Revenue-based financing

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    Chris Godfrey

    Page written by Chris Godfrey. Last reviewed on July 11, 2024. Next review due October 1, 2025.

    Your business may be generating good revenues, but if your credit score is weak or your trading history is short, you may find it tough to get a standard business loan. Revenue-based financing could be your solution to this problem. Use the value of your annual or monthly revenues to get the funds you need, then simply pay the loan back with a percentage of your monthly income. 

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      What is revenue-based financing?

      Revenue-based financing – also known as ‘royalty financing’ – uses the value of an organization’s gross sales or profits to raise capital from lenders or investors. Unlike traditional business loans which typically provide a sum of cash based on business history or the value of corporate assets such as machinery or property, revenue-based financing is a bet by the lender/investor on the future performance of the business. 

      There are no interest charges with revenue-based financing, and usually there is no term limit. The lender/investor simply receives a percentage of your sales until they are paid back their original capital plus a pre-agreed royalty.

      How does revenue-based financing work?

      Revenue-based financing is a hybrid of equity financing – where the business sells shares to raise funds – and debt financing – where the business takes on a loan, often using the company’s assets as collateral. With revenue-based financing, the lender/investor receives no shares or collateral. Nor do they receive interest as with a standard loan. Their return on investment is typically a fixed sum – anywhere between 0.1 and 2.0 x the sum they invest – which is called the ‘royalty’.

      By investing in the performance of the business, revenue-based lenders/investors are gambling that the company’s revenues will grow, allowing them to pay back the invested capital plus the royalty. For the business, the arrangement means they do not surrender any ownership, nor do they need to provide collateral.  

      Lender/investors receive a monthly repayment that represents a mix of capital and royalty. This sum will usually be a set percentage of gross sales or profits (typically 2% – 3%) which means the sum received will ebb and flow according to the performance of the business. When the company is doing well, the payments increase. If sales fall off, so does the repayment. In many cases, the arrangement stays in place until the lender/investor is paid back in full, although some revenue-based finance deals may have a term limit of 3 to 5 years.

      Revenue-based financing is often compared to invoice-financing, where a business uses its unpaid invoices as collateral for a loan

      An example of revenue-based financing:

      Model: Variable collection (see below)

      Sum invested: $100,000

      Royalty multiplier (also known as the ‘repayment cap’): 1.1 = $10,000

      Total sum to be repaid (investment plus royalty): $110,000

      Repayment percentage per month: 3% of gross sales

      Outcome: The lender/investor will invest $100, 000 and get $110,000 back over time. They will receive 3% of the company’s gross sales until $110,000 is reached or until the contract term expires.

      ‍Types of revenue-based finance

      • Variable collection

      Variable collection is the most popular type of revenue-based funding. Businesses take out a loan for a certain amount and repay it each month based on an agreed percentage of their gross sales or profits. They repay until the invested capital and royalty are paid back. With this model, the business knows what their total repayment will be.‍

      • Flat fee 

      Businesses pay a fixed percentage of their future revenues every month for up to five years – usually at a rate of 1% to 3%. With this model, the business has no set total repayment, they simply pay the agreed percentage of monthly revenues for the agreed term of five years. 

      Monthly repayments tend to be much lower than those in the variable collection model, making it a good option for some early-stage companies. However, if the business grows and scales quickly, they can end up paying far more over the term of the loan.

      Who can benefit from revenue-based finance?

      Revenue-based financing may be a good option for high-growth businesses, some startups, existing businesses that are experiencing cash flow problems but still have high revenue, and borrowers who cannot qualify for traditional financing because of poor personal credit. 

      Note that you don’t need to be turning a profit, own collateral or have strong personal financials to qualify for revenue-based financing. However, revenue-based loans rely on immediate revenue, so if you are an early-stage business without any income, this type of financing is not for you.

      How much revenue-based financing can you secure?

      Lenders/investors base their loan offer on a percentage or multiple of your annual or monthly revenues. Typically, this would be one third of annual recurring revenue (ARR) or four to seven times monthly recurring revenue (MRR). 

      Examples:

      • ARR of $10,000,000 – loan offer 33% of this sum: $3,330,000
      • MRR of $100,000 – loan offer 4 to 7 times this sum: $400,000 to $700,000

      What are the pros and cons of revenue-based financing – borrower perspective?

      Pros:

      • Retain full ownership of the business
      • No personal guarantee required
      • Loan repayments are flexible, which reduces strain on cashflow
      • Fast growing businesses that choose the variable collection model to pay off their loan quickly
      • No interest payments
      • Quick to fund – sometimes in less than 24 hours of application

      Cons:

      • Revenues are essential – early-stage businesses without income do not qualify
      • Smaller loan amounts – most revenue-based financing uses your monthly revenues to calculate the sum you can borrow. If you’re an early-stage business with low revenues, the sum you can borrow may be too small for your needs
      • Not suitable for long repayment terms

      Is revenue-based financing right for me?

      You need regular income and a strong growth plan to make revenue-based financing a success. If you can meet these challenges and you don’t want to dilute your business ownership, or you’re concerned about paying high interest charges on a standard business loan, revenue-based financing may be a good fit for you. 

      What are the alternatives to revenue-based financing?

      If revenue-based financing is not an option for your business, there may be other ways to obtain the funds you need:

      Invoice financing

      Also known as account receivables financing invoice financing uses your unpaid invoices as collateral for a loan. Invoice finance lenders typically provide up to 95% of the invoice value. Instead of waiting 30, 60, 90 days or more, you get most of your invoice paid within a day or two of the bill being raised. This type of borrowing can be particularly useful for businesses that have few assets to offer as collateral for a bank loan. Their unpaid invoices are the collateral. There is usually no need for additional security.

      With invoice financing, you are still responsible for chasing payment from your customers and you retain control of your sales ledger. The deal is confidential. Your customers need never know that you are using your invoices as collateral for a loan.

      Startup loan

      Some online and traditional lenders have special loan programs for entrepreneurs. Startup loans may provide an initial payment holiday to help you get underway, or work with a repayment taper where the sum you pay back each month starts small and rises as your business builds its revenues. Although you will usually need good credit and collateral to get a startup loan, this kind of financing can often work out cheaper than revenue-based lending and may be easier and faster to obtain.

      Business line of credit

      This is a business loan that functions like a high-value credit card but comes with lower interest rates and fees. Organizations can withdraw as much as they want when they want from a loan facility up to the limit of their borrowing. The best thing about a line of credit is that you only pay interest on the sum you withdraw, not the whole line. This can significantly reduce your borrowing costs. Collateral may be required.

      SBA loan

      SBA 7a business loans are provided by lenders who are part of the Small Business Administration (SBA) lender network. Partially backed by the US Government, these loans can provide up to $5million to qualifying borrowers with repayment terms as long as 25 years. 

      SBA loans usually come with much lower interest rates and fees than other commercial lending, but meeting their strict rules of eligibility can be tough for many businesses. As well as an approval process that can take several months, organizations will typically need to have been in business for at least four years and have annual revenues over $180,000. Your personal credit score must be at least 680.

      Get started with Swoop

      No matter if you’re seeking your first revenue-based loan or you’re a seasoned borrower, working with business finance experts can make all the difference when applying for funding. Contact Swoop to discuss your borrowing needs, get help with your application and to compare high quality revenue-based financing deals from a choice of lenders. Make your revenues do more for your business. Register with Swoop today.

      Written by

      Chris Godfrey

      Chris is a freelance copywriter and content creator. He has been active in the marketing, advertising, and publishing industries for more than twenty-five years. Writing for Wells Fargo Bank, Visa, Experian, Ebay, Flywire, insurers and pension funds, his words have appeared online and in print to inform, entertain and explain the complex world of US consumer and business finance.

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      At Swoop we want to make it easy for SMEs to understand the sometimes overwhelming world of business finance and insurance. Our goal is simple – to distill complex topics, unravel jargon, offer transparent and impartial information, and empower businesses to make smart financial decisions with confidence.

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