Revenue Based Financing: Compare the Best Options

If your business has significant recurring income, income-based financing can provide growth capital without forcing you to forgo equity capital. Find out if this is right for your business.

What is revenue-based financing?

Income-based financing, also known as income-based investing or revenue-sharing financing, is a form of financing that allows small businesses to obtain financing and pay it back from income. future. Payments are based on a weekly or monthly percentage of income, until the funding is paid off with fees, which are typically in the range of 3 to 7 times the original investment.

How revenue-based funding works

Income-based financing or income-based investing typically describes an arrangement in which investors provide financing to companies with strong continuing income. Often the companies that make these loans specialize in certain types of high growth industries such as software as a service i.e. saas companies. This can be an alternative to traditional venture capital or angel investment structures that require the company to forgo certain shares in exchange for funding.

Unlike a traditional small business loan that requires fixed monthly payments (or sometimes weekly payments), income-based financing offers more flexible repayment terms. The investors or the company providing the funding or financing will receive a percentage of the future income until the agreed total repayment is reached. When incomes are lower, payments will be lower and when they increase, payments increase.

There will be a reimbursement ceiling which will determine the total cost of the financing. It can be as low as 1.35% of the initial investment amount, or as high as 10%, although there is no legal limit that caps the amount these companies can charge.

Advantages and disadvantages of income-based financing

Advantages:

  • More flexible approval criteria than loans
  • The owner can avoid a personal guarantee
  • Payments fluctuate with income
  • No dilution of equity
  • Quick financing

The inconvenients:

  • Higher cost of capital than traditional commercial loans
  • Requires significant recurring income
  • Not available for all industries

Income-based financing is generally more flexible than standard small business loans that require at least a few years of business, good credit scores, and solid income. The entrepreneur may also be able to avoid a personal guarantee.

This type of financing does not require the small business to give up business capital, but it is likely to be more expensive than a traditional small business loan such as a commercial bank loan or even a loan guaranteed by the SBA.

Income Based Financing vs Debt and Equity Based Financing

Debt financing is another term to describe a business loan. With this type of financing, entrepreneurs borrow money and pay it back over time with interest, usually in monthly installments. The cost of financing can be described using an interest rate, fee, or other terminology. (In most cases, small business lenders are not required to disclose an annual percentage rate (APR).

Some small business loans have very low interest rates. Traditional bank loans and SBA loans guaranteed by the Small Business Administration often carry the lowest interest rates, although micro-loans and some online loans are also relatively inexpensive.

The advantage of a small business loan over RBF is usually the cost. Borrowers who qualify for a low-interest small business loan will likely find this option cheaper than an income-based financing deal.

On the other hand, small business loans require regular payments which can be difficult to make, especially for a new and growing business, or one experiencing fluctuations in income.

Equity financing enables companies to obtain financing from investors, whether they are private investors, angel investors or venture capitalists. There is even a type of crowdfunding that allows companies to raise funds from a large number of investors.

The advantage of equity investments is that they can be structured without a payout. Investors cash in when there is a liquidation event (such as an IPO or acquisition). However, the advantage of RBF over this type of financing is that it does not require giving up company capital. The company does not give up control of the company

Income Based Financing Rates and Conditions

Income-based financing can be structured in various ways, but the main feature is that the payments will be linked to gross income. When income goes down, payments go down too. Higher income allows the business to pay off the financing faster, but it probably won’t reduce the total amount owed.

Here is an example of how this funding can be structured:

Lighter capital, a leader in this type of financing, provides loans of up to $ 3 million to technology companies with monthly recurring revenue (MRR) of at least $ 15,000 in the last three months and at least five customers receiving products or services. Borrowers can qualify for a loan of up to 33% of the annualized rate of income. (To illustrate, their website example states that a business on track for $ 1 million in sales this year can receive a loan of about $ 330,000.) Payments are based on a fixed percentage of the income ranging from 2% to 8% but not more than 10%.

How to Qualify for Revenue Based Funding

True revenue-based financing has very specific requirements. The first and most important requirement for this type of financing is that the business has sufficient recurring income. As mentioned earlier, it is typical with this type of financing that companies (or investors) seek companies in certain industries such as technology companies with a track record of generating recurring revenue and strong growth potential.

As part of the application process, the business should be able to confirm the source of income and may also need to document how it will use the new funding to grow the business. Minimum recurring income requirements of at least $ 10,000 to $ 20,000 or more per month would not be unusual. There may also be annual income requirements.

How to get revenue-based financing

Ideally, when looking for a small business, you’ll want to research the financing options that best suit your business needs and are eligible for. Since RBF is available from specialist finance companies, you may have very limited options. You can find potential investors from the investing community, or perhaps from a trade association or networking with other entrepreneurs in your industry.

If you don’t meet the rather narrow criteria for RBF, you might want to consider other types of revenue-based funding. Businesses with strong monthly revenues may qualify for a Merchant Cash Advance or a Business Cash Advance, for example. Both of these products offer advances on future income and will rely heavily on recent income (often the past 6 to 12 months) in making an underwriting decision. MCAs and BCAs are widely available for many types of businesses, provided they have sufficient income. The credit score requirements are generally very low.

Another type of financing that examines revenue is accounts receivable financing or invoice financing (or factoring). With this type of financing, the company pledges revenue from sales already made, but for which it has not yet been paid.

Understanding what type of financing is right for your business can be confusing. One option is to work with a small business finance marketplace that can match your business to finance based on your qualifications.

This article was originally written on December 17, 2021.

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