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 have no
assets with which to collateralize a traditional bank loan. 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.