If your business’ development has reached that all-important phase of achieving steady or growing revenues, you may well be considering raising funds to facilitate further growth and make that crucial leap to the next stage of expansion.
You might also be thinking that this means applying for a bank loan – and with it, having to fulfill all the stringent requirements necessary to be approved for such funding. Or alternatively, you could be considering the option of accessing much-needed capital through an equity financing arrangement - but you are not keen to give up a stake in your business to a venture capital investor to gain access to such funds.
While both funding solutions are certainly popular amongst the small business community, they do have their own drawbacks that may prevent you from committing to them. Thankfully, there is another option that is proving increasingly useful to small businesses, particularly to those with an existing record of revenue-generation and who expect solid gains in revenue over the coming months and/or years.
Revenue-based lending is fast-becoming a preferential funding option thanks to a myriad of features that may prove ideal to your own business’ situation. That said, revenue-based lending is not without its own set of requirements and challenges of which you should be aware, and into which we will delve.
What is Revenue-Based Lending?
Also known as revenue-based financing, royalty-based financing or revenue-based investing, revenue-based lending provides you with access to funds from an investor in exchange for an ongoing percentage of your monthly business revenues.
As such, revenue-based lending is a flexible financing solution which adapts in accordance with the monthly revenue of your business – when revenues are higher for a particular month then your repayment to the lender will be higher. And when the business is perhaps not performing as well and revenues are lower, so too will be your repayment amount.
This makes revenue-based lending particularly appealing for businesses that are exposed to pronounced fluctuations in seasonal demand. With repayments being performance-based rather than fixed (as this case with debt financing facilities), businesses with less predictable revenue projections can also benefit.
Nonetheless, it is important to remember that revenue-based lending is still a type of debt. But if your business is primed for growth, it can be a pivotal source of funding, and even more so if you have a small business that is already generating revenue, and that has further expectations of strong growth going forward.
How Does Revenue-Based Lending Work?
Compared to comparable funding options such as debt financing or equity financing, revenue-based lending can be a straightforward process. Once you decide on a suitable revenue-based lending firm, you will most likely be required to provide information pertaining to the financial history of your business.
You might also need to show revenue projections for the coming months so that lenders can determine how much they are comfortable to lend to you. Increasingly, this involves lenders connecting to your back-end sales systems (such as Stripe, Zero or Google Analytics), as well as stipulating eligibility requirements in terms of your minimum monthly recurring revenue (MRR) and/or annual recurring revenue (ARR).
If you meet the requirements and are approved for revenue-based lending, the lender will offer you a variety of revenue-based funding options with different repayment amounts and terms from which to choose. Once you select the most suitable option you sign a revenue-based lending agreement with the lender.
Under the agreement, you then make repayments every month as a percentage of the monthly revenue your business generates. This percentage might not only be determined by the strength of your business, but also on the areas of your business in which you plan to invest the funds, with more stable activities commanding a lower percentage than higher-risk ventures.
Examples of Revenue Based Lending
Let us assume that as a small business owner with a high probability of stellar growth over the next 6 months, you need a cash injection of $250,000 to fulfill those growth ambitions. But being unable to obtain a bank loan at a competitive rate and unwilling to give up a stake in your business through equity-based financing, you decide to pursue a revenue-based lending arrangement to raise the necessary capital.
So, you agree a deal with a firm specializing in revenue-based lending, which in turn provides you with the $250,000. In exchange for this cash, you must pay the lender 8% of your revenue every month. You also agree to owing a $10,000 flat fee as additional risk compensation for investors, which is added to your outstanding balance at the commencement of the deal:
| Month ($) | Revenue ($) | Repayment ($) | Outstanding Balance ($) |
| 0 | 0 | 0 | 260,000 |
| 1 | 250,000 | 20,000 | 240,000 |
| 2 | 285,000 | 22,800 | 217,200 |
| 3 | 375,000 | 30,000 | 187,200 |
| 4 | 465,000 | 37,200 | 150,000 |
| 5 | 60,000 | 4,800 | 145,200 |
| 6 | 30,000 | 2,400 | 142,800 |
| 7 | 245,000 | 19,600 | 123,200 |
| 8 | 315,000 | 25,200 | 98,000 |
| 9 | 425,000 | 34,000 | 64,000 |
| 10 | 400,000 | 32,000 | 32,000 |
| 11 | 350,000 | 28,000 | 4,000 |
| 12 | 275,000 | 4,000 | 0 |
As shown, if your business generates large revenues in a month (such as months 3 and 4), your monthly repayment will be larger and will thus help to substantially lower your outstanding balance and shorten your overall repayment term.
Months with lower revenues (such as 5 and 6), however, will incur much smaller repayment amounts, which in turn will delay the completion of your payment obligations to the lender.
Revenue-Based Lending vs Debt Financing vs Equity Financing
As comparable funding types, revenue-based lending is often weighed up by business owners against debt financing solutions, whereby you obtain a loan from a bank or lending firm, and you are invariably required to provide collateral and a personal guarantee to repay the lender in case of default.
This comparison is understandable given that revenue-based lending is categorized as a debt agreement. But rather than having interest accumulate on the money you borrow and being required to make a fixed repayment amount every month as is normally the case under debt financing agreements, the promissory note under revenue-based lending instead stipulates that repayment of the loan is tied to a share of your company’s revenue.
Revenue-based lending also differs from debt financing in that neither collateral nor personal guarantees are required by the lender as part of the deal.
As for equity financing – whereby the investor provides you with financing in return for an ownership stake in your business – your repayment to the investor will depend on the value of the sale price and size of investor’s ownership stake, as well as other factors such as dividends if applicable.
In contrast, revenue-based lending provides access to capital without having to dilute your equity; rather, your only obligation is a monthly/periodic payment as a percentage of the monthly revenue generated by your business. And while equity financing means having to share profits and engage in consultations with your investors when making major decisions pertaining to business strategy, the retainment of ownership in revenue-based lending agreements means those investors have no rights to influence the direction of your business.
The Pros of Revenue-Based Lending
- Flexibility – because monthly repayments are proportional to monthly revenue, you will never have to repay more than your sales in any single month. If sales prove to be more modest than normal for a particular month, then your repayment will also be correspondingly modest.
This could be a crucial factor to consider, especially if your business has significant seasonal performance fluctuations – the flexibility afforded by revenue-based lending means you can repay less during low season, and not have to worry so much during this period.
- Non-Dilutive Funding – unlike venture capital funding and angel investing, revenue-based lending does not require investors to take an equity stake in your business. Nor do they interfere with your management structure or occupy any board seats. As such, you maintain complete control of your business and can thus continue to grow it in line with your vision.
- Affordable – not only does VC funding typically require you to give up a share of equity in your business, the cost of this type of funding can be exorbitant, particularly if your business experiences strong growth such that the value of your investors’ share ends up in the many millions of dollars.
Revenue-based lending instead takes a simple flat percentage fee for providing you with funding, while to the total repayment amount remains fixed throughout. As such, it is not possible for revenue-based lenders to continue taking more from you as your business scales and grows.
- Speed – whilst a funding application to, say, a VC firm could conceivably take months to secure, revenue-based lending is a much faster method of obtaining financing. Indeed, some RBF facilities can be approved in just a matter of weeks, if not days, with lenders able to connect to your internal sales and marketing systems to quickly assess your business and respond with a funding offer for you.
- No Collateral Required – to secure a loan, you will most likely be required to post collateral in the form of tangible assets, as well as possible provide a personal guarantee of your willingness to repay in case of a default event. No collateral or personal guarantees are required in revenue-based lending.
- Borrower and Investor Goals Aligned – revenue-based lenders have a vested interest in seeing your business achieve strong growth in revenue, as higher monthly sales figures ultimately mean that you can repay funds quickly via more sizeable monthly payments. Lenders have “skin in the game” in this regard, and are thus broadly aligned with your own growth aspirations.
The Cons of Revenue-Based Lending
- Non-Universal Eligibility - By definition, revenue-based lending requires that you are generating monthly revenue to be eligible for this form of financing. If you are still in the pre-revenue stage of development then this method is not available to you. Indeed, as mentioned above, revenue-based lenders will use the MRR and ARR metrics to determine the extent of funding for which you qualify, which means you will have to have already been generating revenue for around 6-12 months in most cases.
- Limited Amount – investors will only be willing to lend you amounts they are confident will be repaid. And that ultimately means that the funding amount you receive will be capped by your estimated revenues over the ensuing months. As such, the size of funding that you can access through revenue-based lending tends to be much lower than via debt financing and equity financing arrangements.
- Limited Term – although it is possible to make repayments over longer periods of time, revenue-based lending is typically deemed a short-term funding solution to obtain “light” amounts of capital, with repayments often completed within 12 months. And while recurring funding arrangements are available from revenue-based lenders, the limited term on offer for each deal could translate into a sizeable monthly repayment percentage being required, especially when compared to other funding solutions that offer much longer repayment terms – and therefore, less burdensome periodic repayment amounts.
- Monthly Repayment Still Required - Although you are not required to make fixed interest payments, revenue-based lending is still a form of debt funding, in that you are required to make a monetary repayment to investors every month. Should sales generally continue on an upwards trajectory as planned, then your monthly repayments should be manageable. But if your business suffers a series of poor monthly sales, fulfilling your payment obligations in absolute terms may still be challenging, even if the repayment amount itself is smaller. especially given that other fixed cost obligations will take up a much bigger percentage of your available resources in these lower revenue months.
Rather than monthly revenue, moreover, repayment under equity financing is instead dependent on the value of the business, as well as other factors such as dividends and buybacks. As such, this may be a more suitable option to revenue-based lending, especially if a monthly repayment schedule is tough to fulfill.
