Are you in search of a financing solution that exceeds the limitations of traditional bridge financing options? Look no further...
What is Revenue-Based Financing?
While start-up founders have grown accustomed to finance growth exclusively via equity and/or debt, the fintech movement — and the disruptive innovation it sows into financial legacy systems — has come up with the financing solution that every founder has dreamt of. ‘Revenue-Based Financing’ is a lump-sum umbrella term that encompasses a brave new armada of financing options varying in payout structure and some other specifics we’ll get into later on.
Revenue-Based Financing, regardless of the type thereof, does however always conform to some provisions. The basic model insists that neither equity nor traditional debt is issued; but instead, investors are given a claim on revenue directly, in exchange for an upfront injection of capital. For instance, this claim could be on a percentage of revenues until a fixed repayment amount is accumulated, or it could be a claim on a fixed amount of periodic revenues for a prespecified duration. In any case, founders are not asked to give up equity or post-personal collateral, which is just one of the many reasons why it’s no surprise that the global market for RBF is estimated to grow at 61.8% CAGR between 2020 and 2027.
How is it different from already existing financing solutions?
While equity and traditional debt have their perks, they aren’t taken without their shortcomings — if they’re even offered that is. Veteran founders are too familiar with the ‘bank run around’, where they spend weeks, even months, waiting for loans to be approved contingent on a sizable personal guarantee; they are also as familiar with the lengthy and time-inefficient venture capitalist approach, where the VCs will — in more cases than not — show founders the door despite a great pitch, access to board seats and the control that comes with. Other than the obvious cut down in time — attributed to the almost fully automated applying process — effort and mental energy founders place in obtaining funds, Revenue-Based Financing has more than a few advantages over its predominant counterparts that are best summarized here:
Of course, while we maintain the position that Revenue-Based Financing is a superior funding solution, we do recommend having a healthy mix so that founders have an optimal balance of smart and dumb money. It’s also prudent to know, as we’ll explain in the next section, that most businesses can only get funded via RBF after they’ve begun generating some revenue, whereas VCs may join a cap table as early as the seed stage.
Who is eligible for Revenue-Based Financing?
Due to the nature of Revenue-Based Financing, the ground-breaking financing option only exists for companies with predictable future revenues. Like so many innovations with the modern age, data is the all-important facilitator of the newer incarnations of ‘Revenue-Based Financing’ — specifically data that backs a company’s future revenues. While the data itself is by no means difficult for a healthy company to produce, it is important to make a distinction here between the old & the new.
In a general sense, there are two clusters of newer models that specifically target either E-commerce or XaaS companies. While the former may be self-explanatory, the latter refers to subscription-based companies and other recurring revenue businesses. As RBF continues to grow amongst the E-commerce and XaaS communities, the number of Fintech’s offering this new solution grows and as more investors turn towards the new underlying asset class, more and more companies start finding themselves eligible within RBF’s growing scope.
The roots of Revenue-Based Financing & how David Bowie used RBF
The original model for Revenue-Based Financing actually predates the modern era and is also called “Royalty-Based Financing”. In this model, the investor is entitled to a percentage of revenues until a predetermined amount has been repaid, such that there is no predetermined time to repayment, nor a set interest rate. While there is much less restriction upon the scope of this model — which in theory can be applied to almost any business — we do not recommend this funding solution, particularly because the repayment amount is most often a multiple of three to five times the initial investment, making it an expensive option that could become a long-run burden for founders.
RBF was actually very popular in the early-mid 1900s, specifically with the oil and gas industries, but it’s also how David Bowie financed the release of his 1997 albums without giving up equity of his back catalog. By securitizing royalties tied to album sales, the “Bowie Bond” inspired a wave of artists, including Marvin Gaye and James Brown, to follow in Bowie’s footsteps. The “Bowie Bond” however did have a fixed repayment period of 10 years as well as a fixed interest rate of 7.9% — a model closer to today’s innovations however still not quite there yet.
Revenue-Based Financing for E-Commerce
In recent years, a newer founder-friendly model has been introduced by the fintech movement: one that caters to E-commerce companies. Naturally, a great number of platforms have pounced into the new niche, in which platforms give founders upfront capital specifically for marketing or inventory, at rates ranging from 1% to 10% depending on the company’s fundamentals.
The repayment schedule of the platform’s initial investment may however vary substantially between each platform and each company. The majority of these platforms advertise a revenue-sharing scheme where the founder repays the principal and interest on their own terms — meaning founders may choose how much of their daily, weekly, or monthly revenue they wish to share with the investor before signing the contract. Of course, this implies that a longer repayment period would carry a larger interest rate.
It also implies that — in most cases — founders pay out more when they earn more and pay out less when their inventory starts to collect dust. This is because the investor has a claim on a percentage of the revenues until a fixed amount (the principal + interest) is accumulated. While RBF is on the rise within the E-commerce industry, we do recommend that founders study their options before getting funded.
Revenue-Based Financing for XaaS
It wasn’t long after the success of RBF in E-commerce that innovators adopted a new model for XaaS businesses. As aforementioned, this model is limited to businesses with monthly recurring revenues (MRR) backed by subscriptions or subscription-like contracts. A number of platforms have popped up to allow founders to trade these subscriptions for upfront capital at interest rates averaging 4–5% and it has forever changed the XaaS funding status quo.
The exact application of the model may differ among each of these platforms, but most adhere to this intuition: the founder “sells” the future monthly revenues that are tied to a prespecified number of subscriptions for a predetermined amount of time in exchange for an upfront capital injection to grow their business. And while RBF platforms never imply an exchange of equity nor traditional debt (ie. relating to personal guarantees), they do differ in a number of ways.
For one, platform-specific requirements for funding may differ per minimum monthly or annual revenue, duration since the operation began, geographical location, and/or XaaS Metrics. Some platforms may also ask for fees whilst most do not. Restrictions on how long or how short your trade contracts can be, will also be in place depending on the platform, however, a one-year contract has become the most common. A few platforms use a variant of the model that gives the investor a claim on a percentage of MRR rather than on predetermined fixed subscriptions. Many of these platforms insist on transferring the capital injection via a platform-issued credit card and some may have stricter restrictions on how the capital is spent.
Of course, most of these platforms share a majority of features with one another, however, you’ll find that the smallest differences can make the biggest impact on your decision-making, which is exactly why we recommend going through some of the many options we’ve gathered data on before deciding if Revenue-Based Financing is the solution for your company. For founders, features like real-time XaaS metrics dashboards, military-grade data encryption, and complete autonomy of funding can be pretty important, which just goes to show how this new wave of financiers are thinking: they’re thinking like founders.
Whether this funding solution is right for your company or not, depends on a number of factors that cannot be boiled down to a universal definitive answer — as is the case with all funding solutions. If you’re a founder looking for funding, you always owe it to yourself and your stakeholders to do your own research and assess your options based on your company.