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The Leading Alternative to Equity Financing for Startups
If you are the founder of a startup, you are probably well-versed in the traditional financing options available to you. From bootstrapping, friends and family, traditional bank loans, and venture capital, you know what you would be getting yourself into. But do fixed monthly payments make you nervous? Are you turned off by the idea of selling equity? Let us introduce you to revenue-based financing.
Revenue-based financing, also known as revenue sharing or royalty-based financing, is a method of raising capital for emerging and high-growth businesses in which investors inject growth capital in exchange for a percentage of future monthly revenues.
The process is simple. Monthly payments increase and decrease to match the natural ups and downs of your business so you are never burdened with fixed interest payments you can’t afford. On top of its higher degree of flexibility, entrepreneurs also retain equity and control of their company. That’s right – get access to the growth capital you need without having to give up ownership or board seats.
Revenue-based financing is founder-friendly capital, allowing you as the business owner to grow your business your way, leading to healthy and sustainable revenue growth. Less pressure, more control, and sustainable growth. That’s revenue-based financing.
The Loan Structure
Receive Principal Amount
Once the deal terms have been negotiated and a term sheet is signed, you will receive the investment or principal amount in 1 or 2 instalments. At this point, the capital is yours and available to use however you wish. We place trust in knowing that you know your business best and will make the right decisions that will lead to growth.
Make Monthly Payments
Each month you pay the investor a pre-determined percentage of your top-line revenue. These payments are perpetual, meaning you will continue to make these monthly payments until you decide you are ready to buy out the investment. This is dictated entirely by your schedule and can happen at any point in time.
Buy Out the Investment
Once you have decided your company is ready to buy out the investment, you will need to pay back the principal at an agreed-upon capped return multiple. This repayment cap is paid in full and can typically range anywhere from 1.3X to 3X. (Yikes – 3X? Just remember… the cost of equity financing would be much more). Once you have bought out the investment, monthly payments stop and the investment relationship ends. Otherwise, you could ask for a follow-on option.
Cost and Duration of the Loan
The total cost of revenue-based financing will differ from company to company and largely depends on your royalty rate, return multiple, and how long your company takes to buy out the investment. The royalty rate and return multiple are pre-determined based on the status and nature of your company.
Investments that are anticipated to last longer will typically receive higher royalty rates and a lower buyout multiple. Investments that are anticipated to last shorter will generally receive lower royalty rates and a higher buyout multiple. In either case, if you are confident that your business will grow significantly, you will enjoy a lower overall cost compared to the cost of selling ownership in an equity financing deal.
The duration of the loan will depend on the success of your business. The faster your company grows, the faster the loan is repaid. Entrepreneurs can take as much or as little time as they need to pay back the loan (phew!).
Types of Companies That Benefit from Revenue-Based Financing
Companies with Various Growth Rates
Revenue-based financing isn’t startup financing — it’s growth financing. Companies experiencing slow, moderate, and hyper-growth operate well under revenue-based financing. In contrast, VCs will generally seek companies growing beyond 100% annually. Since no equity exit is required, founders financed under revenue-based financing can choose to operate their businesses under controlled growth rates and still have secure growth capital.
Flow’s Founder Tip: Companies that operate with high gross margins and subscription-based revenue models (SaaS) are often great fits for revenue-based financing due to their sticky revenues and ability to scale.
Companies Not Yet Profitable
If your company is not profitable yet, you will likely have a hard time securing a bank or SBA loan. Profitability is not a requirement for revenue-based financing as cash runway and projected growth are used to determine if your company has the ability to cover the monthly payments.
Companies That Are Pre/Post/Anti-VC
As opposed to traditional venture debt, revenue-based financing investors are willing to fund companies that have never raised venture capital. This offers founders the ability to use a blended approach to fundraising. Founders can use revenue-based financing on its own or combine it with debt or equity financing.
Flow’s Founder Tip: If you are already a venture-backed company, you can also benefit from revenue-based financing. Use it as a complement source of capital in order to minimize equity dilution while extending cash runway.
The Benefits of Revenue-Based Financing
Limited Equity Dilution
The idea of handing over a portion of equity and control over their business is daunting for many entrepreneurs. Revenue-based financing is an alternative to venture capital and only requires money back with limited equity dilution. As the company grows, founders are rewarded for those long hours and weekly panic attacks by keeping a higher percentage of their equity than they would have with equity financing.
Innovators Stay in Control
Venture capitalists like to have a finger in every pie while operating under the “growth-at-all-costs” approach. While those 15-minutes/year of “subject matter expertise” may be worth it to some, revenue-based financing investors understand that the best growth happens under the businesses owners themselves. By supplying flexible, non-dilutive capital under revenue-based financing, entrepreneurs maintain control and lead their business with their vision intact. This leads to healthier, more sustainable growth over the long run.
No Personal Guarantee
Do you enjoy sleeping with a roof over your head? How’s that new car driving? The scary reality of taking on a traditional business loan is founders are burdened with personal guarantees. Revenue-based financing does not require personal guarantees, which means founders can get the capital they need without putting their homes and other personal assets on the line.
The nature of startups is volatile. One month your revenues may be soaring through the roof, another month not so much. The fixed monthly interest payments under traditional bank loans are not compatible with this volatility. Since revenue-based financing bases monthly payments off of a percentage of top-line revenue each month, this flexibility ensures monthly payments aren’t a burden and payments are rarely missed.
Aligned Focus Towards Revenue Growth
Venture capital involves the misalignment between investors and founders. Entrepreneurs are placed under immense pressure as they operate under the “growth-at-all-cost” attitude. While venture capitalists aim to achieve 10X returns within their high-risk, high-reward portfolios, this takes focus away from listening to customers, addressing their needs, and adjusting to make long-lasting growth.
Revenue-based financing facilitates healthier relationships between investors and founders as investors’ returns go up when the startup grows faster. As a result, both the investor and the entrepreneur are focused towards growing revenue.
Less Expensive Than Equity
While the repayment cap of revenue-based financing deals may come as a turn off, it is important to note that equity financing does not have a cap. Equity consists of a percentage of ownership of the company in perpetuity (AKA unlimited potential lifetime repayment). If your business grows under revenue-based financing, you’ll catch more of the upside than with venture capital.
Ease of Access to Capital
Entrepreneurs can spend months pitching their business in hopes of receiving funding from traditional equity sources. Since revenue-based investors do not require hyper-growth, industry disruption, or large equity exits, lenders can provide funding within several weeks.
Larger Funding Amounts
Traditional bank loans may not provide the level of funding necessary to get you to where you want to be. While venture capital does offer larger amounts, this comes at a much larger cost. Revenue-based financing is the best of both worlds, where founders get large funding amounts while retaining ownership. At Flow Capital, we can fund up to $4 million through revenue-based financing if the company qualifies based on its MRR/ARR.
Try Revenue-Based Financing With Flow Capital
The Downsides of Revenue-Based Financing
More Expensive Than Bank Loans
Compared to traditional bank loans, revenue-based financing may be more expensive in the long run due to its perpetual nature.
Companies Must Have Revenue
Small startups may find it difficult to acquire this form of funding, especially if they are pre or early-revenue. Many investors look for certain requirements, such as proving you have consistent monthly revenue of a certain amount, requirements based on your customer base, or gross margins.
Requires Monthly Payments
Unlike equity financing, revenue-based financing does require active repayment. Although the monthly payment amounts are flexible, it can cause a company to be tight for cash, especially while in the startup phase.
Flow’s Founder Tip: Make sure you only take a healthy amount of revenue-based financing, which can be based off of your MRR.
How to Decide Which Lender to Use
Since revenue-based financing is becoming more and more prevalent, it’s important to choose the best one for you as bad lenders can ruin companies quickly. Take a look at their portfolio to make sure you are in good hands. Better yet, conduct reference checks by calling past clients and asking them about their experience with the lender.
Flow’s Founder Tip: Be sure to check out if they have case studies or client testimonials on their website.
Businesses should get the best terms they can from the best partner. Feel free to negotiate terms with the investor.
Timely & Dependable Funding
You have enough on your plate, and hunting down your investor for on-time funding and per the agreed-upon terms should be the least of your worries. Take the time to select an investor who has a strong reputation of timely and dependable funding. Don’t let financing be a distraction to your business’s growth.
Commitment doesn’t end when the term sheet is signed and the transaction is closed. It is important to select a lender that will be a good financial partner over the duration of the loan.
About Flow Capital
Flow offers emerging and high-growth businesses the opportunity to grow their businesses in a smart and sustainable way.
Our project is to feed the growth of the world’s most cutting-edge, innovative companies emerging in the markets today through fair funding that meets the needs of each business.
Our promise is to offer you a welcoming and inclusive community, to anticipate needs before they are voiced, and to treat every business owner with thoughtfulness and respect.
Our goal is to make financing your business as simple as possible while securing long-term sustainable growth.
Interested in Applying?
If you’re ready to grow your business while maintaining control and ownership of your company, apply for financing today.
Funding usually occurs within four weeks.
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