Established businesses, as well as early-stage enterprises, experience a cash crunch in their operations. Businesses consider traditional financing options like bank loans, equity, or debt financing to continue operations and increase cash flow.
However, with the wrong funding source, entrepreneurs could end up with huge debts, rigid repayments, and unhealthy growth expectations.
Further, while banks have traditionally served as a lending option for businesses, they are increasingly hesitant to lend to small businesses in the present climate of uncertainty.
In this scenario, more and more businesses are turning to Revenue-based financing for their Working Capital needs.
Revenue-based financing provides much-needed flexibility and, at the same time, allows businesses the freedom to grow at their own pace.
What is Revenue Based Financing?
Revenue-based financing is a financial model popular in the US, which offers much-needed flexibility to entrepreneurs. Under this capital-raising method, investors agree to provide capital to a company in exchange for a portion of the company’s gross revenues.
It is also referred to as royalty-based financing and provides an alternative investment model to more traditional equity-based investments and debt financing.
Revenue-based lending was seen as a means to provide entrepreneurs in developing countries with much-needed growth capital.
In the age of economic upheavals, it offered a means to spark economic development in industries struggling to stay afloat and new enterprises alike.
Originating in the US in the early ’90s, the model is now gaining traction among India’s rising start-up entrepreneurship. In the post-pandemic scenario, start-up ventures have turned to revenue-based financing to overcome their financial woes.
How Revenue-Based Financing Works?
A company might require funds to finance its marketing costs or scale up its operations. Whatever may be the reason, they approach a lender and seek a loan through the Revenue-Based Financing option.
The borrower and lender discuss terms and agree upon a deal. The deal states that the borrower will receive a Principal investment amount in exchange for a portion of their revenue. The company will be required to pay a fixed percentage monthly from its overall revenue.
Revenue-based financing loans typically do not have a target date for repayment as the amount is based on a percentage of the revenue and the revenue generated every month varies. The higher the returns, the more the number of installments will result in quicker repayment.
Investors calculate the capital required for the business operations and expenditures by studying their current, monthly, or annual recurring revenue.
How Does Revenue-Based Financing Compare to Other Types of Loans?
Revenue Based Financing is generally seen as a hybrid between Equity and Debt financing. It combines the most advantageous features of both financing models.
Let’s look at how Revenue Based Financing compares to equity and debt:
1. Revenue Based Loans vs Equity-Based Financing
Revenue-based financing differs from equity financing, as the investor does not have a direct stake in the business. Unlike the Equity-based model, the investor does not get inducted into the Board of Directors.
2. Revenue Based Loans vs Debt Financing
Revenue-based financing is closer to the debt financing model, as the investor receives regular repayments on their investments. However, the main difference between the two is that Revenue-based financing doesn’t involve interest payments.
Also, in Revenue-based financing, the investors do not receive any collateral.
What Benefits Do Revenue-Based Financing Offer?
Revenue Based financing offers many benefits to businesses seeking funds, compared to other conventional sources of credit.
It is comparatively easier to raise funds using the Revenue Based Financing route than through other methods like bank loans, debt, or traditional venture capital.
Equity financers like venture capitalists and angel investors expect a 10 or 20 times return on the principal investment. Companies are under pressure to post unhealthy growth to meet the demands, which could harm the businesses. Invoice discounting also helps companies to make Working Capital. With Revenue Based Financing, the borrowers can retain more control and grow at a healthy pace.
Entrepreneurs do not have to worry about cash crunch affecting their operations. With seamless cash flow, businesses can aim to grow their businesses. It helps in taking on new orders, generating sales, and developing their business.
Newer financing models like Revenue-based financing have helped small and mid-sized businesses a great alternative to conventional sources of credit. The non-dilutive financing models are more appealing to start-ups and small-sized enterprises as they keep control and aim to grow their business.