Revenue-Based Financing – A Complete Guide
Fundraising for startups has always been crucial to meet their working capital needs and grow faster. Traditionally, business owners have been dependent on venture capital firms, angel investors and banks for raising money at the cost of equity shares or hefty interest rates. But not anymore; with revenue-based financing or royalty based financing (RBF), businesses can now seek the equity-free funds they need for future growth without diluting ownership.
Read along to know all about revenue based financing – a new, founder-friendly way of financing your business!
P.S: If you already know about revenue based financing and are looking for options to fund and scale your ecommerce business, you are at the right place! Raise growth capital of upto 4 Crore from Velocity – India’s largest revenue based financier.
What is revenue-based financing?
Revenue-based financing (RBF) is a new alternative to more conventional equity-based investments (such as venture capital or angel investment) and debt financing. Revenue based funding loans (RBF) let founders raise funds without diluting equity, and the repayments happen as a percentage of monthly revenue. This ensures that your business always has sufficient capital to take care of inventory and marketing needs. It is ideal for D2C start-ups and small businesses looking for scalability without diluting the equity.
As you seek a loan from them, the revenue-based financier will ask for specific data points about your business to predict growth and make funding decisions. For example, they will ask for read-only access to your digital marketing spend (Google Ads, Facebook Ads, etc.) and monthly sales overall revenue (Shopify, Amazon etc) to predict your future business growth. If your growth projections look solid, they will then quickly share the financing terms and disburse the amount within a few days.
Here are the characteristics of typical revenue-based financing,
- Structured as a loan with a principal amount, a fixed fee of 4 to 8% and no interest
- As the financing is provided against future revenue, it does not require any equity dilution
- The monthly repayment is made as a percentage of future revenue (usually 5% to 20%) based on your requirements
- The maturity period of revenue based loans is a function of your actual revenue trajectory, typically modelled for less than 6 months
How does the revenue-based financing model work?
Growing any business needs upfront financial investment much before revenue trickles in. Most of the money goes into building inventory, paying vendors, and marketing efforts, leaving a substantial working capital gap for at least three to six months. Moreover, the faster your brand grows, the more capital it would need to support the growth. In such cases, even if you invest most of your earned revenue back into the business – you will face an ever widening cash-flow gap.
Now imagine if you can get a part of your future revenue upfront at a small fee through a revenue-based financier
like Velocity. You can now have the flexibility to use this cash for expanding your business. Not even this, as the repayments are linked to a percentage of your sales – you pay more when you earn more and less when the revenues are less, and keep the additional profit to yourself (no strings attached). Below is one such example to help you understand this better,
If you are wondering whether raising capital from investors is better than using revenue-based financing, our next section will help you decide.
How does revenue based financing differ from venture capital and bank loans?
There are many ways to raise growth capital for your business, but each option comes with a caveat. Most startups initially rely on bootstrapping or taking funds from friends and family and as they grow, they start looking for angel investors and VC funds.
Angel investors and VC funds are usually difficult to get as they are most interested in hyper-growth startups and seek at least 10X return on their investment. Getting VC funds makes sense for startups that require heavy investment 0-to-1 bets like product R&D, new market entries, technology development etc. But if you are a D2C business getting funding from investors early in your business can leave you with significantly less stake in your company and hence lesser control. Alternatively, bank loans will require you to be profitable and seek collaterals and personal guarantees towards the loan. Not to forget the long and tiring process of pitching to the VC funds and the cumbersome offline method of seeking loans from banks.
It is always better to scale your business and reach significant milestones before looking for VC funding at much better terms. Once you have stable revenues, revenue-based financing is the best option as you get the investment to grow without losing any stakes in the company. The summary table below will help you understand which type of financing model will work best for you,
Also, getting financed by a revenue based financier does not block your option of raising funding at a later stage. Instead, some RBF investors also provide smart tools (like Velocity Insights in our case) to help you track all the important business growth metrics. So when you reach out to VC founders, your future investors will have much more confidence in investing.
If you are an online business with at least 6-12 months of revenue history and healthy gross margins, revenue based financing is the best growth capital option for your next leap. You can read more on if revenue based funding is right for your business in this blog.
Advantages of revenue based financing
While we have already discussed the benefits of revenue-based financing compared to venture capital and bank loans, here is a comprehensive list of advantages.
As a business owner, you keep total control of your business and don’t have to give away any equity for the money you raise. This is important for rapidly growing businesses that need capital to fuel their growth.
No collateral or personal guarantees needed
Some revenue based financing lenders might not need personal guarantee or collateral during application, making it a less risky and faster option for raising the capital.
Flexible repayment plans
Unlike traditional loans, the repayments linked to revenue based financing are based on the performance of your business. Like we have explained in the above section, you pay more when your sales are high and less when the sales are low. This also means that you will always have sufficient working capital to overcome your post-holiday sales slump.
Large funding amount
As the amount you can raise is linked to the business growth, most revenue based financiers are ready to give you the money based on your past business performance.
Faster loan disbursal and ease of access to capital
Unlike VC funds and bank loans which might take months to release the funds, you can secure revenue based financing in less than a week.
Revenue based financing works well with other funding sources
Revenue based financing allows businesses to access the funds they need during their growth stage to build traction without diluting their equity. Also, when these businesses are ready to raise equity financing, they are in a much stronger position in terms of stakes and growth projections.
How to evaluate revenue-based financing options?
While evaluating your revenue-based financier, make sure to consider all the aspects as mentioned below:
1. Evaluate financing terms carefully
Think carefully about how the loan is structured as it will affect your company’s future growth. Look beyond the amount and your ability to pay back, and consider your future growth options. Few factors you should consider are,
a. Evaluate debt percentage
While looking for external capital, ensure that you follow “The 33% Rule,” meaning your company’s debt should always be less than 33% of your annual revenue. Having a debt more than this might lead your business to a severe cash crunch.
b. Consider your repayment ability & timelines
As under revenue based loans, you will be paying a percentage of your future sales, your company’s growth can cover your debt easily. If your gross profit is more than the debt payment, your loan repayment can be easily managed.
c. Look for warrants attached (if any)
Some RBF financiers might ask for Warrants. Warrants are the right to buy your company’s equity in the future at a price agreed today. For example, the revenue-based financier can ask for 2% stakes in your business at the current X price/share evaluation, diluting your ownership. Sometimes lenders also keep a “put option” with warrants; in such cases, you can buy back these shares from the lenders but at a hefty price in the future (again, not a good idea). In the long run, you want to keep as much equity as possible for better control of your business and future funding rounds. So make sure you choose a revenue based financing partner like Velocity that doesn’t offer warrant-based funds. We believe in a transparent process of financing and hence facilitate revenue-based financing at a fixed fee without equity.
d. Future options
Ensure that lending terms keep your future options open. As you evaluate your options, ask questions like, will you be able to get additional funding from them in the future? Are the pre-payment terms fair? Is there any hidden cost attached to the revenue based loan?
2. Choose the right financier
The relationship between an investor and borrower is long-term and sometimes complicated. Trustworthy investors are a must. Look for your revenue based financing partner’s fund balance and existing client base. Many times it would be difficult to understand their position from their websites, so you should ask around in your networks and give due weightage to recommendations from other D2C brand founders.
Revenue-based financing is the way to grow your business!
Now that you know everything about revenue-based financing and how it can help your business, it’s time to partner with the right revenue-based financier to fuel your business growth. We, at Velocity, offer revenue-based financing of up to Rs 4 crore to Indian D2C and e-commerce brands. With our 100% online process, you can get your term sheet now and get funded in less than a week.