- Alicia Heeger
- The basis
- 15 Mar 2023
- Edited 22 Jul 2022
- 3 min
- Managing and growing
Instead of taking out a loan in exchange for interest or shares, you can also borrow funds in exchange for a portion of your future revenue. Known as revenue-based financing, this option is a new addition to traditional debt and share financing, which is gaining in popularity.
Revenue-based financing is, first and foremost, a good alternative to venture capital, while also providing solutions to several other financing issues, such as working capital. As the name suggests, it involves borrowing money based on your revenue. What does this form of borrowing involve, and could this be of interest to your business?
Borrowing without personal guarantees
Revenue-based financing is a loan that is initially provided by investors as growth financing. However, it can also be part of acquisition financing (in Dutch) for goodwill (in Dutch), or working capital to buy your business stock.
This type of loan is characterised by a limited collateral with no personal guarantees, and no administrative fees, fines, or penalties. You will repay the loan from a percentage of your monthly revenue until you achieve a maximum repayment limit – this is typically 1.5 to 2.5 the principal sum. You will borrow the financing amount from an entity or individual with ties to investors.
Lending amount and repayment amount
What about amounts? How much can you borrow, and how much are you supposed to repay? You should operate on the assumption of a loan of approximately four times your monthly revenue, and you will repay the loan in monthly instalments over a 5-year period. Depending on your revenue, the repayment rate is between 3 and 8%. The repayments are variable and change in tandem with your business’s revenue. The faster your revenue grows, the sooner you will repay the loan.
Calculation example: Suppose you borrow €100,000 and that your revenue is €50,000 per month, and you have agreed with your financier(s) to repay 8% of your monthly revenue. In this case, you will pay a total of €4,000 that month. If your revenue increases to €80,000 per month, you will pay €6,400 that month. This will then continue until you have repaid the agreed amount.
Revenue-based financing is less expensive than having investors acquire shares in your business, as well as being more efficient and more flexible for your business (within one month to 6 weeks).
You can take out several revenue-based loans in succession.
You will not need to relinquish control.
Your shares will retain their value.
Rapid growth means you can repay the loan quickly, which means your business will increase in size.
Interest charges are tax-deductible.
Revenue-based financing is more expensive than taking out a loan from a bank, as you do not offer the same guarantees and security.
Less suitable for market strategies based on rapid growth and businesses at the early start-up stages.
If your growth falls below target, it will cost you a lot to repay the borrowed funds.
Prospect of revenue
Erwin van der Veen, a partner at Capital Mills, sets the following conditions for revenue-based financing: “Your business must generate revenue, or at least have the prospect of generating revenue at some point. Note that you must at least be able to repay the loan and that you can borrow a maximum of 40 to 50% of your annual revenue. You should also make sure you have a solid plan in place which shows how you intend to use the revenue-based financing.” Van der Veen highlights that revenue-based financing is designed to drive growth or to maintain cash flow during seasonal fluctuations – and not, for example, to pay off other loans. “If you meet these conditions, you have a good chance of securing revenue-based financing.”
Growing costs money
You can also use revenue-based financing to cover working capital: money you spend on buying goods or on online marketing campaigns. In the words of Lotte Vink of LabFresh, a company selling ‘life-proof’ menswear online: “As a young start-up, cash flow may be one of your biggest challenges. Growing costs money, and when you sell physical products you are usually tied to large stocks. Borrowing money from a bank is often not an option, because they want to see a solid financial record going back at least three years. However, we were not even around three years ago!”
Revenue-based financing bridges the gap in your cash flow. “At times when you need extra funding, you can borrow money which you then repay based on your revenue. If you earn less, your repayments will also be lower, and if you earn more, you will be able to repay the loan sooner.” Vink states that this form of financing is slightly more expensive than the traditional way, but a lot more flexible: “There are currently several providers operating in the market. We have had positive experiences with Wayflyer: they helped us through the seasonal peak twice, during which we had to buy extra stock.”