Revenue Based Financing (RBF) is a financing option that enables start-ups and growing businesses to access growth capital. An RBF company provides the growth capital to the small business in exchange for a percentage of gross revenue. This percentage ranges from about 3-8% of gross revenue and is paid on a monthly basis. This means that during good months, the RBF company receives a larger payment than during bad months since the percentage is fixed. The term of most RBF loans is 3-5 years and the average interest rate is about 20%. A loan is said to be repaid once the principal and a multiple (also referred to as a cap) is repaid to the investment company. This cap is agreed upon by both parties.
For a company to qualify for Revenue Based Financing, it must first demonstrate that it is generating revenue. This is because the repayments are made from this revenue. Secondly and closely tied to this, the company must have healthy gross margins that can enable it to complete the loan repayments, including the cap, within the term of the loan. As such, many businesses with low margins such as restaurants, or those having large infrastructure needs such as big factories would in all likelihood not qualify for this type of financing. Companies that would make good candidates for RBF include light manufacturing companies and certain technology firms.
Revenue Based Financing is described as a financing method that is positioned between bank and equity financing. Unlike bank loans, there is no need for collateral, and the RBF company does not often require to do credit or background checks. However, this option is more expensive than bank financing since the interest rates charged are higher. The option is thus suitable for start-up businesses that do not have significant assets and where the owners do not want to surrender their personal assets as collateral, and who are not averse to paying the higher interest rates. Furthermore, the interests of a borrowing company and those of an RBF company are aligned, since both benefit when the borrowing company does well and vice versa. This is in contrast with a bank which continues to receive its fixed monthly repayment regardless of the state of the business. This is one reason why growing companies that are yet to stabilize their revenue bases prefer this option.
Revenue Based Financing differs from equity financing in that, in the case of RBF, the borrower does not have to sell an equity portion as it would with equity financing, leading to a partial loss of control of the company. Another advantage that RBF has over equity financing is that the cost of capital of the former is generally significantly lower than that of the latter. This is in terms of the interest rate that the RBF company charges on the loan it provides which is much lower than the effective interest rate that an angel investor requires in return for his investment. Furthermore, the legal fees in the case of RBF are lower than in the case of equity financing. Lastly, in the case of RBF the interest rates are tax deductible since it is a loan.
Revenue Based Financing definitely meets the needs of young businesses that may not fulfill the conditions required for accessing bank financing, or which are unable or do not wish to access equity financing. Sometimes, such businesses require only a small capital injection to get them to the next level of growth, and RBF often fills that need perfectly. It would be wise for a growing business to explore this type of financing to see if it is the best option for it.