Most businesses need financing to make initial investments, gain market share, and maintain operations. While some founders fund startups with their own cash, most people turn to loans. However, you may have a difficult time receiving a loan if your startup is relatively new. Some business owners also need to preserve their cash flow instead of committing to traditional bank loans with fixed monthly payments. Revenue based financing is an alternative way to borrow capital that offers flexible payments. It may be a good option for your startup.
What is Revenue Based Financing?
Revenue based financing is a method of acquiring capital that involves repayment via a percentage of gross revenue. Instead of making fixed monthly payments like you would with an installment loan, your weekly or monthly payment fluctuates. You’ll pay more money in a month when you earn $10,000 than a month when you only earn $5,000.
How Does Revenue Based Financing Work?
Lenders that offer this financing option will review your company’s finances and other documents to determine a percentage. You will have to repay the loan each month based on a percentage of gross revenue for a pre-determined duration.
If you cannot repay the loan on time with gross revenue, you will have to pay additional costs and fees. Lenders also require that you continue to pay them for a set amount of time after you have repaid the initial balance. This stipulation can help lenders make a higher profit if your company experiences substantial revenue growth.
How Is Revenue Based Financing Different from Other Business Financing Methods?
Traditional business financing methods involve fixed monthly payments, while revenue-based financing payments depend on your company’s revenue. Interest rates and the total amount you pay are clearly laid out in traditional business financing. However, the amount you pay for revenue based financing depends on how much your startup grows over time.
Revenue based financing has a similar premise to a business line of credit. You receive funds right away and have the flexibility with how often you pay in the beginning. Lines of credit often have minimum monthly payments and convert them into installment loans at the end of their terms. You can incur additional costs if you do not repay a revenue based financing loan on time.
What Types of Businesses Can Benefit from Revenue Based Financing?
Many business owners can benefit from this type of financing. These are some of the startups and organization categories that can capitalize on revenue based financing.
- Restaurants: The industry is known for low profit margins, and revenue based financing can provide the capital to hire workers and address other costs without fixed monthly payments.
- e-Commerce stores: e-Commerce business owners can use these loans to buy inventory and enjoy lower monthly payments when they get started. They will then make higher monthly payments as e-commerce sales ramp up.
- Construction: Construction companies have low profit margins. Revenue based financing can help business owners obtain the necessary materials to complete a project without putting too much pressure on margins.
- SaaS companies: These companies are known for burning through cash during their early stages in exchange for high revenue growth. Revenue based financing can help SaaS businesses preserve cash flow.
- Seasonal businesses: These companies can pay more money during busier months and have lower monthly loan payments when they are in the middle of slower months.
- Small business: Companies that are just getting started may not have access to traditional financing. An alternative funding source, such as revenue based financing, can help.
- Companies offering digital services: Revenue based financing can preserve your margins and keep initial loan costs low as you build up your services.
What Can You Use the Funds from Revenue Based Financing For?
Business owners have a lot of flexibility in how they can use funds for revenue based financing. These are some of the opportunities to consider:
- Advertising and marketing campaigns: Many local and online businesses use advertising and marketing campaigns to get in front of more customers. You can use these marketing channels to attract new customers and retain your existing customers.
- Product innovation: Investing in your product can lead to a higher quality design or service. Better products can increase customer loyalty, retention, and the average lifetime value per customer.
- Additional inventory: Some businesses, like e-commerce stores, need to frequently buy additional products to sell to customers. With the extra capital, you can invest in more products and then sell them in your e-commerce store.
- Workers’ salaries: You can treat revenue-based financing funds as working capital and use them to pay your workers. This approach can help businesses that are tight on funds now but have a few invoice payments on the way.
Business owners can use the capital for other expenses, but these four ideas serve as good starting points.
Pros and Cons of Revenue Based Financing
Knowing the strengths and weaknesses of revenue based financing can help you make a better decision. These are the pros and cons to keep in mind:
Pros:
- Flexible monthly payments based on fluctuations in revenue
- You do not give up equity
- Quick funding
- No personal guarantees
Cons:
- Your company must generate revenue
- Weekly or monthly payments are required
- You might receive more capital from other funding sources like venture capital firms
Key Features of Revenue Based Financing
Revenue based financing offers several distinct perks, making it a valuable financing method for many businesses.
Repayment Flexibility
Your monthly payments are based on your revenue. Startup founders won’t have to pay as much money when their businesses experience slow months. However, they end up making higher payments when their companies do well in a given month.
No Equity Dilution
Revenue based financing lets you preserve your equity without limiting your cash flow via fixed monthly payments. Preserving equity gives you more control over the company and enables you to keep the profits.
Fast and Efficient Process
You can receive revenue based financing in as little as 1-3 business days after approval. That’s a quicker turnaround than most types of financing.
Revenue Based Financing Process
The revenue based financing process consists of a few steps.
Qualification Criteria
Lenders will look at your company’s revenue during the application process. Higher gross revenue can help you receive better terms and increase your chances of getting approved. Companies with high revenue are less risky for revenue based financing providers.
Documentary Requirements
Most lenders do not have credit score requirements for revenue based financing. However, you still have to provide the following documents:
- Government-issued photo ID
- EIN
- Articles of Organization
- Operating Agreement
- Certificate of Good Standing
- Financial statements
- Financial projects and a business plan
- Other financial documents
Calculation of the Funding Amount
Lenders will assign a percentage of gross monthly revenue and a factor rate. This rate is the amount you must repay the lender. If a revenue based financing provider has a 1.2x factor rate and lets you borrow $100,000, then you will have to repay $120,000 over the loan’s term.
The Funding and Repayment Process
You will receive the funds shortly after getting approved. The entire process can take 1-3 business days. You will then have to repay the lender each week or month, depending on the terms of the loan. The lender will take a percentage of gross revenue to pay off the debt.
Example of Revenue Based Financing
Suppose an e-commerce business owner needs extra capital to acquire more inventory. The extra inventory will help the store owner manage a rising demand in orders. However, profit margins are tight, and the business owner doesn’t want a traditional loan.
The e-commerce business owner borrows $100,000 through a revenue-based loan. That capital helps the business owner buy more inventory to satisfy the product’s growing demand. The e-commerce store generated $30,000 per month before receiving financing and is now up to $35,000 per month thanks to the investment.
If the agreed-upon rate were 5% of gross revenue, the business owner would pay $1,750 each month as long as revenue stays at $35,000 per month. The monthly payment will fluctuate alongside revenue. The business owner must pay $120,000 back to the lender over the duration of the loan if it has a 1.20x factor rate.
Is Revenue Based Financing Right for Your Business?
Revenue based financing can be a great option for your business if you have tight profit margins and need extra capital. You can repay the loan through a percentage of gross revenue each week or month. Some business owners use the capital to increase total revenue without having to worry about fixed monthly payments. Having more cash upfront and fewer expenses can set the stage for a strategic expansion. However, it’s important to know how you plan on using the funds and determine if the loan will help you maintain or grow revenue.
This type of financing also offers quick capital, which is a big advantage for business owners who are short on time. You also get to keep your equity and don’t even need a good credit score to get this type of financing.
Where to Get Revenue Based Financing
Stenn offers revenue based financing as one of their funding options for businesses looking to access working capital without the constraints of traditional loans. To date, Stenn has funded over $20 Billion in funding to various eCommerce and SaaS businesses. Submit an online inquiry to see if your business qualifies and to learn more about their revenue financing solution with no obligation.
