Revenue-based Financing 101
What Is Revenue-Based Financing?
Revenue-based financing or “RBF”, is a method of raising capital for a business from investors who receive a percentage of the enterprise's ongoing gross revenues in exchange for the money they invested. In an RBF investment, investors receive a regular share of the businesses' income until a predetermined amount has been paid. Typically, this predetermined amount is a multiple of the principal investment.
Revenue-based Financing vs. Venture Debt, Venture Capital & Bank Financing
RBF seems similar to venture debt as investors are entitled to regular repayments of their initially invested capital. However, RBF does not involve interest payments. Instead, the repayments are calculated using a particular multiple of the startups revenues that results in returns that are higher than the initial investment. In addition, unlike venture debt which only invests in companies that have raised capital and relies on an equity cushion for underwriting, RBF can be used for bootstrapped companies as well since the underwriting process is more comprehensive and data driven. More importantly, venture debt, can at times, create equity dilution while RBF is non-dilutive for the companies.
As compared to equity-based venture capital, there is no transfer of an ownership stake to the investors in RBF. Also, in this type of a financing model, entrepreneurs are not required to provide investors with a seat on their board. More importantly, unlike venture capital which only funds companies with a potential of a high return at least 10x of the invested amount, RBF can be applied to a much broader universe of companies.
In the case of bank/NBFC lending, there are a significant number of regulatory constraints. Whereas in the case of RBF, a company is typically not required to provide any collateral to investors as compared to traditional debt financing by a bank/NBFC where a collateral in most cases shall be required by the lending institution. For businesses with seasonal revenue profile, RBF gives them the flexibility to pay as a share of their revenue instead of a fixed amount every month in case of bank/NBFC lending.
The following table gives us an insight into key elements that differentiate the above-mentioned financing options available to aspiring entrepreneurs of the Indian startup ecosystem:
|Measures||Bank Loans||Venture Debt||Revenue-Based Finance||Venture Capital|
|Guarantees & Controls||Financial Covenants Sometime Personal Guarantees||
Partner in the business (Board Seat, Voting Rights)
|Added Value||Low / None||High||Medium||High|
|Dilution||None / Low||None/Low||None||High|
|Payment Flexibility||Low: Fixed Payments||Low: Fixed Payments||Medium: Variable Payments||High: No Payments|
Revenue-based Financing: The “Why”
From an investor’s perspective, revenue-based financing provides an opportunity to earn lucrative returns. Nevertheless, an investor should be aware of the risks associated with the financing model because the repayment rate has a direct relationship with revenues. If the company’s revenues experience a significant decline, the repayment rate will drop proportionally which in turn will have a direct affect on the IRR.
RBF can provide significant advantages to entrepreneurs and businesses as well. The nature of RBF, however, requires that businesses have two key attributes.
- First, the business must be generating revenue, as it will be from that revenue that payments are made towards the loan will be made
- Secondly, the business should have strong gross margins to accommodate the percentage of revenue dedicated to loan payments.
The interests of an RBF investor align with the interests of the companies in which they invest. Both parties benefit from revenue growth in the business; both parties suffer when revenue declines. This is in contrast to a typical bank loan, which has a fixed monthly payment over the life of the loan regardless of business revenue. RBF helps manage rough months in the business by having a payment that traces revenue.
Cost of capital is also an important consideration for entrepreneurs raising money. Usually, the cost of capital in an RBF investment is significantly less than a similar equity investment, for several reasons:
- First, the actual interest rate on the loan is much lower than the effective interest rate required by an equity investor on their invested capital if the business should be sold or additional funding is raised.
- Legal fees for compliances and other regulatory checks are lower than with equity financing.
- Lastly, considering the investment is a form of debt, the interest payments on the same is a tax deductible for businesses
Major players in Revenue-Based Financing
Clearbanc: One of the largest players in the space, Clearbanc offers growth capital in the form of RBF. Strong predictive models analysing revenue, ad performance and other third party data is used to generate funding offers. Some key facts about Clearbanc are as follows:
- Funding offers are based on performance
- Ticket size ranges from $10,000 to $10 mn
- Capital can be deployed in as less as 3 days
- Clearbanc charges a small flat fee on our capital that ranges from 6-12% depending on how the funds are spent.
Bigfoot Capital: Bigfoot capital provides RBF, term loans, and lines of credit to SaaS businesses with $500k+ ARR.
- ARR of $500,000+
- At least 12 months of customer history, generally 20+ enterprise customers or 200+ SMB customers
- Rational burn profile, up to 50% of revenue at close, scaling down
Earnest Capital: Earnest Capital provides early-stage funding, resources and a network of experienced advisors to founders building sustainable profitable businesses. Some key facts are as follows:
- They agree on a Return Cap which is a multiple of the initial investment (typically 3-5X).
- They don’t have any equity or control over the business.
- As the business grows, they calculate what they call “Founder Earnings”, and Earnest is paid a percentage. Essentially, they get paid when founders get paid.
Feenix Venture Partners: New York-based investment firm that partners with consumer-facing businesses raising growth capital. The company focuses on investment in early and mid-stage businesses. Some key facts are as follows:
- Average check size is $1-3 mn
- Multi-year term and competitive interest rates for debt.
- 10% of portfolio companies have received prior VC equity earlier
Feenix Venture Partners has a unique investment model that couples investment capital with payment processing services. Each of Feenix’s portfolio companies receives an investment in debt or equity and utilizes a subsidiary of Feenix as its credit card payment processor.
Lighter Capital: Lighter capital is a revenue-based financing lender that specializes in providing financial capital to small technology companies. Lighter Capital is one of the largest provider of non-dilutive debt capital to early-stage startups. Some key facts are as follows:
- 350+ companies funded
- $200 mn invested
- 650+ rounds of funding
They typically fund companies that demonstrate over $8 mn in ARR and 30% year-over-year growth, with an average ticket size of $10 mn - $30 mn.
Klub: Klub takes a marketplace approach to RBF by working with both institutions (banks/NBFCs) as well as individuals to provide capital to loved consumer brands. Klub is India’s leading RBF player and provides capital in the range of Rs. 5 lakhs to Rs. 5 cr. to consumer brands for a tenure of 3 months to 18 months.
- Since its launch post-Covid in July, Klub has evaluated over 400 brands and has built a capital base of multiple million dollars from its patrons and partners
- 40% of the brands funded by Klub have availed or are in discussions for their 2nd or 3rd investment from Klub
- 40% of the brands funded by Klub have at least one women co-founder
Getvantage: One of the first revenue based financing platforms in India, Getvantage facilitates growth stage businesses to fund their digital spends for a fraction of future revenues. They cater to companies with a digital-first approach.
- Capital advances between ₹20 lakh to ₹2 crore
- No interest %, no equity dilution, and no hidden charges
- Just one flat fee that’s recovered as a small share of future revenues
Revenue based financing is a relatively new asset class in India with a huge potential to grow in the future. The predicted growth for the asset class has been accelerated due to the pandemic with a large number of startups with inconsistent revenue streams for whom this becomes an attractive funding option.