not the primary focus of RBF, it still plays a role in certain situations. A strong credit history can enhance a business’s credibility and may influence negotiations. However, a less-than-perfect credit score does not automatically disqualify a business from securing RBF.

This sets RBF apart from traditional bank loans, which often impose stringent credit requirements, making it difficult for some businesses to qualify. On the other hand, venture capital and angel investors prioritize high growth potential and large returns, with less emphasis on credit history. RBF strikes a balance between these approaches, focusing on business performance and growth potential, making it a viable option for a wider range of businesses.

6. RBF is a last-resort financing option

There is a belief that RBF is a last-resort financing option. In reality, RBF can be a strategic choice for many businesses seeking growth capital at any stage of their journey.

Thanks to its flexible repayment terms, emphasis on business performance over credit history, and non-dilutive nature, RBF is a viable and attractive option for businesses. In fact, many companies consider RBF as their first choice due to these unique benefits:

• When a business has consistent and predictable revenues, allowing them to comfortably allocate a portion of future revenue to repay investors.
• When business owners prioritize maintaining control and ownership of their company.
• During high-growth phases when a business requires flexible financing to fuel expansion.
• For companies operating in sectors with strong profit margins and scalable business models, making them ideal candidates for RBF.

When it comes to pursuing RBF, it’s all about understanding the unique advantages it offers and how they align with the specific needs and goals of your business.

7. Your data is not secure when you sign up for RBF

Data security is a critical concern for any business, and we understand your hesitation when it comes to sharing sensitive information. As former founders, we know how hard it is to build a business from scratch. That’s why we’ve taken extensive measures to ensure the utmost security and confidentiality of your data.

• Highly Encrypted AI-Based System: We utilize a highly encrypted AI-based system to provide data-driven intelligence for your business. This advanced technology not only safeguards your information but also empowers you with valuable insights to make informed decisions.
• Sharing Login Information: We recognize that sharing login credentials for your online portals can be uncomfortable. Rest assured, your login information is handled with the utmost care, and we take every precaution to protect it.
• Involvement in Business Decisions: You might wonder about the level of involvement we, as the RBF provider, will have in your business decisions. The answer is simple: none. Your business remains entirely under your control. While we can offer insights and facilitate introductions to enhance your business, how and when you choose to utilize this information is entirely your prerogative. 
• Seamless and Secure Integrations: We’ve developed APIs that seamlessly integrate with popular sales platforms such as Shopify, Amazon, and WooCommerce, as well as marketing platforms like Google, Facebook, and Amazon Advertising. These integrations ensure that data is shared securely, allowing us to build a holistic overview of your business’s performance without any friction.
• Confidentiality and Encryption: Your data security and confidentiality are paramount to us. Everything you share with us is treated with the highest level of confidentiality and is secured with bank-level encryption. Your sensitive information is safeguarded at every step of the process.

Embracing RBF

Understanding RBF and its potential benefits is crucial for entrepreneurs and business owners. It offers unique opportunities for growth, repayment flexibility, and the ability to retain control of your company. As with any financial decision, it’s essential to conduct thorough research and consider all available options. When properly understood, RBF can be an excellent financing tool that supports and empowers businesses at various stages of growth.

At Velocity, we provide founder-friendly revenue-based business loans to growing DTC businesses. For further insights into revenue-based finance and to explore the advantages of RBF for your company, simply follow this link. If you are a D2C brand looking for funding to manage your inventory and marketing needs, apply here, and get funded within 7 days.