What Is Revenue-Based Financing?
Revenue-based financing, sometimes referred to as royalty-based financing (or RBF), is a type of business funding in which a company secures capital from investors—and these investors receive a certain percentage of the business’s future monthly revenues in exchange for their initial investment.
The investor or financing firm will claim the agreed-upon monthly revenue percentage until a predetermined amount has been paid.
Unlike traditional business loans, therefore, revenue-based financing is often considered a mix of debt and equity financing. This funding method is popular with startup businesses, particularly those in the technology or software-as-a-service (SaaS) space.
The Ultimate Guide to Revenue-Based Financing
How Does Revenue-Based Financing Work?
With this revenue-based financing definition in mind, let’s break down how this type of funding works in greater detail.
As we mentioned above, revenue-based financing is typically considered a mix of debt and equity financing, however, it’s distinct from these two funding branches in a few ways.
First, this type of financing is similar to equity financing in that the capital you receive comes from investors or a financing firm, like a venture capital firm (VC), as opposed to a small business lender, like a bank. Unlike equity financing, however, the investors that provide revenue-based financing have no ownership in the business.
This being said, on the other hand, revenue-based financing is similar to debt financing in that you’re receiving an advance of capital that you’ll need to pay back through a series of payments. Unlike debt financing though, you do not pay interest on an outstanding balance with RBF, nor do you follow a schedule of fixed payments
Instead, your payments are based on your incoming sales revenues—in this way, making revenue-based financing akin to a merchant cash advance.
In addition, because revenue-based financing comes from investors or financing firms, you’ll find that there are fewer regulations in comparison to traditional debt financing. To this point, RBF usually doesn’t require physical collateral or a personal guarantee.
Moreover, an investor or firm’s decision to offer capital to your business will be based on a number of factors, but those that are not necessarily the same as traditional business loan requirements.
Revenue-Based Financing Structure
Overall, revenue-based financing can be structured in a few ways.
This being said, the most common revenue-based financing structure is akin to a term loan—in that you receive a set sum of capital and repay that capital (with interest) over time.
However, unlike a term loan, you’ll often see that with RBF, the full amount of capital is not advanced upfront. Instead, the business can draw from their “loan amount” over a number of years—and this way, they’re not accruing interest until they need the capital. In this way, revenue-based financing can be similar to a business line of credit.
With this in mind, the differences in revenue-based financing structure often stem from how payments are made. Depending on your agreement with the investor or financing firm, you might make payments until:
- The investor receives a pre-determined multiple of the initial loan amount—this multiple is usually referred to as a “repayment cap” and ranges from 1.35 to 3,
- The investor reaches a pre-determined internal rate of return, or
- A pre-determined, final date is reached
Of these three structures, you’ll probably see the first option most frequently.
Overall, payments on revenue-based financing are based on a fixed percentage of revenue (usually 1% to 3%, but as high as 8%). These payments, including both principal and interest, are made on a monthly basis, and vary based on your sales—the higher your sales for the previous month, the larger payment you’ll make.
Therefore, unlike a business term loan, revenue-based financing doesn’t have repayment terms as we typically think of them—the time it takes you to repay the initial investment will vary, like the payments themselves. Generally, however, the “terms” will range from three to five years.
Revenue-Based Financing Example
As you can see, revenue-based financing can be complex, especially as it compares to more common forms of financing.
To get a better sense of how this type of financing works, therefore, let’s break down an example:
Let’s say that you have a startup business that is looking for $100,000 in capital. Your sales revenue generally comes in at about $25,000 per month.
You find an investment firm that’s willing to offer you this funding in a revenue-financing arrangement, with a repayment cap of 1.3x. This means then, you’ll end up paying a total of 130,000 for this capital.
The monthly revenue percentage in your arrangement is set at 5%, meaning your average repayment will be 5% x $25,000—or $1,250 per month. In this case, we’ll assume that your sales, do, in fact, remain at $25,000 every month—and therefore, it would take you almost nine years to repay the money you borrowed.
Now, although this example gives you an idea of how revenue-based financing works, it’s important to note that this type of business funding often involves amounts of capital and monthly revenues much greater than the numbers we’ve used here.
Revenue-Based Financing Rates and Terms
So, continuing off the last point with our revenue-based financing example, the loan amounts, rates, and terms will be very different than what you see with traditional business loans.
First and foremost, this type of financing usually is available in larger amounts—you can expect a minimum of $100,000 to $2 million or more.
In terms of interest rates, as we discussed above, you’ll typically see these expressed as repayment caps, ranging from 1.35x to 3x. When it comes down to it, repayment caps are very similar to factor rates that you’ll find with a merchant cash advance or short-term loan.
Therefore, like any factor rate, you can multiply your principal debt (your financing amount) by the repayment cap to find your total debt.
Finally, and again, as we discussed above, because of the way revenue-based financing payments work, you won’t usually see set repayment terms of one, two, or five years. Instead, the term associated with your revenue-based financing will depend on your revenue and the percentage of that revenue (1% to 8%) that you’re paying each month.
Once again, in most cases, you’ll continue to pay your investor or VC firm until you’ve reached the predetermined amount—the repayment cap multiplied by the amount you borrowed.
In this way, the more revenue you make on a monthly basis, and the higher your percentage, the faster you’ll repay your debt.
Revenue-Based Financing Requirements
Finally, the last component of understanding revenue-based financing is requirements—in other words, what businesses are eligible for this type of funding.
As we’ve mentioned, you’ll find that traditional business loan requirements are not necessarily applicable to revenue-based financing.
This being said, to be eligible for this financing, you’ll typically need:
- Annual revenue of $200,000 or higher
- Consistent revenue with high growth margins ($15,000 per month with gross margins of at least 50%)
- Profitability isn’t always required, but you should be close to it or have a defined path to profitability
- Little to no existing debt obligations
Additionally, because eligibility for this financing is based largely on sales and revenue—instead of credit score and time in business—you’ll find it’s a popular option amongst startups and other new businesses.
Revenue-Based Financing: Pros and Cons
At this point, we’ve explored the key aspects of revenue-based financing—structure, rates and terms, requirements—as well as reviewed an example. So, you might be wondering, why would a business choose to utilize this type of financing?
When it comes down to it, like other types of business loans, there are both pros and cons to revenue-based financing.
Benefits of Revenue-Based Financing
Here are four revenue-based financing benefits that are worth considering:
The Top Revenue-Based Financing Firms
Using these pros and cons, you should be able to determine whether revenue-based financing is a viable form of startup funding for your business.
If you think revenue-based financing might be right for you, you’ll want to look at some of the top investment companies and see what they can offer:
1. Lighter Capital
Lighter Capital is a revenue-based financing firm that offers financing to tech companies across the U.S. As long as you averaged at least $15,000 in monthly revenue over your past three months with gross margins of at least 50%, you’ll be a good fit to work with this revenue-based commercial financing company.
Here are the numbers on what you can expect from revenue-based financing from Lighter Capital:
- Financing amounts of up to $3 million
- Monthly payments of 2% to 8% of monthly revenue
- Repayment caps of 1.35 to 2
2. GSD Capital
Another top revenue-based financing firm, GSD Capital works with early-stage SaaS companies in the mountain west region of the U.S.
Granted, GSD only works with a very niche subsect of borrowers, but they also offer some of the best revenue-based financing terms on the market. Plus, they’re able to fund qualifying customers with revenue-based financing in as little as 30 days—which is a pretty quick turnaround for this type of funding.
The following ranges of terms on revenue-based financing make GSD Capital worth mentioning, despite their limited reach:
- Financing amounts from $200,000 to $1 million
- Monthly payments of 3% to 8% of monthly revenue
- Repayment caps of 0.4 to 0.6 over a three-year term
3. SaaS Capital
SaaS Capital is a bit different from Lighter and GSD in that they offer a monthly recurring revenue (MRR) line of credit.
This means the amount a business is eligible to borrow is tied to how much revenue they make each month. Additionally, SaaS Capital only works with a very specific subset of businesses: B2B SaaS companies with at least $250,000 in monthly recurring software revenue based in the U.S., Canada, or the UK.
If you fit these criteria, SaaS Capital can offer you the following:
Frequently Asked Questions
The Bottom Line
At the end of the day, only you can decide if revenue-based financing is right for your business.
This being said, although revenue-based financing is an appealing solution for startups, you’ll generally need to meet a very specific mold for this type of financing to work well for your business. Therefore, if you’re a technology, SaaS, or other subscription-based business, you’ll certainly want to consider revenue-based financing.
On the other hand, this type of financing will likely not be a viable solution for many small businesses. In this case, you’ll want to continue to explore your funding options. To this point, if you’re a startup or newer business, you might start your search with online business loans or other flexible forms of financing from alternative lenders.