In the new economy it can be very difficult or impossible for a small business owner or entrepreneur to find capital to fund small business growth. Historically, small businesses and entrepreneurs have sought capital through “angel’ investors and traditional lending institutions, however these options are increasingly unavailable even to well established businesses. The revenue-based financing model, sometimes called the royalty-based financing model (RBF), is a financing plan that was introduced over 50 years ago and is gaining popularity today. The RBF model provides unique benefits to both the small business and the investor.
The RBF model is called a “non-dilutive” form of finance since the small business owner does not trade an ownership in the company in exchange for cash. Instead, the loan is structured so monthly payments are a percentage of increased revenues. This factor tends to be the most important and desirable feature of the RBF funding system to small business owners. Additionally, the investors payout is capped to a specific amount that is paid out of the revenue the company earns within a specified time period.
Business owners benefit by receiving investment dollars to build their business (without losing ownership) and investors benefit by receiving increasing payments as revenues increase. The investor has purchased the rights to a portion of the revenue earned by the small business, but they have not purchased any other ownership of the business. The terms of the RBF model are typically negotiated to allow some time for revenue to accrue before payouts need to be made, and typically there is a time period limitation and a payout limitation that is included in the negotiated terms.
This model is now used by many investment companies across the nation including even local and state government agencies. Notably, not all small businesses or investors will benefit by using this model. Investors who agree to RBF terms need to accept the ‘capped’ earning potential of the investment. And, some businesses with low profit margins and limited flexibility on pricing may not be appropriate for an RBF loan.
The RBF model can provide capital now to help small businesses grow to that next level, without getting a second mortgage on mom’s house, or selling an ownership stake in the business. This kind of financing aligns the goals of the investor and the business owner, in a win-win situation!