Is Revenue-Based Financing right for your business?

Revenue-based financing is a unique way of financing through which an enterprise pledges a percentage of future revenues in exchange for loans given by the investors. This form of finance provides combined benefits for both equity and debt financing.

In this article, we will explore the advantages and disadvantages of revenue-based financing. Next, we will examine whether revenue-based financing is a good fit for your business. Lastly, we will explore the factors when revenue-based financing is not right for your business.

Advantages & Disadvantages Of Revenue-Based Financing

Under revenue-based financing, a borrower pays interest as a percentage of future revenues rather than a fixed amount under traditional financing. This helps an enterprise manage its costs and working capital effectively. The interest payments to investors reflect the growth of the business.

Investors in revenue-based financing do not acquire any equity stake in the business. Hence, founders don’t have to worry about the dilution of the business. They can maintain control over the company and run its affairs accordingly.

The future revenue of a business is the only guarantee under revenue-based financing. As compared to traditional debt financing, which requires an enterprise to place certain guarantees or collateral in the form of physical assets of an enterprise or personal assets. Also, the cost of revenue-based finance is comparatively lesser than the cost of equity.

Revenue-based financing has certain drawbacks too. Under this arrangement, a borrower must pay its investor monthly, unlike equity financing, where the payouts depend on the enterprise (for example, dividends or buybacks). 

Revenue-based financing favours those companies which generate adequate revenues with healthy margins. Hence, in their initial stages, many start-ups and companies do not qualify for this financing.

Is Revenue-Based Financing Good For Your Business?

We will now discuss the parameters through which one should assess whether or not revenue-based financing is a good option for their business.

Generating revenues through online sales

Investors in revenue-based financing prefer companies whose sales are generated through their website or any online merchant platform. The repayment to investors is linked to the sales of the company. Investors prefer transparency in sales data because they rely on it to make funding decisions.

High gross margins

Under revenue-based financing, a percentage of sales is given as a consideration to the investors. Hence, a company should earn healthy margins to cover the enterprise’s interest and other direct expenses.

Working capital efficiency

Under revenue-based financing, a borrower needs to pay its investor monthly. Hence, a company should have quick, repeatable working capital cycles to manage its commitments toward revenue-based financing. 

Factors To Consider, If Revenue-Based Financing Is Not Right For Your Business

This section will consider when a company should not opt for revenue-based financing.

Business in its initial stage

Investors in revenue-based financing look for a revenue history of at least 6 to 12 months. So, if a business is still testing its product or is in the process of acquiring customers, one should not opt for this form of finance.

Pure offline or in-store customer

Most investors in revenue-based financing prefer to cater to tech-savvy businesses as their revenues are traceable. So, if a business generates revenues from offline mode, for instance, walk-in customers or door-to-door selling, you might not prefer revenue-based financing.

Objective of raising funds

Revenue-based loans are usually used to finance revenue-related costs (for example, digital marketing). So if a business is seeking to fund its capital expenditure or research and development, then revenue-based financing is not an appropriate option for your business.

Conclusion

Every business must evaluate, based on the factors given above, whether they can choose to go for revenue-based financing for their funding needs.