Income-Based Financing: Compare the Best Options

If your business has significant, recurring revenues, revenue-based financing can provide growth capital without sacrificing capital. Find out if it’s right for your business.

What is revenue-based financing?

Income-based financing, also known as revenue-based investment or revenue-sharing financing, is a form of financing that enables small businesses to obtain financing and pay it back out of future earnings. Payments are based on a weekly or monthly revenue percentage until the financing is paid off along with a fee, which is typically between 3 and 7 times your initial investment.

How revenue-based financing works

Income-based financing or income-based investing typically describes a system where investors provide financing to companies with high current income. Often times, the companies that provide these loans specialize in certain types of fast-growing industries, such as Software as a Service – that is, saas companies. This can be an alternative to traditional venture capital structures or angels that require the company to give up some of its capital in return for financing.

Unlike a traditional small business loan that requires constant monthly payments (or sometimes weekly payments), revenue-based financing offers more flexible repayment terms. Investors or the company providing the financing or financing will receive a paid percentage of future revenues until the agreed aggregate payment has been reached. As revenues are lower, payments will be lower, and as revenues are higher, payments will increase.

There will be a repayment limit that will determine your total financing cost. This can be as low as 1.35% of the original investment amount or even 10%, although there is no legal limit that limits how much these companies can charge.

Pros and cons of revenue-based financing

Pros:

  • More flexible acceptance criteria than loans
  • The owner can avoid a personal guarantee
  • Payments change with income
  • No capital dilution
  • Fast financing

Cons:

  • The cost of capital is higher than that of traditional commercial loans
  • Requires significant recurring revenue
  • Not available for all industries

Income-based financing is typically more flexible than standard small business loans that require at least several years of operation, good credit performance, and high revenues. The trader can also avoid a personal guarantee.

This type of financing does not require a small business to forego equity, but is likely more expensive than a traditional small business loan such as a commercial bank loan or even an SBA guaranteed loan.

Income-based financing versus debt and equity financing

Debt financing is another term that describes a business loan. With this type of financing, entrepreneurs borrow money and pay it back over time with interest, usually by making monthly payments. The cost of financing can be described in terms of interest rate, fee, or other terminology. (In most cases, small business lenders are not required to disclose an Annual Interest Rate (APR).

Some small business loans have very low interest rates. Traditional bank loans and SBA loans guaranteed by the Small Business Administration often have the lowest interest rates, although microloans and some online loans are also relatively inexpensive.

The advantage of a small business loan over an RBF is usually the cost. Borrowers who qualify for a low interest small business loan will likely find this option cheaper than revenue-based financing.

On the other hand, small business loans require regular repayments, which can be difficult to make, especially if you are a new and expanding business or experiencing fluctuating income.

Equity financing enables companies to obtain financing from investors, whether they are private equity investors, business angels or venture capitalists. There is even a type of crowdfunding that allows companies to raise money from a large number of investors.

The advantage of equity investments is that they can be structured without fees. Investors pay out money in the event of a liquidation (such as a stock market or takeover). However, the advantage of RBF over this type of financing is that it does not require giving up equity in business. The company does not give up control over the company

Revenue-Based Financing Rates and Conditions

Income-based financing can be organized in different ways, but the characteristic feature is that payments will be tied to gross revenues. When income goes down, so does payments. Higher revenues allow the company to pay off the financing faster, but it is unlikely to reduce the total amount owed.

Here is an example of how this funding is structured:

Lighter capital, the leader in this type of financing, provides loans of up to $ 3 million to technology companies with a monthly recurring income (MRR) of at least $ 15,000 in the past three months and at least five customers receiving products or services. Borrowers may qualify for a loan of up to 33% of the annual interest rate on earnings. (To illustrate, an example from their website says that a company that is on track to sell $ 1 million this year could get a loan of around $ 330,000.) Payments are based on a fixed income percentage of 2% to 8% but not more than 10%.

How to qualify for revenue-based financing

True income-based financing has very specific requirements. The first and foremost requirement for this type of financing is that the business has sufficient recurring revenues. As mentioned earlier, with this type of financing, it is typical for firms (or investors) to look for firms in specific industries, such as tech firms with a history of generating recurring revenue and high growth potential.

As part of the application process, the company must be able to confirm the source of revenue and may also have to document how it will use the new funds to grow the business. A minimum recurring income requirement of at least $ 10,000 – $ 20,000 or more per month would not be unusual. Annual income requirements may also apply.

How to get revenue-based financing

Ideally, when you’re looking for a small business, shop around for financing options that best suit your business needs and for which you qualify. Since RBF is available through specialized financing companies, you may have very limited options. You can find potential investors from the investor community and maybe from an industry association or network with other entrepreneurs in your industry.

If you don’t fit into the fairly narrow criteria for RBF, you can look at other types of revenue-based financing. Businesses with a solid monthly income may qualify for a merchant or business cash advance, for example. Both of these products offer advances against future income and will rely heavily on recent income (often in the last 6-12 months) when making insurance decisions. MCA and BCA are widely available to many types of businesses as long as they have sufficient revenues. Creditworthiness requirements are usually very low.

Another type of financing that looks at revenues is receivable financing or invoice financing (or factoring). With this type of financing, the company pledges sales revenue that has already taken place but has not yet been paid for.

It can be confusing to understand what type of financing is right for your business. One option is to work with a small business financing market that can match your business with financing based on your qualifications.

This article was originally written on December 17, 2021.

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