Here, in this post, you will learn all the essential details you need to know about revenue-based finance. By the end of this post, you will know exactly what ways your establishment can use the revenue gotten from investors and ways of generating more profit.
Additionally, this post will share the types of revenue-based funding available for all interested companies. Also, by the end of the post, you will know the companies eligible for this type of funding.
Let us dive right in:
What is revenue-based finance?
Also known as royalty-based financing, revenue-based financing is a type of financial capital given to growing businesses by investors. The investors inject a certain amount of capital into the business, and in exchange, they get a percentage of the gross revenues for an agreed period of time.
Normally, the investment returns go on until the initial capital is fully repaid, plus a multiple agreed on by both parties. Additionally, revenue-based financing investors expect the money to be repaid by 3-5 years of the injection.
Alternatively, RBF can also be described as selling an equity portion of the company in exchange for the investment. In this type of financing, the investors do not take upfront ownership equity but take an equity warrant instead.
Additionally, there is a misconception that needs to be debunked. That RBF investors need to have a seat at the Board of Directors. That is entirely not true. Additionally, they do not require any valuation exercise to invest. However, some investors may insist on the valuation if they are not confident they will get the money back after the agreed period of time.
Further, revenue-based financing does not require the company's founder to set his/her personal assets as security for the loan. If the investor should demand this type of security, then you should turn down the deal because you do not stand a chance to gain from it.
RBF has significant advantages the business can reap from. However, the RBF model requires that all businesses generate revenue well before the investment. That is because; the payments to the investor will be made from that revenue.
The second requirement is that the business should have a strong gross margin. Soon enough, after the grace period is through, the business should make payments to the investor. That means the business must accommodate the revenue that is being channelled towards repayment of the loan.
The types of revenue-based financing
The most common type of RBF is akin to a term loan. That means that you receive a determined sum of capital and repay it over an agreed period of time with interest. In most cases, the investor will give you a certain grace period, after which the repayment process will commence.
The main differences in RBF types come from how the payments are made to the investor. You will have to agree with the investor on the terms of repayment.
Revenue-based financing has significant upsides as compared to other forms of financing available on the market today. If your company has a consistent profit margin that is reliable or a good MRR, you stand a good chance of getting the financing.
The first significant advantage of revenue-based financing is that the owner does not have to set personal assets as security or guarantee of payment. The loan amount does not give details on the size of growth funding the company needs. Additionally, you will find the interest rates to be quite low.
As compared to other forms of financing, the RBF has a low-interest rate that is very tempting. However, the catch is in obtaining one. Many investors want a stable business that will guarantee their investment does not wash down the drain.
Besides, if you are the beneficiary of any revenue-based financing, you will not have to give up control of the company. Many investors will only want small equity of the company's revenue, but that is it. They will not demand anything further.
Additionally, you will not have to go through the hassle of going to the bank for loans with an exorbitant interest rate. However, the catch lies in securing this funding type, as stated earlier. Many business models do not accommodate RBF into their structure. That is why it is important to design your company to blend in with this funding type.
Lastly, research development finance is important for any growing business. Through these funds, you will discover new products that may add an extra revenue stream, which will help you repay your investor.
Companies eligible for this type of funding
As earlier mentioned, many companies do not design their models to accommodate this funding type. Many business owners are accustomed to seeking loans from banks, so they design their model to suit this option.
However, if your company is generating sufficient revenue to repay an investor and still maintain normal operations, then you might be in for an investment. If your company does not have a strong gross margin, you might risk bankruptcy.
In the recent past, tech companies have been the main target of this type of financing. That is because they have designed their models to suit RBF, and also, they have multiple sources of revenue. That would translate into the investor being repaid on a timely basis.
To sum it up, RBF works best with SaaS companies. Saas companies host applications and avail them to clients over the internet. Saas is an abbreviation for Software as a Service.
Saas companies work on a subscription basis. They require the client to pay a certain fee monthly or annually. Additionally, examples of these types of companies include Uber, Netflix, and Dropbox.
Wrapping up
Revenue-based financing is essential because it is the future of financing. Many small and medium business owners should redesign their businesses to accommodate RBF. Aside from its numerous benefits, RBF gives the owner a sense of accomplishment. After securing the funding, you will be able to accomplish numerous goals for your business, including expansion and generating more revenue streams.
Additionally, securing the funding is an uphill task on its own; you will stand to reap multiple benefits if you go through with this idea. Further, you do not have to put your personal assets as a guarantee. Many banks or alternative sources of funding will require you to do this.
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