Entrepreneurs and founders around the globe are increasingly embracing the non-dilutive capital model of revenue-based financing recently. In fact, during the first 6 months of FY21, investors around the world poured in more than 500 million USD into revenue-based financing companies. Though this new-age funding option is still in its early days in India, it is high time the country leverages it fully.
So, here’s a primer on how it works.
What Is Revenue-Based Financing?
Revenue-based financing meaning, or RBF, is simple – it is a model for a business to raise funds premised on its past and estimated revenue. It is also known as cash flow-based lending. Under this model, an enterprise pledges a proportion of its annual revenue in order to acquire growth capital.
Although this funding model is suitable for all types of companies, it works best for smaller firms as their required quantum of funds may not be significant, and venture capitalists will not entertain their pitches. So, SMEs and early-stage ventures turn to revenue-based funding instead. Moreover, it allows them to avail funds without any equity dilution or collateral.
How Does It Work?
In India, there are several companies engaged in revenue-based financing. To begin with, a company specialising in RBF assesses several parameters of a potential borrower before sanctioning a portion of the estimated revenue as advance. Some of these parameters are as below:
- Cash Flows
- Operating Margins
- Growth Potential
When convinced about the firm’s prospects, the lending entity provides the required capital in exchange for a fee or mutually decided interest rate.
Sounds similar to how a VC or an angel investor functions, doesn’t it?
However, what differentiates revenue-based financing from other means of funding is how a borrower repays the funds. In RBF, a borrowing company agrees to share a part of its estimated revenue with the financier. Therefore, the interest or fee charged by the lender as well as the principal amount is returned by the borrower from the revenue it earns through the normal course of business.
For a clearer understanding of how revenue-based financing works, let’s take an example:
Suppose a company, ABC, opts for RBF. It borrows a sum of Rs. 15,00,000. Now, ABC’s monthly turnover will determine its loan term, and the repayments will be based on an agreed percentage of its monthly sales. Here, ABC and its lending institution have mutually decided to offer 10% of its monthly sales as repayment.
Therefore, if ABC has a turnover of Rs. 10,00,000 in a month, it will pay back Rs.1,00,000 to the lender. However, in the next month, its turnover drops to Rs. 7,00,000. So, ABC will pay Rs. 70,000 in this month to its lender. Moreover, this cycle will go on till the agreed amount is repaid.
Why Should Businesses Choose Revenue-Based Financing?
Businesses in India can opt for RBF due to its numerous benefits, such as the ones highlighted below:
- Cheaper Than Equity
Venture Capitalists and Angel funding tend to have high expectations for returns, which can be as much as 10x-20x the investment. As a result, these can be expensive sources of capital for start-ups. Besides, these sources are beyond the reach of smaller players, such as micro, small, and medium scale enterprises.
- No Need Of Personal Guarantees
Some sources of funding, such as bank loans, call for personal guarantees from businesses, given the risk associated with start-ups. As a result, borrowers put their assets on the line, such as cars, houses, heavy machinery, or commercial property. With RBF, business owners can breathe easy as no such guarantees are involved.
- Retention Of Ownership And Control
As mentioned earlier, RBF is a non-dilutive model of financing. Therefore, companies offering funding through revenue-based financing do not take equity. So, there is no dilution of ownership for founders and business owners.
Furthermore, RBF investors do not place any financial covenants on a borrowing company or take board seats. As a result, founders can retain control over their company and direct it towards their vision.
For instance, as the investment gets repaid over time, RBF investors do not need an exit from the company (as is the case with VC financing). So, businesses can continue operations for as long as they want. Additionally, as these investors do not hold voting rights, RBF permits the sale of a business if its owner wishes to do so.
- Fast Funding Timeline
Needless to say, acquiring funds via a bank loan can take considerable time. On the other hand, securing a deal with VCs can take months, or even years, for start-ups. However, as RBF does not need businesses to achieve hyper-growth, financiers offer funding in less than 24 hours*.
- No Large Payments
In RBF, monthly payments are based on a percentage of one’s monthly revenue. This implies that in the event of a business experiencing a bad month, i.e., stagnant sales, its monthly payment also reflects that. Therefore, it need not fret or be burdened by a large and unaffordable payable amount.
- Shared Efforts Towards Growth
Unlike other financing tools, revenue-based financing does not have an approach of ‘growth-at-all-costs. Instead, given its flexible repayment structure, lenders and borrowing businesses share a common vision of business growth.
- Financing Optionality
With RBF, start-ups and small-scale businesses can achieve growth, thereby becoming more established. This makes the traditional sources of financing more accessible and attainable for them.
Over the years, revenue-based financing has emerged as a new-age financing tool for business growth. It can be viewed as a simplified version of venture financing, minus the hassles of stake sale or collateral. Some fintech companies in India specialise in RBF. A prominent name among these is KredX, which offers customised solutions based on the requirements of SAAS and D2C businesses.