As a startup, getting the right amount of funding at the correct intervals is absolutely crucial to growing your business. Unfortunately, securing this funding isn’t always easy.
The traditional option is to use venture capital firms, but they can be tricky to work with — they often have very specific requirements about what kind of companies they fund, and they usually want a large share of your company in exchange for their investment. This makes it so that it can be flat-out impossible for certain startups to receive funding, and for the ones that make it work, they often receive it under unfavorable circumstances.
Fortunately, there’s another option for startups who can’t or don’t want to work with VC firms or banks: revenue-based financing.
Revenue-based financing is an alternative system of financing that is based on recurring revenue. With this form of financing, startups can quickly receive funding based on their recurring monthly revenue amount. They then repay the loan on a monthly basis rather than promising equity to investors.
Revenue-based financing is ideal for early- to mid-level startups that are achieving modest growth and are regularly receiving revenue but can’t or don’t have the means to apply for traditional venture capital or bank loans. This could mean that they don’t have the necessary collateral, or they don’t have time to wait for the lengthy capital funding rounds.
It’s also a great option for business owners who want to stay in control of their business and get equity-free funding that ensures their investors receive a capped return and don’t take over the business.
In a nutshell, revenue-based financing fills in the gap between early-stage VCs and private equity firms. It can be a great choice for funding in between equity rounds so your business can continue to grow and build itself consistently, or in other situations where traditional funding is out of reach. The funding requires smaller returns for the investor, with an average of a one to three time expected return compared to the exponential growth expected from venture capitalists, which could be as much as one hundred times the value of the initial investment.
Revenue-based financing is also typically ready to be used in a shorter time frame than traditional venture capital, with a three to four weeks waiting period rather than the traditional three to six months period, so you can hit the ground running with your new funds.
The qualifications required for revenue-based financing are fairly straightforward: You need to prove that your business is making a consistent revenue every month. This makes it an ideal choice for businesses that are achieving profit but are too small or slow-growing to successfully secure venture capital funds.
Startups that qualify for revenue-based financing will typically have a stable monthly recurring revenue (MRR) growth rate, high margins, and a proven potential for future growth. This information is used to determine your loan amount, and is important in proving that your startup will be able to repay the loan on the required monthly basis.
These requirements make it significantly easier to receive revenue-based financing rather than venture capital financing. Traditional VC loans often require a business plan, a management team, an internal rate of return, and an ambitious scaling plan, while revenue-based financing only asks that your business is steadily growing and creating sizable revenue.
Revenue-based financing is a relatively new industry, with only thirty-two companies providing this service as of 2021, according to Techcrunch. While some of these companies provide revenue-based financing as well as traditional financing, many of them focus solely on revenue-based financing, which makes them highly capable of managing it correctly.
Notable big players in this emerging industry include Novel Capital, Bigfoot Capital, and Founderpath. Most of these companies use a monthly payment model and target SaaS and e-commerce businesses, but the financing model is rapidly finding its way into a variety of other verticals as well.
As COVID-19 and general market instability causes venture capital firms to be more conservative with their funds, revenue-based financing is very likely to fill in the gaps. Many startups who have previously found success securing venture capital funding are now having trouble repeating the process, and revenue-based financing can be a great option for these business owners to keep growing their business.