Whether your startup just launched, has been in the market for a few years, or has grown to millions in sales, at some point, it will need funding to accelerate growth.
Startups have traditionally sold a portion of their company (equity ownership) to a business partner — typically a venture capital (VC) firm — to raise growth capital. While that alone is no easy feat, founders also have to negotiate a company valuation in the process without overly diluting equity; and startup valuations are more subjective than not, particularly for earlier stage businesses.
Without a high valuation, owners make costly sacrifices to secure VC funding — excessively diluting equity and giving up control to investors — which can turn a founder’s dream into something else entirely. Y-Combinator advises that most funding rounds will require up to 20% equity dilution, and Harvard Business Review reports that up to 40% of startup founders are replaced at the behest of their investors.
VC funding might be the Holy Grail of startup funding, but it’s not a worthwhile endeavor for every startup — or even for most startups that can achieve success when founders dedicate their time and resources to growing a healthy, sustainable business.
Negotiating a high valuation in an equity raise has always been more favorable for startups with sizable market potential. Startups that serve niche or smaller markets can struggle to woo VCs, as well as favorable valuations, if they don’t play in trendy spaces that already interest investors, whether they’re lucrative markets or not. Female and minority founders often discover that implicit bias puts them at an even greater disadvantage.
What’s the alternative?
Startups looking for growth capital find that debt funding can better meet their needs, without diluting equity. For SaaS startups and startups with subscription-based pricing, one debt funding option in particular is often an ideal source of capital: revenue-based financing (RBF).
Though RBF has been around for decades, it’s still a relatively obscure source of startup funding that has many benefits for growing a business. In this detailed resource, we’ll explain how revenue-based financing works to help you determine if RBF is a viable funding source for your startup.
What is revenue-based financing (RBF)?
Revenue-based financing is a source of growth capital that enables businesses to pay back the investment with a percentage of their future gross revenues — it’s similar to a startup business loan that’s paid off over time, but with flexible payments that ebb and flow with the business’ revenue streams.
Unlike equity funding, where a portion of the company is sold to investors, RBF does not require selling equity. Commonly referred to as non-dilutive funding, revenue-based financing has zero impact on equity tables or ownership percentages and doesn’t require ceding any control of the business.
How does revenue-based financing work?
The revenue-based financing model gives startups an upfront injection of capital to invest in the business and repay at a later date, with interest, much like a traditional term loan. Instead of fixed monthly payments, RBF payment terms are structured as a fixed percentage of monthly revenue — so when your startup’s revenue increases your payment also increases, and vice versa.
This flexibility benefits young tech startups that typically have lumpy or fluctuating revenue streams, making it easier to manage cash and scale the business. When monthly revenue grows and you make bigger payments, you’ll pay back your loan faster. If you have slow months where revenue is down it may take you longer to pay off your loan, but you won't be locked into monthly payments you can’t make.
Advantages of revenue-based financing
With revenue-based financing, entrepreneurs retain ownership and control of their businesses, which makes better exit outcomes possible. RBF is a good funding option for many kinds of startups in various growth stages. Tech and SaaS startups that struggle to meet the funding requirements for traditional bank loans, simply because of their business models, find revenue-based financing particularly advantageous.
Startups are well-positioned to benefit from RBF if the loan and its repayment terms align with their financial situation and goals, and the lender is trustworthy. These benefits include:
Funding is non-dilutive and does not impact equity or ownership
Funding approval is fast and objective
Funding doesn’t require valuation negotiations, pitch decks or presentations
Personal guarantees aren’t required as collateral
Your business doesn’t have to be profitable
How you use your funding is entirely up to you
You decide how to grow, how fast to grow, and when to exit
Flexible revenue-based payments make managing cash easier
Funding is right-sized to your revenue, so deployment and repayment is manageable
Funding scales easily with the business as it grows
Disadvantages of revenue-based financing
Is revenue-based financing bad for startups? As the saying goes, the devil is in the details. What may be an advantage to one startup can be a disadvantage to another. Here are a few reasons RBF might not be a good fit for your business:
Revenue-based financing, though objective, can have specific requirements for approval, and some lenders are more selective than others. At a minimum, revenue is required, so it’s not a funding option for pre-revenue startups.
The funding amount is limited by revenue, which may not be sufficient for large market disruptors who need tens of millions of dollars.
Like any loan, repayment is required, with interest; and while RBF is a bargain compared to equity funding, the cost of capital will be higher than a traditional business loan — you have to consider how payments will impact your future cash flow.
It takes time to see ROI after deploying capital, so RBF loans with a short payback period have the potential to cause some startups financial stress.
Revenue-based financing is not ideal if your startup is out of runway and you’re in survival mode. You might get approved for a loan but expect a higher interest rate and terms could sink your startup.
Use cases and examples
There are a variety of different ways that startups use RBF. While many entrepreneurs are drawn to revenue-based financing for its non-dilutive benefits, the funding is also effective for scaling and accelerating business growth.
Below are 8 common revenue-based financing use cases and examples.
1. Expand sales and marketing to capture more market share
Make key hires, build out teams, enter new markets, and increase budgets to support new customer acquisition and drive revenue growth.
2. Invest in product development and innovation
Your product is the core of your business and a keystone of scalability. Investments in both engineering talent and infrastructure to support growth often require a large injection of capital.
dbt Labs hired a world-class team of engineers and expanded its product offering to drive revenue growth with RBF, before raising 3 equity rounds, which included $150 million from Altimeter, Sequoia Capital, and Andreesen Horowitz. Read their story >
3. Build out customer support to improve customer retention
If your business needs to increase long-term customer retention and customer lifetime value, it may be the right time to start building a customer success team or automating customer support solutions.
4. Buy out old equity partners and clean up cap tables
You’ll need to negotiate a fair price for the investors’ shares (neither too high nor too low), since there will be no valuation associated with your funding; but RBF can help you get investors off your capitalization table — whatever the reason.
5. Pay off old debt to reduce cash burn
You don’t have to let existing debt and loans with higher interest rates slow you down. Revenue-based financing can help reduce your cash burn and increase cash reserves so the business can grow more efficiently.
As the pace of the business accelerated, it became clear Qnary had outgrown their previous lender who didn’t understand the additional capital and liquidity they needed to scale. Qnary used revenue-based financing to pay off the old debt and make bigger investments that drove double-digit growth. Read their story >
6. Fund acquisitions to scale growth
Sometimes the quickest and most effective method for scaling growth is acquiring a business partner or third-party solution — you can do that with RBF.
7. Bridge financing between equity rounds to fund working capital
Whether you need capital to fuel continued growth and increase your startup’s value before raising an equity round or you need a bridge to avoid a down round, revenue-based financing is a smart non-dilutive solution.
After raising $1.7 million in seed funding, HBox used revenue-based financing to purchase additional inventory of the customer tablets it needed to meet aggressive growth goals — with minimal equity dilution. Read their story >
8. Extend runway to fund cash reserves and maintain momentum
Healthy startups should have 18 to 24 months of runway to ensure the business can absorb stresses and capitalize on opportunities, and it will help get the best funding terms when it’s time to raise more money.
Revenue-based financing bought Aisle Planner extra runway to pivot when physical shutdowns from COVID-19 threatened the business. Aisle Planner kept growing and got acquired the next year! Read their story >
How much funding can a startup get?
RBF loan amounts are based on a startup’s revenue, and every lender has different ranges and requirements that determine how much funding a startup can get. Typically, you’ll need to complete an application and provide some basic information about your business to see how much you might qualify for, which is usually a quick and easy process.
You can get up to $4 million in upfront capital from Lighter Capital in a single funding round. Most startups in our portfolio start with smaller amounts (proportional to their revenue), then receive additional, larger funding rounds as the business grows. For example, your first round might be $200K in funding, then a second funding round of $500K, and final round of $1M.
Some of Lighter Capital’s clients have received more than eight rounds of funding over many years. Other clients only take one or two rounds of funding to fuel the business for a short period of time.
One of the best features of RBF is your ability to control how much funding you take, and more importantly, when you take it. Just like buying a house, you might qualify for a certain loan amount, but you can still overextend yourself if you borrow all of it. Always investigate how paying back debt funding will impact your startup’s future cash flow.
Terms and rates
Revenue based financing term lengths can be as short as one year or as long as five years. While many lenders offer shorter-term RBF loans, they tend to be disadvantageous for most startups, with the exception of certain scenarios like a bridge to an acquisition, for example.
There’s always time that elapses between deploying capital and generating a return from those investments. Consequently, a short-term RBF loan is more likely to negatively impact cash flow and cause unnecessary financial stress when the full loan balance is due before revenue begins to scale. In other words, your startup will spend a year paying for funding using a big portion of the capital you borrowed, leaving very little fuel for the business.
With a three-year term or longer, the business has enough time to deploy capital and produce returns that cover capital costs, and then some. Longer-term RBF loans help growing startups smooth out cash flow and maintain momentum until revenue begins to scale from strategic investments.
Unlike traditional business loans with a compounding interest rate, an RBF loan features a repayment cap. A repayment cap is expressed as “1.x,” where x is the rate that determines your borrowing cost — it’s applied only to the original amount borrowed and results in a flat fee for the loan. So, whether you pay an RBF loan off early or not, your cost of capital is the same.
This key distinction often causes confusion when comparing the cost of different startup debt financing solutions. If you look at the repayment cap like an annual percentage rate (APR), you’ll incorrectly inflate the cost of an RBF loan.
For example, say you are approved for $500K in revenue-based financing with a three-year term and 1.2 repayment cap. The cost of your funding will be $100K ($500,000 x 0.2) and you’ll repay a total of $600K over three years.
If you, instead, calculate costs over three years with a 20% APR that’s compounded monthly on that same $500K loan, you get $169K of interest — almost $70,000 more than you’d actually pay. Also remember, you’ll have far more flexibility with your RBF payments, so you aren’t as likely to burn up your cash. That translates to additional value from the RBF loan.
How to get the best RBF terms for your business
There may be hidden costs and risks with revenue-based financing agreements, so it’s important to dig into the fine print and investigate lenders so you don’t get burned.
Here are 7 tips for getting the best RBF deal possible:
Choose long-term over short-term if you want more value and less risk. You’ll be able to utilize capital more effectively to get a better return on your investment.
Apply for funding before you need it and steer clear of merchant cash advances. With at least 12 to 18 months of runway, you’ll get the best rates from the best lenders.
Demand transparency. A discount rate, for example, does not indicate savings on a loan and is often used to confuse and mislead you on your true cost of capital.
Avoid debt covenants that can restrict your growth and unnecessarily complicate your business strategies.
Stick with a capital partner that doesn't require warrants.
Watch out for personal guarantees or other collateral requirements and fees. You don’t need to put your house or savings on the line to get an RBF loan.
Vet your investors like they vet you. Fast cash can be too fast — if a lender doesn’t take the time to do their due diligence, they might not be the best financial partner for you.
Is RBF a good fit for your startup?
We’re a bit picky compared to other revenue-based financing companies, but with good reason. Since 2010, Lighter Capital has helped more than 500 startups grow through more than 1,000 rounds of funding and over $300 million in financing. More than 20% of our portfolio clients have been acquired to date by companies that include Amazon, Salesforce, and Eventbrite.
We know what it takes to help entrepreneurs realize their dreams on their terms, and we know which startups have what it takes.
Our focus is mainly on SaaS and subscription-based tech startups in the U.S., Canada, and Australia. If the following describes your startup, we might be a great fit!
Your recurring revenue is at least $15K a month or $200K a year, and growing
Your revenue is from multiple, diverse customer accounts
Your churn is minimal
You have 12-18 months of cash runway
Your gross margin is over 50%
Your business has strong unit economics