Access to capital remains a big problem for many small businesses today. According to Goldman Sachs, “Among small business owners who have applied for a business loan or line of credit within the last year, 81% found it difficult to access affordable capital, with 49% having to halt expansions and 41% limited in taking on new business. Fifty-one percent said that with current interest rates they are unable to afford to take out a loan.”
That said, small businesses continue to seek funding and there are two basic ways to get money…by borrowing money or taking in investors. Each option has its pros and cons. But there may be another way, which functions much like a hybrid of these two options: revenue-based financing. Here’s what it’s all about…but be sure to read carefully.
How it works
Conventional options. Conventional debt and equity funding have drawbacks:
- For debt financing, it’s the ongoing obligation to pay interest on the debt, regardless of how the business is doing. Debt servicing and repayment are a drag on cash flow, and if the owner has given a personal guarantee to a business loan, puts the owner’s personal assets at risk.
- For equity financing, it’s having to give up a portion of ownership to get the money. What’s more the investors who become co-owners continue to have a presence in the business unless they sell or are bought out.
Revenue-based financing. Revenue-based financing smacks a little of each of these financing options, but is fundamentally different. The party providing financing—the revenue-based financing provider (RBF provider)—does not get an equity stake. Instead, it receives a percentage of monthly revenue (which can’t be called interest payments); no personal guarantees are required.
Example of revenue-based funding. In simple terms, if you get $100,000 financing through a revenue-based arrangement, the RBF provider receive 2.5% (or the agreed-upon percentage) of your monthly revenue until the funds are recouped in full. In addition, there’s an upfront fee of say 10% of the borrowed amount ($10,000).
The repayment percentage can vary (1%/month to 10%/month), as can the limits of funding. For example, Uncapped says the maximum amount it provides is a third of a company’s annual recurring revenue or 4-7 times monthly recurring revenue. But in addition, there’s an upfront fee, which is a percentage of the funding amount.
What types of companies are suited to revenue-based funding?
This funding arrangement isn’t for all types of businesses. There has to be a steady income stream to assure the revenue-based financing provider will receive good payments monthly and without too much risk. In other words, this type of funding works best for businesses with recurring revenue. RBF providers limit their funding to specific sectors. For example, Efficient Capital Labs only deals with B2B and SaaS.
What is the process for obtaining revenue-based funding?
The process is straightforward. You need to find a revenue-based funding provider. Efficient Capital Labs has a list of the 14+ best revenue-based financing companies.
Then you need to share your financial information. You don’t need to provide a business plan or pitch deck to show the revenue-based financing provider on how the funds be used and your vision for the future of your company. Instead, you give the RBF provider you’ve selected access to your financial accounts (e.g., QuickBooks, Xero) to enable it to view your financial history and determine whether your revenue is steady enough to support this type of financing arrangement.
Is revenue-based funding a good deal?
The concept of revenue-based funding can be very appealing because it’s quick and easy to arrange, there’s no dilution of ownership, no collateral required, no credit rating criteria, and no personal guarantees are involved. But don’t discount the cost to this financing arrangement. It can be MUCH higher than a traditional loan. Because of the upfront fee, the overall cost can be expensive for the time of repayment involved. If, for example, revenue is strong enough to repay the funding in 3 months, then the overall cost (the effective APR) likely will be considerably more than it would have been with traditional borrowing.
Final thought
For the right type of business seeking quick access to capital, revenue-based financing may be a good solution. But it’s highly advisable to understand how this type of financing arrangement works and to have a CPA or other financial adviser run the numbers to help make an informed decision. Traditional financing options may be a better choice in your situation.
Additional information related to business financing can be found in this list of blogs.
