Pros and Cons of Revenue-Based Financing

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

In this article, we will explore the key pros and cons of revenue-based financing for an enterprise.

Pros of Revenue-based financing

1. Flexible Cost of Capital

Under revenue-based financing, an enterprise pays interest in the form of a percentage of future revenues rather than a fixed interest on the loan. This helps an enterprise by adequately reducing its fixed cost and managing its working capital. The interest is dependent on the enterprise’s future performance.

2. No Dilution of Shareholders Equity

Investors in revenue-based financing do not receive any equity or shares of the enterprise. Accordingly, a start-up company or a founder does not have to worry about ownership dilution. Also, these investors do not take part in board or committee meetings. Hence, a founder can maintain control over the company and direct the company to its objective.

3. Guarantees or Collateral not required

Guarantees or collateral under revenue-based financing are the enterprises’ future revenues. Bank loans and other forms of debt financing require an enterprise to place personal guarantees, physical or personal assets. Hence, an enterprise is relaxed, knowing no guarantees or collateral are required.

4. Common goal to grow

Revenue-based financing involves flexible repayment, so the returns to an investor increase when the enterprise grows. Hence, the investors and the enterprise work towards a common objective to grow revenues and profitability.

5. Lower than the cost of equity

Equity shareholders have rights towards an enterprise in the form of voting rights and dividends. The returns to these shareholders are dependent on the growth of the enterprise. Hence the cost of equity is the highest among all forms of financing.

Returns under revenue-based financing are too dependent upon the growth of the enterprise. So, if an enterprise achieves low sales in a month, the interest cost will reduce for that month. Hence, the cost of revenue-based financing is less than the cost of equity.

6. Quick Funding

To source funding from banks, an enterprise needs to be eligible for the loan and satisfy many compliances to secure this funding. To achieve funding from venture capitalists or private equities, an enterprise needs to pitch its business model and growth perspectives to investors.

It involves many rounds of discussion and typically takes 6 months to a year before securing the deal. Under revenue-based financing, an enterprise can achieve the funding in a minimum of 4 weeks.

Cons of Revenue-based financing 

1. Monthly payments

Revenue-based financing requires monthly payouts to investors. Unlike equity financing, whose payouts depend on the enterprise (for example, dividends or buybacks). Many companies find themselves short on cash, so it is very essential to obtain a sufficient amount of finance that matches the enterprise’s financial plans.

2. Revenue-generating companies

Revenue-based financing favours companies which generate adequate revenues. The companies in their initial stages or pre-revenue stage mostly are ineligible for this form of finance. Alternatively, these companies approach venture capitalists as they provide finance even if an enterprise does not generate revenues.

Conclusion

Every business must weigh both the pros and cons of revenue based financing before deciding to go for it.