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.

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.

 

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.

To learn more about revenue-based financing you can get in touch here and one of the team will be in touch to help.