We all know that small businesses form the crux of the American economy. As foot soldiers of the economy, they carve out a path to economic resilience and prosperity, ensuring that America’s financial future always remains solid and stable. Yet, their path to success is riddled with challenges – right from funding to planning to hiring. They struggle to get the financing they need for their growth, as traditional banks are not always flexible enough to come to their aid. Hence, a lot of small businesses fail to grow and thrive, unlike their big-name competitors.
But not everything is lost! In the last few years, alternative funding options have been tailored for small businesses. One such option is revenue based financing, which has become popular with small business owners and startups. It allows borrowers to raise money by repaying investors with a percentage of their future revenue rather than fixed monthly payments or equity stakes.
But before you get excited, let’s understand exactly what revenue-based funding is, how it works, what it can be used for, and finally, whether it is the right kind of financing for you.
How Does Revenue Based Financing Work
A truly revolutionizing funding option, revenue based financing (RBF) offers small businesses and startups an attractive alternative to traditional financing methods. RBF’s adaptable repayment structure suits businesses with fluctuating revenues by allowing companies to raise money instead of a percentage of their future income rather than fixed monthly payments or equity stakes. Since this financing type is often processed faster than traditional bank loans, funds can be made available more quickly, making it perfect for businesses with urgent capital needs. Another feature of RBF is that it does not require collateral, making it easier for businesses without significant assets to seek necessary funds.
What Can Revenue Based Financing Be Used for?
The capital from revenue based financing can be used to drive growth and innovation in small businesses and startups. From scaling operations to purchasing inventory to hiring additional staff, RBF can act as a catalyst to drive business growth to the next level. Here are some more ways to use funding from RBF:
- Expanding Operations – By providing the capital to expand the operations quickly, RBF helps businesses grab market opportunities and increase their customer base.
- Fostering Growth-Oriented Mindset – As RBF repayment is linked to revenue, it encourages small businesses and startups to focus on revenue-generating activities, resulting in a growth-oriented mindset.
- Effective Cash Flow Management – The flexibility offered by revenue based financing helps businesses handle their cash flow more efficiently, ensuring they do not experience financial strain during slow periods.
Industries That Benefit from Revenue Based Financing
This alternative form of funding benefits many businesses, but a few still flourish.
- Technology and SaaS:
With fluctuating revenues and a frequent need for capital for rapid scaling, technology and SaaS companies require the flexible funding that RBF offers. This form of financing allows the companies to invest in growth without giving up equity or facing fixed repayment schedules.
- E-commerce:
This loan works well for online retailers as the capital can be used to manage their revenue fluctuations during the off-season and investment in growth opportunities during the peak ones. They can stock up on inventory and save up on ad spend for the peak season, then quickly pay off their loan with the revenue they make.
- Subscription-Based Services:
As these companies receive monthly or periodic payments, they know exactly how much revenue they will make each month. This pattern and low overheads make it easier for them to make monthly payments.
Step-by-Step Revenue Based Financing Process
Revenue based financing works in four key steps and borrowers must pay attention while completing all these stages to ensure they get their funding without any hitch:
- Eligibility: A proven track record of steady revenue, with at least six months of operational history, is required to be eligible for revenue based financing.
- Assessment: Financial and bank statements, as well as revenue reports, allow lenders to assess the creditworthiness of the borrower and decide whether the applicant is eligible or not. They may analyze future revenue trends to determine whether the business can meet the repayment obligations.
- Quote and Agreement: Post review, an initial investment amount or quote will be shared by the lender – outlining the capital amount, repayment percentage, duration, and total repayment cap. Once both parties sign the agreement – funds will get dispatched quickly – often within a week.
Things to Keep in Mind While Applying for Revenue Based Financing
Choosing funding is not an easy task. As it may affect a business’s financial health, business owners must carefully consider every aspect related to financing needs. Here are a few things to keep in mind while applying for RBF:
- Select the Right Lender
Not all revenue based financing lenders are the same. It is necessary to conduct in-depth research and choose a reputable lender with transparent terms and supportive customer service.
- Understand Your Revenue Patterns
Most lenders advise borrowers to understand their business’s revenue patterns thoroughly. It is of utmost importance as it will determine whether they can manage the flexible repayment amounts. For example, seasonal businesses must be ready to pay high repayment amounts during peak sale periods.
- Assess Creditworthiness
A lot of lenders look for certain annual revenue generation, credit scores, type of business, and usage of funds while trying to assess the creditworthiness of the borrower. It may vary depending on lenders, but it is better to maintain a score of 650+ to make this a seamless process. Any business that has not generated revenue yet or will not be generating income soon should steer clear of RBF.
- Prepare Documentation
It is important to ensure that proper documentation is in place while applying for revenue based financing. It includes financial statements, bank and legal statements, tax returns, and revenue reports. Having all this information in one place can expedite the approval process.
Conclusion
For small businesses and startups looking for flexible, non-dilutive funding, revenue based financing is attractive. By linking loan repayment with monthly revenue, RBF offers a financial buffer that encourages growth while helping businesses maintain a stable cash flow. However, companies need to determine whether this is the right funding for them or not. With flexibility comes a higher rate of interest that might affect the company’s financial future. Nevertheless, RBF still offers a viable alternative to small businesses without the shackles of traditional financing methods.
