A startup company is always likely to find the route to financing a challenging one. Even innovative companies with established backing may struggle to finance themselves early on. Many, in fact, turn away from venture capitalism, and head for revenue-based financing. But what does this involve?
What is Revenue-Based Financing?
In many cases, startups and businesses turn to venture capital firms for equity-based funding. Revenue-based funding takes a slightly different view on what investors stand to get from their money. For startups, it's a fixed way to make sure they get the capital they require to grow.
Unlike the VC system of old, RBF revolves around income. That is, instead of revolving around equity, a company will pay back investor funds at a set rate depending on their turnover. Crucially, this means that investors get money back from each and every sale. It is fast becoming an appealing option to parties looking for enhanced security on all sides.
This, effectively, means companies would pay back – for example – 20% of sales towards investor loans. If a startup company borrows $100,000, for example, they will need to pay this off with significant leads and revenue.
What Are the Benefits?
RBF is seen as a strong competitor to angel investors and VC investing. That is somewhat thanks to the lack of board intervention. What's more, it is likely to be a quick process for all parties involved.
Compared to VC investment, too, there is no need to release or share equity. According to Lighter Capital, payments back to VCs through this system may be equivalent to sharing 100% interest each year.
Lighter Capital also states that RBF loans have grown hugely in the past decade, by at least 5x since 2014.
With RBF, businesses have quicker access to the capital they need. What's more, from the investor's point of view, business is easier to untie. When an investor owns equity in a company, they will need to sell their share of a firm if they need to get out.
RBF, too, is likely to help harness the growth of wealth. The bigger the sales, the bigger the returns investors will receive. Once a loan is repaid, an investor is free to leave if they wish.
What Are the Drawbacks?
Many businesses and investors prefer VC and angel investing for guaranteed returns. With RBF, a firm must make revenue. If projections are higher than the resulting figures, this can lead to disappointment and resentment from investors.
In addition, RBF deals may make firms feel under immense pressure to make money. It may, therefore, be a strong route to take if revenue is all but guaranteed, but a potential gamble if not.
Beyond this, RBF may not fit all business models. It's thought that, generally, less money is available from RBF upfront than through equity share.
Is RBF Right for the Average Startup Company?
There are plenty of reasons why revenue-based funding could fit some startup companies. However, the funding models they choose may differ depending on their long term goals. RBF is a worthwhile choice if revenue is likely – but firms will need to be sure this is going to be the case.