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Is Revenue-Based Financing Right for Your Business?

Marty Aquino
Contributor

Choosing the right type of funding is an integral part of your company’s success trajectory. Is your business a high-growth company? Or a post-revenue startup with aspirations of strong growth? If so, revenue-based financing (RBF) might be an attractive funding source for your company. 


New business loans from traditional lenders can be inflexible and require too much collateral. And there are tactical advantages for your company in utilizing revenue-based financing. According to Allied Market Research, the global revenue-based financing market is projected to reach $42 Billion by 2027, up from $901 Million in 2019.


Consideration #1: Your Company Has a Very Bright Horizon

When your company is on the fast track to success with increasing revenues and an ever-sticky customer base, each share of your company is worth so much more. If you raise capital using outside investors, those investors will naturally have stakes in your growing startup or small business. That allows them to potentially receive disproportionate returns from your company’s success. Outside investors can also mean you’re not the only decision maker, depending on the investment covenants.


Revenue-based financing allows for greater flexibility because lenders or investors only receive a set percentage return of the loan amount plus fees. This limits the overall return characteristic for the investor. Yet, the risks are still high because many startups and small businesses lack the required collateral for traditional loans. This innovative mix of debt and non-dilutive equity funding sets the tone for your high-growth organization to retain and reinvest more of your generated profits.


Consideration #2: Confirmed Demand for Your Product

Consistent or consistently growing sales is key for a strong match between revenue-based financing and your startup. For example, you have an e-commerce store with a subscription model and growing, sticky revenues. RBF is best suited for startups that are post-revenue. Think at least six months of sales data with a monthly revenue you can count on because that will often be the primary revenue-based funding criteria. Strong demand for your core product or service is critical because your revenue is the engine that allows for the more flexible RBF terms.


Revenue-based financing isn’t for everyone. The effective interest rate can be higher than a traditional bank loan. Furthermore, your startup will need higher profit margins to offset the variable payment method of revenue-based capital.


Consideration #3: Avoiding the VC Foie Gras Effect

Just because you can doesn’t mean you should. Raising small business capital is like filling up the tank of your car. There’s a limit to what you can effectively use. In the VC realm we call it the “foie graseffect.” And, it’s rarely discussed outside of venture capital or private equity circles. Foie gras’ing is the use of jumbo-size financings ($100 million and above) and how that mega-funding still doesn’t guarantee success. According to a report by CB Insights:

  • …the most highly funded startups tend to underperform those that raised less.
  • Companies that raised the most almost uniformly struggled to create long-term growth.
  • Plenty of companies that raised [less] have seen top exits.
  • The biggest exits, backed by the deepest-pocketed investors, are returning less and less as foie gras’ing becomes more common and more extreme.
  • Exceptions like Facebook (both lavishly funded and successful) tend to get most of the attention due to survivorship bias.


In fact, there are many success stories involving companies that raised relatively little, such as WhatsApp and Fitbit , compared with Jet.com or Zayo. The key takeaway here is that if your business style tends to err on the side of efficiency, then revenue-based capital gives you functional capital guidelines. In turn, this will allow you to grow responsibly versus growing fat on a potential foie gras effect. Revenue-based funding offers a more sustainable alternative that allows you to retain more ownership in your business.


How to determine what type of capital to attract and secure can be a difficult choice for many startups and small businesses. However, if you have a robust business model with a solid revenue stream and want to keep your ownership in-house instead of exchanging shares of your company for capital or obtaining new business loans, consider revenue-based financing as a viable alternative of raising business capital. The best part is that high-quality offers can be made in days, not months, as compared with conventional bank loans.


Marty Aquino has been a passionate writer on venture capital, technology, forecasting, risk mitigation, wealth and entrepreneurial topics since 2009. He is the founder of Carbonwolf Energy, a venture-capital firm specializing in world-changing and status-quo-defying technologies and people.


Sources:

Allied Market Research - Revenue-Based Financing Market Size, Share, Industry Growth & Analysis – 2027 (alliedmarketresearch.com)

CB Insights - The Foie Gras’ing Of Startups: Does Raising More VC Lead To Bigger Outcomes?

CB Insights - WhatsApp - CB Insights

CB Insights - Fitbit - CB Insights

CB Insights - Jet.com - CB Insights

CB Insights - Zayo Group Holdings - CB Insights

Sifted.eu - It’s finally the moment for revenue-based startup financing