Revenue-based financing is an alternative or complement to equity or debt financing. As a good fit for growing startups, it allows startup founders to maintain more ownership and control of their business than they would under equity financing. Below we highlight the pros and cons with respect to other traditional startup financing options:
With expectations for 10X-20X returns, Angel and VC funding are the most expensive sources of capital possible if your startup is successful.
When it comes to revenue-based financing (RBF), investors generally do not take equity. As a result, there is no ownership dilution to founders and early equity investors. In addition, RBF investors do not take board seats or place difficult financial covenants on a company. Founders are able to maintain control and direct the company towards their vision.
Bank loans require personal guarantees from founders based on the high-risk nature of startups. This requires founders to put their personal assets, such as a house or car, on the line. Founders can breathe easier under RBF knowing that no personal guarantees are required.
Monthly payments are based on a percentage of your monthly revenue. This means if you experience a bad month, your monthly payment will reflect that and you are not burdened with a large payment you can’t afford.
As part of their “growth-at-all-cost” approach, VCs overstuff companies with capital until they self-destruct. Since RBF involves a flexible repayment structure, investors’ returns increase when the startup grows faster. As a result, both the entrepreneur and investor share a common goal for the company to grow revenue.
Pitching to venture capitalists can take anywhere from months to years before securing a deal. Since RBF investors do not require companies to achieve hyper-growth or large equity exits, lenders can provide funding in as little as four weeks.
Revenue-based financing allows founders to grow and become more established, making traditional forms of financing more attainable. Options for financing include:
Delaying Venture Capital – RBF helps extend cash runway, which not only helps delay venture capital, but can help set higher valuations as a company reaches development milestones.
Running the Business Long Term – Because VC’s take on equity, they are looking for the company to “exit” or form a sale of the business. Since RBF investors do not require an exit since the investment is repaid over time, founders are able to keep their companies for as long as they’d like.
Option to Sell the Company – On the other hand, founders may decide they want to sell the company. Under VC financing, VC investors have the power to veto a decision to sell the company. RBF allows the sale of the business if the entrepreneur wishes to do so, as long as the loan is repaid.
Because this form of financing is revenue-based, pre-revenue startups are generally not a fit. A revenue-based investor uses metrics such as MRR/ARR and growth projections to determine eligibility for a loan.
Venture Capital is known for shovelling out enormous amounts of cash for companies, even if they are pre-revenue. Investors in RBF deals will not provide capital that is worth more than 3 to 4 months of a company’s MRR. However, RBF investors may choose to provide follow-on rounds as a company grows, providing entrepreneurs access to more capital over time.
RBF requires monthly payments unlike equity financing. Startups may find themselves tight on cash, so it is crucial to take on a healthy amount of revenue-based financing that aligns with the company’s financial status and plans.
For more information about revenue-based financing, be sure to read our Founder’s Guide.
