An old idea, used in a new way
Revenue-based finance (RBF) is a new type of financing structure where a company “sells” a
set percent of its future revenues to the investor in exchange for a capital investment. The
simplest way to think about it is as a revenue share between the company and the investor. RBF
is something of a blend between bank debt and venture capital, and a company should expect the
cost of capital to fall within that range as well. RBF, sometimes also known as royalty-based
finance, is a financing structure that’s historically been used in drug development, mining, and
film production, but as the early-stage funding landscape has shifted, funding growth with
revenues is gaining a lot more interest – from entrepreneurs and investors alike!
How revenue-based finance works
Instead of a business being required to pay fixed interest payments like a typical bank loan,
a RevenueLoan is paid with a percentage of revenues. In that case, monthly “interest” payments
will fluctuate if a company has lumpy cash flows or seasonal revenues. As software, infrastructure
and other business costs evolve into “-as-a-service” to adjust with the ebbs and flows of
a business needs, revenue-based payments naturally adjust up and down along with a business. The
built-in variability of RBF makes the structure so compelling. Potentially if a company’s
revenues drop to zero one quarter the loan payment drops to zero in lock-step, and when revenues
come back up (hopefully) loan payments increase by the same percent. Instead of a fixed monthly
expense regardless of business performance, RBF turns a loan payment into a variable expense.
When revenue-based finance works
Companies with hard assets (property, equipment) should usually qualify for a typical bank loan,
but what if your business doesn’t have that? Revenue-based loans are, by nature, most appropriate
for companies already generating revenues but. It’s useful for companies that have lumpy, seasonal, or
hard to predict revenues.
For entrepreneurs, revenue-based loans are attractive to founders who are allergic to dilution
and loss of control. The structure of RBF is often non-dilutive to founders and does not require
a board seat. The financing is obtained without having to agree to a valuation, which leaves management
in control of the company and typically requires no personal guarantees from management.