Let’s say you have an idea for a brilliant new product, but you just don’t have the money to research, develop and market it, and you’ve been turned down by traditional lenders and the private equity markets for capital. What if your small business needs cash to cover a business emergency, but your bank’s lending process just takes too long?
What do you do?
The answer could lie in one of the fastest-rising – yet least known – funding solutions out there: revenue-based financing (RBF). RBF is a form of financing that could get you the assets you need quickly and without the need for personal collateral or an impeccable credit score.
What is Revenue-Based Financing?
RBF is a capital-raising method in which a lender, such as Kapitus, agrees to provide money to a business in exchange for a predetermined percentage of a company’s future gross revenues, plus a pre-agreed upon multiple of the original amount, over a predetermined time frame.
In essence, it allows a company to successfully raise money without giving away any ownership stake and without the business owner having to pledge personal assets, such as his or her home, as collateral. Furthermore, relative to debt and equity financing, revenue-based financing is a much easier process that requires less documentation when applying.
In short, RBF is one of a few types of business financing methods that limits the personal exposure of the business owner and looks to the business itself when making underwriting decisions.
In deciding who qualifies for RBF, lenders primarily look at a company’s sales history. In some cases, all you will need to submit is three months of business bank statements. Therefore, the underwriting process is relatively fast, and approval can come in mere hours. Once approved, many lenders can have funds in your bank within 24 hours.
Who Should Use RBF?
RBF can be used by virtually any small business with a strong sales history. If you own a plumbing or retail business and you need $20,000 because the roof starts leaking or your air conditioning machines break down, RBF may be your solution since you can get cash in your hands quickly with little paperwork relative to a business loan or other forms of financing.
RBF can also be an ideal solution for larger small businesses, such as consumer software firms that have a strong sales history, which can borrow larger amounts to fund the research, development and marketing of a new product. According to a 2020 report issued by BootStrapp, the most popular users of RBF were software-as-a-service (Saas) companies, followed by food and beverage companies, consumer products companies, eCommerce and healthcare businesses.
How Does RBF Work?
Let’s say you own a larger business, such as a software-as-a-service (SaaS) company, and you believe that the future growth of your business can only be ensured by introducing a new software product that requires an additional $250,000 in capital to research, develop and market. However, you are not able to obtain a loan from traditional lenders because of your credit score, and the initial stakeholders in your company do not want to add any additional investors.
Your company can arrange a deal with an RBF provider to get $250,000 in exchange for a portion of your company’s future revenues. Your company will be required to make agreed-upon installment payments equal to a percentage of your overall revenue plus a small multiple of the original amount to compensate for the risk.
What are the Advantages of RBF?
In revenue-based financing, investors are entitled to regular repayments of their initially invested capital, so it is like a loan in that regard. However, it differs from a loan in that interest is not charged. Instead, there is a fixed cost of capital, meaning that the repayments are calculated using a predetermined multiple that results in returns that are higher than the initial investment and that cost does not change as long as the terms of the agreement are met.
Also, RBF offers unique advantages over receiving investments from venture capital or angel investors. With private equity, investors often require collateral, an ownership stake in your company and/or seats on your company’s board of directors, if you have such a board. RBF could also be an attractive financing model if your small business has no intention of going public any time soon – as most small businesses do not – as private equity investors often look for a big exit strategy such as an IPO.
Who Needs Revenue-Based Financing?
Really, any business large or small with strong, predictable monthly sales can qualify for RBF, if it is appropriate. In general, companies that have strong sales and are seeking to expand with a new product offering or need money for an emergency or may look to RBF as an alternative to traditional lending.
What Are the Risks of RBF?
As a business, the biggest risk of RBF is that your sales go south, making the repayment of the loan longer. That said, investors take on much of the risk because the repayment of the investment is in direct proportion to the company’s revenues. For the company receiving the financing, if sales unexpectedly drop, the repayment of the investment will take longer, and the investor will still expect to receive the same multiple on the principal investment amount.
Generally however, the lender and the borrower both benefit in an RBF deal because they both want the company to be successful and for repayment of the investment to be quick. The structure of the RBF deal prevents either party from getting completely burned, unless the borrowing company goes under and is forced to declare bankruptcy.
Finally, it is important to note that RBF is not for every company. The model works only with companies that historically generate strong revenues, be it a healthcare, consumer software or business services company. A company that wants to use revenue-based financing must also have strong gross sales margins to ensure their ability to repay the investment.