Understanding revenue based finance

Not all businesses make the same amount of money all year round – some have busy periods that keep them running when things are quieter.

Traditional forms of business finance could see seasonal businesses struggling to repay their loans during these quieter periods, or having to be extra careful with budgeting to make sure they have enough cash in the bank to see quiet spells through. 

Because businesses taking revenue based finance only pay an agreed percentage of their turnover each month, it’s well suited to ones that don’t have consistent revenue streams all year round.

If you run a startup with a promising future, but lack trading history for traditional business finance then you’re likely to be drawn to revenue based finance. This form of business finance allows you to get the cash you need upfront, while only having to repay at a rate that’s proportional to your growth. If your business is slower than expected, you won’t be left struggling to repay your monthly instalments.

Subscription-based businesses tend to have steady and predictable streams of income, making it easier to work out how much they can afford to repay each month. Because of this, revenue based finance could be a good way of raising capital, with the comfort of knowing your repayments will decrease if business slows up.

So you're considering financing options? Let me help you understand why you might choose revenue-based financing (RBF) over traditional debt financing.

1. Flexibility: The main advantage of RBF is that it's super flexible. You pay back a percentage of your revenue, so if you have a slow month, your payment will be smaller. This is great because it takes off some of the financial pressure during tough times. Traditional loans, on the other hand, have fixed monthly payments regardless of how well your business is doing.
2. No collateral needed: With RBF, you don't need to put up any collateral (like your house or other assets) to secure the financing. Traditional loans often require collateral, which can be pretty risky if things don't go as planned.
3. No personal guarantees: RBF usually doesn't require personal guarantees, which means that your personal assets are safe even if your business can't repay the funding. With traditional loans, you might need to provide personal guarantees, and that can put your personal assets at risk.
4. No dilution of ownership: Unlike equity financing, RBF allows you to keep 100% ownership and control of your business. You're not giving away any shares or decision-making power to investors. Debt financing doesn't dilute ownership either, but RBF's flexibility can make it more appealing.
5. Growth-focused: RBF is well-suited for businesses with high growth potential, as the payments adjust to your performance. Traditional debt financing can sometimes be restrictive and limit your ability to invest in growth opportunities.

However, keep in mind that RBF can be more expensive in the long run compared to traditional loans, and you need a proven revenue track record to qualify. But if you're looking for a flexible, non-dilutive financing option that can help you grow without the pressure of fixed monthly payments, RBF might be a great choice for your small business.

The fees can vary depending on the funding provider and the specific terms of your agreement, but here are some common fees you might encounter:

1. Origination fee: This is a one-time fee that some funding providers charge to cover the costs of processing your application and setting up the financing. It's usually a percentage of the total funding amount, typically ranging between 1% to 5%.
2. Due diligence fee: In some cases, the funding provider might charge a fee for conducting their due diligence, like evaluating your financials and assessing the risks involved. This fee could be a flat rate or a percentage of the funding amount.
3. Early repayment fees: Some funding providers may charge a fee if you decide to pay off the entire amount earlier than expected. This could be a flat fee or a percentage of the outstanding balance.
4. Late fees: If you miss a payment or don't pay the full agreed-upon percentage of your revenue, you might be charged a late fee. This could be a flat fee or a percentage of the missed payment amount.

It's important to carefully review your RBF agreement and ask the funding provider about any fees you don't understand. Also, don't be afraid to negotiate! Some fees might be negotiable, and you can potentially save some money by discussing the terms with the funding provider.

Just remember, while RBF can be a great flexible financing option for small businesses, the fees and overall cost can be higher than traditional debt financing. So, make sure to weigh the pros and cons before deciding if it's the right fit for your business.

Here's a breakdown of the differences between venture debt and revenue-based financing (RBF).

1. Repayment structure: The biggest difference is how you pay back the funds. With RBF, you pay back a percentage of your monthly revenue until you hit a predetermined repayment cap. This means your payments are flexible, adjusting based on your revenue each month. Venture debt, on the other hand, is a fixed-term loan with regular principal and interest payments, similar to traditional debt financing.
2. Eligibility: RBF typically works best for businesses with a strong revenue track record, as you need to show that you can generate enough revenue to pay back the financing. Venture debt is often used by startups and growth-stage companies that have received venture capital (VC) funding but need additional capital without further diluting their equity. So, if you've already raised VC funding, venture debt might be a better option for you.
3. Collateral and personal guarantees: Venture debt often requires collateral (like company assets) to secure the loan, and sometimes even personal guarantees from the founders. This can be risky if things don't go as planned. RBF, on the other hand, usually doesn't require collateral or personal guarantees, which can be less risky for you as a business owner.
4. Use of funds: RBF is generally more flexible in terms of how you can use the funds, making it suitable for various business needs like expansion, marketing, or working capital. Venture debt is often used for specific growth initiatives or as a bridge to the next equity financing round.
5. Cost: RBF can be more expensive in the long run compared to traditional loans, but it's often less expensive than equity financing. Venture debt is typically cheaper than RBF but can still be more expensive than traditional loans due to the higher risk associated with startups and growth-stage companies.

Both options have their pros and cons, so it's essential to carefully consider your business's unique needs and growth plans before deciding which financing option is the best fit for you. Finally, just so you know, we've written a piece on venture capital that could of use.

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