Many early-stage ventures and even small and medium enterprises (SMEs) are now opting for revenue-based financing (RBF) instead of approaching venture funds or angel investors. If you are wondering what is the fuss about, here is a primer.
What is revenue-based financing?
Revenue-based financing is a model for raising funds based on the ongoing revenues of the company. Simply put, a company can pledge a part of its annual revenues in return for growth capital. Typically, early-stage ventures and even SMEs nowadays prefer revenue-based finance as they can get access to funds without any form of collateral or equity dilution. It is considered to be a good source of capital raising for the smaller businesses as it is likely that the quantum of funds they might be looking at would not be significant and the VCs would not entertain pitches or proposals for such fund requirements.
How does revenue-based financing work?
There are firms that specialise in revenue-based financing. To start with, these companies look at parameters like revenues, cash flows, operating margins, scalability and growth potential among other things as part of their due diligence. Once convinced with the potential borrower’s prospects, they lend the required capital at a mutually decided rate of interest or fee. Interestingly, this is quite similar to how an angel investor or even a VC would function, but what makes revenue-based financing different is the manner in which the funds are repaid by the borrower. The borrower commits to sharing a part of the business revenue with the lender. In other words, both the principal and the fee or interest that the lender charges, is returned from the revenues that the company earns during the normal course of the business.