The rise of alternative lending — diving into revenue-based-finance (RBF)
In the landscape of business financing, traditional methods such as loans and equity investments have long been the go-to options. Revenue-based finance (RBF) in some form, has been around for decades and has historically been used by the oil & natural gas, pharmaceutical and movie production industries. Over the last five years, this type of financing has become used to offer businesses an alternative path to funding without the constraints of debt or equity dilution; financing their R&D, marketing or overseas expansion.
What is it and who is eligible?
RBF is a form of finance where capital is provided in exchange for an agreement to pay a fixed percentage of future revenues to the lender until the invested amount, plus a fee, has been repaid. Typically there is no equity, personal guarantees or hidden fees involved, which makes it attractive for early-stage companies.
Companies can borrow between £10,000 and £1 million, depending on their last month’s revenue, and may qualify if they:
- Generate digital revenue which exceeds £20k per month
- Can show sufficient revenue data (usually over 9 months)
- Can show positive unit economics
- Have a plan on what to do with the funding
- 6+ months of runway
RBF providers usually take you through a diligence process to determine whether or not you are eligible and quickly get back to you on their decision.
How does it work?
The funding provided is based on historical and projected revenues from your business. If eligible, you will need to connect your data sources (typically your CRM, bank data, Xero and marketing accounts) to the provider’s prediction engine. Depending on your sales metrics, you will be able to access additional tranches of capital as you grow, rather than via a lump sum.
Repayment of the loan will be set at a fixed percentage of your future revenues each month, plus a fee on the amount borrowed (the interest). The repayment structure allows your business to cope with revenue fluctuations, and typically there is no specific repayment date or late payment fees. The fee applied to your repayment will depend on the provider — some charge a fixed fee, whilst others charge you more if you are more established.
The total amount repaid depends on whether the provider uses a:
- Multiple approach: You will repay the loan amount plus a multiple (also called the “cap”) of the initial capital, usually between 1.5x and 2.5x
- Uncapped approach: You will repay the principal amount plus a fixed fee.
A worked example
Let’s assume your monthly revenue is currently £50,000. You want to borrow £100,000. Under the multiple approach with a repayment cap of 1.25x, you will repay £125,000. Under the uncapped approach (fixed at 10%), you will repay £110,000. Both repayments will be spread throughout the payment term by taking a fixed percentage of your future revenue
Benefits
- Fast: It is significantly quicker to get money. You apply in minutes and receive the funding in days.
- Flexible: If your revenue slows down, so do your repayments — extending the loan period.
- Less risky: You don’t give any equity or control to external investors, nor are there any personal guarantees.
- Transparent: The option is transparent regarding what founders will have to pay to reimburse the loan, there are no hidden payments.
Challenges
- Fees: It can be more costly than traditional loans, especially using the “multiple” system. However, bank debt can be very difficult for startups to obtain, given established banks’ conservative approach to lending.
- Limited amount: It adapts better to earlier stages of startups with high growth potential. The total funding available typically doesn’t exceed £1m.
- Complexity: Agreements can be complex, involving detailed calculations and negotiations to determine repayment terms, revenue-sharing percentages and other conditions.
Different providers have different terms and conditions. Make sure you understand all the specificities of the loan agreement. Some agreements may include exit fees in the case of a change of control.
How do you access it?
In both the US and Europe, revenue-based financing has gained traction as an alternative to traditional equity funding leading to a number of RBF providers launching — although many have now retreated from business as usual due to the difficult market conditions.
Are you a founder interested in raising RBF? Get in touch with a team member here!
Conclusion
Revenue-based Financing offers a compelling alternative to traditional debt and equity financing. While it has its strengths, such as flexible repayment structures and no equity dilution, it also has its weaknesses, including higher costs and limited regarding the quantum raise that is possible. Ultimately, the suitability of RBF depends on the specific needs and circumstances of the business, but it remains an increasingly popular option in the evolving landscape of business financing.
