Revenue-Based Finance
Specialized lenders provide capital into an early-stage business and get paid back as a percent of future revenue
Revenue-Based Finance (RBF) is a type of capital provided to growing businesses in which investors give funds for a pre-determined percentage of ongoing gross revenues.
Revenue-based finance vs. venture capital
Venture capitalists want to own a part of your company, and likely get the rights to own more in future fundraising rounds if all goes well. Providers of revenue-based finance typically do not lay claim to ownership – they only claim a future share of your revenue. Revenue-based finance is known as “non-dilutive capital,” meaning that company owners do not give up any ownership to providers of this type of finance. That said, many combine both types of capital at different stages in their growth.
Revenue-based finance vs. asset-backed loans
Revenue-Based Finance is not an asset-backed loan. Previously, the only types of debt available to early-stage businesses were loans that made a claim to the company’s balance sheet. Debt providers would be able to repossess cash if the company was generating cash on the balance sheet, or hard assets like “property, plant, and equipment” which is the line item on a balance sheet devoted to capital expenditures.
Meanwhile, software companies were left out of the equation as an early-stage tech company typically has a fairly light balance sheet: no hard assets and cash flow deferred into the future, the greatest value is intangible. RBF is not new – it was used to finance oil exploration and repackaged to fund growth companies. What is new is the use of RBF instruments to fund the early stages of private company growth.
Example Firms
Lighter Capital | Bigfoot Capital | Earnest Capital | Decathalon Capital
Is revenue-based finance the right capital for your business at this stage?
COMPANY PERSPECTIVE
Benefits
- Funds growth phases
- Keep ownership and control (no dilution)
- No hard assets required
- The amount owed is "capped" - there is a limit to the benefit to finance providers
- No personal guarantees required
- Interest is deductable
Challenges
- Repayment multiples may be high
- You need revenue so if you make less than $100k you are likely not eligible
- If you become deliquent, you stand to lose patents, domain names, trademarks, and other assets
Key Performance Indicators
- Repayment percentage
- Multiple
CAPITAL GIVER PERSPECTIVE
Benefits
- No liquidity event is required (valuable ahead of acquisition or a public offering of shares)
- Based on predictable cash flows or other signals of business success
- High rate of return vs. conventional bank loan
Challenges
- Upside is capped - so very high growth outcomes for the company do not change the terms of the deal
- Founders and managers are typically not required to secure the loan personally
- Repayment amount not guaranteed
Key Performance Indicators
- Revenue Growth
- Monthly recurring revenue
- Strong Gross Margins to allow for repayments
- Load factor rates
When it Works Well
Quick decision process
The Revenue-Based Finance process is relatively quick and data-driven and does not require a laborious process to find funders and complex term sheet negotiations. Terms are reasonably standard and companies report receiving RBF within days and weeks.
Company has revenue
Once the company is up and running and has revenue and the ability to demonstrate a gross margin to help finance future growth, they are eligible to be considered. Companies with higher growth rates for revenues, or predictable revenues such as in Software-as-a-Service or other as-a-Service business models, tend to fare better in RBF terms.
Growth phase ahead
RBF loans are ideal for companies going through a growth phase or growth surge when getting ahead of demand.
Challenges to Revenue Based Finance
Not for uncertain business models
Early-stage companies that are not certain about their business model and want funds to search and explore first are not a good match for RBF, because the debt is priced to the value of revenue, not a theory about revenue. Once a company figures out its model and starts to earn predictable revenue, then RBF is a better match.
Not ideal for capex heavy startups
Deeptech, cleantech, robotics, or large-scale data pipeline developers likely need to rely on equity to start. These companies that require substantial capital expenditures or capex upfront may have to take equity-diluting terms from angel investors or early-stage VCs. RBF may be considered later on in the company’s growth, but cannot fund that first phase.
VC-funded can outspend
Consider RBF in context. If you are in a heavily funded sector or category and your competitors are raising substantial capital, they may put that to use in order to create a winner-takes-all or winner-takes-most outcome. Planning a long-term strategy that leads from bootstrapping early growth to funding growth only through RBF may leave you exposed if venture funding accelerates.
Draws money away from investing
RBF requires monthly payments, whereas equity-based capital like VC does not. Founders may find themselves tight on cash in any given month, so it’s important to choose the right amount of funding for the company’s growth stage.
Trends in Revenue Based Finance
Specialized RBF
When a finance provider for RBF becomes specialized in a specific type of business, like Software-as-a-Service, they can use benchmarks from the larger loan base to develop data-driven loan factor agreements. Other sectors like Podcasting have started to attract specific RBF offerings.
Podfund provides funding and services in exchange for a percentage of total gross revenue (including ads/sponsorship, listener support, and ancillary revenue such as touring, merchandise, or licensing) per quarter.
Earmarked for impact
A number of RBF instruments have been developed to address the needs of impact investors. Why would this alternative finance type be so appealing to impact investors? They may want to set their sites on smaller markets and more local contexts and not pursue the scale required for venture capital but have plans to invest in more local change.
The Founders First Capital Partners targets service-based companies led by minority, veteran, or women founders that do not fit the venture capital pattern, but do have the potential to create well paid jobs and generational wealth.
Revenue-focused accelerators
Where most accelerators follow a Y Combinator model helping founders move through inflection points set by VCs, emerging accelerators are gearing for smaller markets, non-traditional geographies, and RBF as a primary funding source.
Whereas a startup in a Bay Area accelerator might be encouraged to build an MVP pilot, first, and then optimize for growth over profit, these emerging accelerators focus energy on getting to revenue – finding consulting income, paid pilots, and optimizing the growth plan towards achieving profitability. Accelerators like TinySeed and the above-mentioned Founders First Capital Partners are examples of RBF accelerators.
Before You Consider Revenue-Based Finance
- Do you have revenue? You’ll need it!
- Do you have operational rigor to predictably pay off the principle and interest?
- Are you growing? You’ll want to grow, otherwise, it’s an expensive loan.
Exploring Revenue-Based Finance
- Take a look at RBF companies with quick decision processes.
- Compare the true cost of capital for equity fundraising and compare the difference to RBF.
- Plan out your funding and capitalization strategy to figure out when RBF might be right for you.
Discover Alternative Capital
Revenue-Based Finance is one way to grow your company, and you can choose other capital types as an alternative or pair and combine at different stages of your business. Consider these alternative capital sources or explore our Capital Library.
