Revenue-based financing is a type of funding in which a company agrees to share a percentage of future revenue with an investor in exchange for capital up front. The loan payments are tied to monthly revenue, going up for strong-revenue months and down for low-revenue months. The simplest way to think about it is as a revenue share between the company and the investor.
Revenue-based financing, sometimes known as royalty-based financing, was used by oilmen in the early 1900s to finance oil and natural gas exploration, and later by the pharmaceutical industry, Hollywood, and energy companies. Investors began applying it to early-stage companies in the 1980s. Revenue-based financing blends the best of bank debt and venture capital, and a company should expect the cost of capital to fall within that range.
Instead of fixed interest payments like a typical bank loan, revenue-based financing is paid with a percentage of monthly revenues. If a company has erratic cash flows or seasonal revenues, monthly “interest” payments will fluctuate accordingly. If a company’s revenues drop to zero one quarter, the loan payment also drops to zero. When revenues come back up, loan payments resume. Instead of a fixed monthly expense regardless of business performance, revenue-based financing turns a loan payment into a variable expense.
Companies with hard assets (property, equipment) usually qualify for a typical bank loan, but what if your business deals in intangible assets like software and service? 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. Revenue-based financing is also attractive to founders who don’t want to give up equity and control because the loans are non-dilutive to founders and lenders don’t 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.