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:
Pros of Revenue-Based Financing
1. Cheaper Than Equity
2. Retain More Ownership & Control
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.
3. No Personal Guarantees
4. No Large Payments
5. Shared Alignment Towards Growth
6. Faster Funding Timeline
7. Financing Optionality
Revenue-based financing allows founders to grow and become more established, making traditional forms of financing more attainable. Options for financing include:
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.
Cons of Revenue-Based Financing
1. Revenue Required
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.
2. Smaller Check Sizes Than VCs
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.
3. Required Monthly Payments
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.