Traditionally, commercial lending was focused on asset-based security. For years, this has proven to be a great option for a lot of businesses as typically they would have a lot of heavy assets like plant and machinery, property and other heavy assets that lenders deem as suitable security.
As times change, more and more businesses are able to operate without heavy assets. Sectors like SaaS and e-commerce typically don’t own heavy machinery because it doesn’t suit the needs of the business and often don’t hold much stock either.
When it comes to raising finance for these types of businesses, typically they’ve been restricted to debt financing and equity financing. Debt financing is fantastic for already established brands with trading history and filed accounts, but can often be more difficult for newer brands and doesn’t always help those who are looking to grow rapidly.
Enter Revenue-based financing
Revenue-based financing allows companies to borrow money against their regular payments and pay back a split of revenue agreed with the lender. The term is typically dependent on the split being repaid, the higher the split of revenue, the shorter the term.
Rather than charging interest, most lenders charge a flat fee, making it a flexible and cost-effective option for fast-growing brands.
What are the types of revenue-based finance?
Much like how businesses themselves come in all shapes and sizes, revenue-based finance isn’t a one-size-fits-all arrangement. There are different models to suit different growth stages and cash flow patterns. Here are the two most common structures you’ll find:
1. Variable Collection Model
This structure is the most widely used. Here, your business borrows a lump sum and repays the lender by sharing a fixed percentage of your monthly revenues – usually from card or subscription payments – until you’ve repaid both the original sum and a pre-agreed lender’s fee. Because the repayment amount fluctuates with business performance, it’s particularly friendly to businesses with seasonal swings or unpredictable revenue streams. Importantly, you always know at the start what your total obligation will be, so there are no nasty surprises lurking in the small print.
2. Flat Fee Over Term Model
Unlike the variable collection approach, this model has you pay a set percentage of your monthly revenue for a fixed period – often up to five years. The percentage is typically smaller (think 1% to 3% of turnover each month), and there’s no set cap on total repayments. This can mean lower monthly outlays upfront, which is music to the ears of early-stage founders keeping a close watch on cash flow. However, if you hit the accelerator and your business grows faster than anticipated, you might end up paying more in total than you would with the variable method.
Both models give businesses flexibility that traditional debt can’t match, especially when quick growth or revenue unpredictability are the order of the day.
The real beauty of this model is the facility can scale as you grow, as lenders often lend based on your card/ subscription takings. Most lenders offering revenue-based finance will integrate directly with your payment processor, meaning they’ll be able to see how your business performs and grows. Providing the repayments have been made on time and the business maintains a good credit standing, lenders will be able to adjust facilities based on the new, higher revenue.
Compare to a term loan, this can be a really attractive option for brands as it allows the facility to scale with the business, and they’re less likely to become burdened with debt. If the funding purpose is for a short-term push like investing in ad spend for example, typically a loan might not be the best option as you could still be making repayments 4-5 years after taking out the loan. There’s also the issue that long-term debt for short-term projects tends to get “lost” in the business, which can lead to another long-term long being taken out for a short-term push, further burdening the business with debt.
Example of revenue-based financing
A brand borrows £50,000 on a 7% revenue split.
During the first month, the brand makes £60,000, meaning £4,200 goes towards reducing the balance.
In month 2, they make £100,000, meaning £7,000 goes towards repaying the facility.
If there’s a drop in month 3 and the brand only takes £40,000, the repayment reduces to £2,800.
The beauty of this type of facility is the payments are flexible, making it perfect for those brands with seasonal peaks and troughs.
Most lenders offering revenue-based financing charge a flat fee, rather than interest, making the cost stable and predictable. The downside is that there’s usually no incentive for early repayment, compared to the interest model.
What are the drawbacks of revenue-based funding?
Any financing comes with its drawbacks. While revenue-based funding doesn’t have fixed repayments, it will fluctuate based on the performance of the business. This means you have to know your margins very well, if the business takes more in revenue but the margins drop for whatever reason (say discounts), the split would still be the same as agreed in the initial term, meaning you could potentially erode your profit for that month.
It’s also less suitable for longer-term projects such as investments in infrastructure that you expect to provide a return over a longer period. A longer-term loan would be more appropriate in this case.
Finally, any financing facility taken out needs to be repaid in full, and some lenders may ask for a personal guarantee, which means you could be personally liable for the repayments should the business default. Fortunately, a lot of lenders in the space currently aren’t asking for personal guarantees.
Personal guarantees can also be insured for your peace of mind.
What are the alternatives to revenue based funding?
Invoice Financing
Also known as accounts receivable financing, invoice financing allows businesses to unlock cash tied up in unpaid invoices. Lenders typically advance up to 80% of the invoice value, though in some industries and for “strong” businesses it can be as high as 95%, often within a day or two of the invoice being raised. This can be especially handy for businesses light on physical assets, as the invoices themselves serve as collateral – no extra security usually needed. Plus, you retain control of your sales ledger and your customers remain unaware you’re using this type of finance.
Business Line of Credit
A business line of credit works much like a high-limit credit card, but with lower interest rates and fees. You can draw funds as needed up to your approved limit, paying interest only on the sum you actually use. This flexibility makes it a useful safety net for managing cash flow or seizing short-term opportunities, though lenders may require some form of collateral.
With these alternative options, businesses that don’t fit the traditional lending mould – or simply want to keep their equity intact – have more flexibility to find the right fit for their growth plans.
More about revenue-based financing
To summarise, revenue-based financing is a great option for fast-growing businesses like e-commerce and SaaS businesses. It’s great for short-term projects like investment in marketing and inventory with a fast turnaround.
However, to make the most of this funding route, you’ll need a consistent stream of revenue and a solid growth strategy in place. If you’re looking to avoid diluting your ownership or are wary of high interest charges tied to traditional business loans, revenue-based financing can provide a flexible alternative. Just remember, success with this approach relies on having steady income flows and a clear plan for scaling your business.
Our range of financial products include business loans, invoice finance, revenue based finance and much more. Fill out our application form or leave your details and one of our experienced team will be in touch to discuss your funding needs.