Revenue-based financing is undeniably one of the most powerful funding options out there. With the revenue-based investing market valued at over $901M in 2019 alone, it proves to be a promising financing method for taking your business past early-stage private equity and venture investments.
In this blog, we enumerate the pros and cons of RBF to help you decide whether it’s worth taking the plunge (and risking your hard-earned revenue).
Revenue-Based Investment Structure
There are a number of ways through which RBF is structured, and may depend on how your payments are made. You might have to continue making payments until:
- The investor receives a repayment cap of the initial loan amount (minimum multiple is usually 1.3x; maximum at 3x)
- The investor receives a pre-determined IRR; or
- A final date has been determined
The first one is what happens most frequently, but generally, payments are based on a fixed revenue percentage. Both the principal amount and interest are paid monthly and are based on your incoming sales revenues. So the higher the sales, the higher the amount you pay.
Challenges in RBF
Revenue-based financing is considered a hybrid of debt- and equity-based financing minus the interest and ownership stake, respectively. While it may seem like the best solution, it’s important to first understand the challenges that often come with adopting it.
- It may be hard to qualify. You must first have strong MRR/ARR with growth margins of at least 50% for you to qualify. The ARR amount usually approved is no less than $200K.
- Initial investment is lower. Investors can only provide you with 2-3 times the amount of your MRR. But don’t be disheartened just yet — you would still be allowed to secure funding from future rounds, something that can’t be done in debt-based financing.
- Monthly payments may be uncertain. Since your payments are based on the gross revenue you’ll generate monthly, it may be hard to come up with definite figures in advance. Customer churn, opt-outs, and a number of other factors will affect your ability to plan ahead for your payments.
- An equity kick may be required. The no-interest and no-stakes might actually come with a price — investors may require extra incentives, especially if your company’s MRR isn’t attractive enough by itself. They may ask for a warrant, which can also pose risks.
Advantages of RBF
Now that the negatives have been addressed, here are the top benefits of going with revenue-based investments:
- You get to keep control. Since RBF is non-dilutive, you get to have full control over ownership and business decisions.
- Flexible Repayments. Risks are considerably low in RBF compared to debt-based financing as you only have to pay a portion of your monthly top-line revenue. This allows for a more flexible repayment plan, and you don’t have to worry as much about unexpected expenses or missed payments.
- Capital is provided quicker. RBF enables you to receive funding potentially within weeks, compared to traditional equity funding that may take months, especially for tech companies. The simple reason is that investors won’t need to invest large sums, especially if your company is performing well in the market.
- No collateral needed. While similar to traditional bank loans in that there are monthly payments, RBF won’t require you to declare your assets as collateral if payments ever get delayed.
As with other business ventures, doing your research is key if you’re considering the revenue-sharing route. Pick an investor who will be a good partner as your business grows — someone who can also share their expertise in addition to their capital. Weigh your options, calculate the risks, and constantly assess whether it’s the best path to take in the long run. Financial services experts at Pilot have produced an informative video and blog that discusses the long-term ramifications of the different ways you can fund your startup.
While RBF usually works well for most SaaS companies, you might want to consider other financing types if you’re an early-stage small business, such as crowdfunding. You can find out more about other options here.
Before you make your pitch for RBF financing, you want to make sure your business is attractive to funders. Make sure you’re not overlooking something — watch our exclusive Annual Conference video, What VCs Are Looking For, And How To Stand Out.