FLOW CAPITAL

THE FOUNDER’S GUIDE TO REVENUE-BASED FINANCING

Revenue-Based Financing

A Complement or Alternative to Equity Financing for Growing Companies

Revenue-based financing, also known as revenue sharing or royalty-based financing, is a method of raising capital for emerging and high-growth businesses. Investors inject growth capital in exchange for a percentage of monthly revenues.

If you are the founder of a company, 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 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 minimize equity dilution and maintain full control of their company. That’s right – get access to the growth capital you need without having to give up 30% of your company.

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 Investment Structure

Principal Amount

Once the deal terms have been negotiated and a term sheet is signed, you will receive the principal amount in 1 or 2 installments. At this point, the capital is yours and available to use however you wish. Lenders like Flow Capital will place trust in knowing that you know your business best and will make the right decisions that will lead to growth.

Monthly Royalty Payments

Each month you pay the investor a pre-determined percentage of your top-line revenue. While most lenders offer a fixed term loan, Flow Capital provides a unique option for founders where there is no fixed term. Instead, payments are perpetual until you decide you are ready to buy out the investment. Offering a perpetual structure provides you with more flexibility than you would with traditional debt financing. In other words, if you don’t want a payback deadline hanging over your head, RBF is for you.

Investment Buyout

If you do move forward with a no-fixed-term agreement, buying out the investment is dictated entirely by your schedule and can happen at any point in time. When you are ready to buy out the investment, you will pay the principal and a premium. The principal is the same initial amount given by the investor. The premium is the cost associated with the investment given its high-risk nature and added flexibility. For most lenders, you can expect the premium to range anywhere from 0X-1X. After this is received, monthly payments stop and the investment relationship ends – no strings attached.

Cost and Duration of the Investment

Cost

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, nature, and risk-level of your company. In any 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.

Duration

While you can opt for a fixed term agreement, Flow Captial’s no-fixed-term agreement aligns the duration of the investment with the growth of your business. The faster your company grows, the faster the investment can be repaid. Entrepreneurs can take as much or as little time as they need to pay back the investment.

Pros 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. This may come in the form of warrants or a success fee. For more information about warrants, please read our Founder’s Guide to Warrants.

Innovators Stay in Control

Venture capitalists take company board seats, allowing them to dictate the direction of the company and operate under the “growth-at-all-costs” approach. While this may be worth it to some, revenue-based financing investors understand that the best growth happens under the businesses owners themselves. By supplying flexible, minimally-dilutive capital with 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 Guarantees

Do you enjoy sleeping with a roof over your head? How’s that new car driving? The scary reality of taking on a traditional bank debt 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.

Flexible Repayments

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 type of volatility. In fact, high-growth companies may even have a harder time qualifying for bank debt given their higher-risk nature. 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

Sometimes venture capital may involve 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 the company’s customers, addressing customer needs, and adjusting to achieve 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 share an aligned focused towards revenue growth.

Less Expensive Than Equity

While revenue-based financing still comes with a price tag, 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, investors can provide funding within several weeks. On the other end of the spectrum, higher-risk companies (e.g. tech) may have a harder time qualifying for traditional bank loans. Revenue-based financing lenders are aware of this higher risk and price the loans accordingly.

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 $5 million through revenue-based financing if the company qualifies based on its annual revenue or annual recurring revenue level.

Cons 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 higher ‘interest’ rates.

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 RBF lenders 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.

Types of Companies That Benefit from Revenue-Based Financing

Various Growth Rates

Revenue-based financing isn’t startup financing — it’s growth financing. Companies experiencing 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.

Close to or at Profitability

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, positive unit economics, and projected growth are used to determine if your company has the ability to cover the monthly payments.

Pre, Post, or Anti-VC

Revenue-based financing can be used as a complement or alternative to equity financing. RBF can be used to extend cash runway or to eliminate the need for a final funding round.

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.

Choosing a Lender

Investing History

Since revenue-based financing is becoming more and more prevalent, it’s important to choose the best lending partner 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.

Competitive Terms

Investors and companies should work together to come up with the best terms, taking into account the needs of each party.

Timely & Dependable Funding

You have enough on your plate. 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.

Partner Mentality

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.

Interested in revenue-based financing?