September 2, 2024 | Last Updated on: September 5, 2024
Disclaimer: Information in the Business Financing Blog is provided for general information only, does not constitute financial advice, and does not necessarily describe Biz2Credit commercial financing products. In fact, information in the Business Financing Blog often covers financial products that Biz2Credit does not currently offer.
We all know that small businesses form the crux of the American economy. As foot soldiers of the economy, they carve out a path to economic resilience and prosperity, ensuring that America’s financial future always remains solid and stable. Yet, their path to success is riddled with challenges – right from funding to planning to hiring. They struggle to get the financing they need for their growth, as traditional banks are not always flexible enough to come to their aid. Hence, a lot of small businesses fail to grow and thrive, unlike their big-name competitors.
But not everything is lost! In the last few years, alternative funding options have been tailored for small businesses. One such option is revenue-based financing, which has become popular with entrepreneurs and startups.
It allows borrowers to raise money by repaying investors with a percentage of their future revenue rather than fixed monthly payments or equity stakes. It also ensures that businesses do not run out of working capital when they need it the most.
Sounds interesting, doesn’t it? No wonder there has been an increase in the application of revenue-based financing in recent years. But before you get excited, let’s understand exactly what revenue-based funding is, how it works, what it can be used for, and finally, whether it is the right kind of financing for you.
A truly revolutionizing funding option, revenue-based financing (RBF) offers small businesses and startups an attractive alternative to traditional financing methods. RBF’s adaptable repayment structure suits businesses with fluctuating revenues by allowing companies to raise money instead of a percentage of their future income rather than fixed monthly payments or equity stakes. Since this financing type is often processed faster than traditional bank loans, working capital can be made available more quickly, making it perfect for businesses with urgent capital needs. Another feature of RBF is that it does not require collateral or personal guarantees, making it easier for businesses without significant assets to seek necessary funds.
With this type of financing (also known as royalty-based funding), after deciding on the initial investment amount, the lender charges a fixed fee on the principal amount, calculated as a percentage of future revenue, to be repaid by the borrower. This percentage is usually between 3%-8%, depending on the agreement. RBF stands apart from traditional business loans because it adapts to the company’s revenue cycle – increasing during peak periods and decreasing during slower ones. In short, the payments are directly proportional to the company’s monthly revenue growth.
This funding is also different from other alternative financing options. Unlike Merchant Cash Advance (MCA) loans, which are paid back from credit/debit card sales, RBF considers total sales and offers a more flexible repayment term. It is also different from a line of credit loan, which allows borrowers funding up to a certain limit with repayment based on usage. With RBF, the focus remains on the revenue rather than credit scores, making it easier for the borrower to qualify for the loan. But keep in mind that interest rates are typically higher with revenue-based loans. So, while selecting a funding option, businesses must consider the trade-offs between flexibility, accessibility, and overall expense.
Before we talk about the best use of revenue-based financing, it is important to understand what underwriters look for in candidates and businesses when assessing RBF.
As mentioned before, revenue-based funding is suitable for businesses with high-profit margins, certain startups, and businesses experiencing cash flow problems yet maintaining a steady recurring revenue. Borrowers who are unable to apply for traditional business loans due to poor credit history or lack of significant assets can also qualify for this type of financing. As RBF depends on immediate revenue, any company just starting out or in the pre-revenue stage of the business should skip this funding option.
The capital from RBF can be used to drive growth and innovation in small businesses and startups. From scaling operations to purchasing inventory to hiring additional staff, RBF can act as a catalyst to drive business growth to the next level. Here are some more ways to use funding from RBF:
This alternative form of funding benefits many businesses, but a few still flourish.
RBF works in four key steps and borrowers must pay attention while completing all these stages to ensure they get their funding without any hitch:
While negotiating the agreement for this type of business loan, keep in mind the following components that are very important to understand:
Choosing funding is not an easy task. As it may affect a business’s financial health, business owners must carefully consider every aspect related to financing needs. Here are a few things to keep in mind while applying for RBF:
RBF works best for those businesses who are in the market for a flexible and non-dilutive funding option. Since the repayment is linked to monthly revenue, the company’s cash flow will not be under pressure. However, while these aspects make RBF very useful financially, the drawbacks are also hard to ignore. Non-dilution and flexibility come with a higher rate of interest that might make repayment difficult for some small businesses in the long run. It might put a strain on the company’s financial future. That’s why its borrowers must understand all the aspects of revenue-based financing clearly before making any decision.
RBF is an intelligent alternative funding option for small businesses and startups, where upfront funds are provided for a percentage of the business’s monthly revenue instead of a fixed interest or equity. It helps small businesses, especially those with variable monthly income, to maintain a steady cash flow to meet their business needs.
This type of funding allows companies to raise capital in exchange for a percentage of their monthly revenue. It will help those companies with fluctuating monthly revenue as they can avoid paying a fixed amount of interest. Instead, as their repayment is linked with their monthly income, they will have to pay a higher repayment amount during peak seasons and lower during off-seasons.
Any small business with steady annual revenue, even if their monthly income fluctuates, can apply for RBF. Moreover, a credit score must be above 650, though some lenders are willing to accept a marginally lower score. They need to have an annual income of $250,000 and should have been in business for at least six months.
There are many advantages of revenue-based funding. It includes flexible repayment terms, non-equity funding by avoiding equity dilution, and enhancing business performance since the repayment is tied to the revenue.
Several platforms offer revenue-based funding options, but it is always advised to go with a reputable lender with transparent terms and notable customer service. Because any funding has long-term implications, starting with someone trustworthy like Biz2Credit is best.
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