Revenue-based finance: the essentials
2 Jul
,
2024
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Revenue-based finance (RBF) is a financing method that allows businesses to raise capital by selling a percentage of their future revenue to investors. Unlike traditional loans, which require fixed monthly payments, instead payments fluctuate based on the business’ actual revenue performance. This flexible model appeals to businesses with variable income streams, such as eCommerce and SaaS companies, as it aligns payment commitments with their cashflow. In recent years, revenue-based finance has gained popularity as an alternative to more rigid financing options like bank loans and venture capital.
This method offers a possible solution for businesses seeking growth capital without the pressure of fixed payments or the dilution of ownership that comes with equity financing. This article will outline key information and help you make informed decisions on how best to leverage this funding model to support your growth and operations.
What is revenue-based finance?
Revenue-based financing – also known as merchant cash advance – is an agreement that allows a business to raise capital by selling the future receipts to the RBF provider as percentage of their future revenue.
How does a revenue-based finance agreement work?
In a revenue-based finance agreement, a business sells a portion of its future receipts (future revenue) to a revenue-based finance provider in return for daily, weekly, or monthly payments that are directly based on the business' revenue. This means there are no fixed payment figures and payment instalments fluctuate alongside business’s revenue performance.
Payments typically continue until a pre-agreed sum is paid in full. This figure is often calculated as a multiple of the initial investment – for example, 1.5 to 3x the investment.
Why is revenue-based finance popular?
Revenue-based finance is popular because payments are proportional to the success of the business (the revenue-based finance client).
For example:
eCommerce Ltd. lacks the liquid capital to fund its accounts payable and growth, so it’s decided to raise funds by accessing revenue-based financing.
Investor Co. buys $100,000 (USD) of future receipts from e-Commerce Ltd. for an agreed return of three times the purchase price ($300,000). The payment is collected monthly and the payment rate is 5% of eCommerce Ltd.'s revenue – until the purchase price is paid in full. As per a standard revenue-based finance agreement, these monthly payments are based on the business' performance (i.e. revenue).
For example the first three months of the agreement look like the following:
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eCommerce Ltd. continues to pay Investor Co. at an average monthly payment of $5,000 (with the exact figure fluctuating each month) and pays the agreed figure of $300,000 after 60 months. Once this final payment is made, the purchase price for the future receipts is paid and there are no further long-term payment fees.
How does revenue-based finance work?
Revenue-based finance (RBF) allows businesses to improve cashflow by receiving cash up front. For this reason, it is a popular form of eCommerce finance.
Compared with traditional financing services – such as bank loans – it is a relatively simple financial transaction and offers access to immediate funds once documents are signed. Revenue-based finance agreements typically only require the investor to review the financial history of the business for approval.
The investor and borrowing business simply need to agree on:
- The investment amount
- The payment amount
- The fee or discount fee
The payment plan is simple, with the business pledging a percentage of its revenue each day, week or month until the agreed payment amount is met.
How to manage your payments
It's important to maintain accurate revenue forecasting and allocate a portion of income for payments. This requires a disciplined approach to financial management, ensuring the business's growth trajectory and payment capacity are balanced. Challenges in payment management can arise from unexpected revenue dips or overestimating growth projections.
To mitigate these risks, develop a contingency plan, regularly review financial performance, and be prepared to adjust business strategies to maintain steady revenue growth and meet payment obligations.
How to develop a contingency plan
The purpose of the contingency plan is to ensure your business remains financially stable and can meet its payment obligations, even when unexpected challenges arise. This plan outlines the strategies and actions your business needs to take to manage revenue fluctuations and maintain payment capacity.
Risk assessment
To develop an effective contingency plan, start by identifying potential risks to revenue, such as market fluctuations, seasonal variations, and economic downturns. Assess the impact of these risks on your company’s revenue and payment capacity to prioritise which risks to address first.
Revenue monitoring and forecasting
Implement a system for regular revenue tracking and forecasting to stay ahead of potential financial issues. Set key performance indicators (KPIs) for monitoring your financial health, ensuring that you can quickly identify and respond to revenue changes.
Financial allocation strategy
Allocate a fixed percentage of your revenue for payments to ensure consistent progress in meeting your obligations. Additionally, establish a reserve fund to cover unexpected revenue shortfalls, providing a safety net for unforeseen financial challenges.
Action plan for drops in revenue
Identify immediate actions to take if revenue dips below a certain threshold, such as reducing discretionary spending or renegotiating payment terms with suppliers. Outline steps to increase revenue quickly, like launching marketing campaigns or sales promotions, to recover from shortfalls promptly.
Regular financial reviews
Schedule regular reviews of your financial performance on a monthly or quarterly basis. Compare actual performance against forecasts and adjust your strategies as needed to stay on track with your financial goals and payment obligations.
Business strategy adjustments
Develop a flexible business strategy that can be adjusted in response to financial performance. Identify potential areas for cost reduction or revenue enhancement to maintain stability and support growth, even in challenging times.
Communication plan
Define a communication strategy for informing stakeholders about financial performance and any necessary changes to payment plans. Ensure transparency about the company’s financial status to maintain trust and support.
Review and update the contingency plan
Regularly review and update the contingency plan to reflect changes in the business environment and financial performance. This ensures the plan remains relevant and effective, adapting to new challenges as they occur.
Documentation and record keeping
Maintain detailed records of all financial transactions, forecasts, and actions taken under the contingency plan. Ensure this documentation is readily accessible for review and audit purposes to support accountability and informed decision-making.
Contact information
List key contacts involved in managing the contingency plan, such your accountant, and business advisor. This ensures that everyone involved knows who to contact for guidance and support in enforcing the plan.
Which types of businesses benefit from revenue-based finance?
Revenue-based finance is one of the most popular forms of eCommerce finance, providing growth capital to invest in areas such as inventory, marketing and/or payroll. Many businesses turn to RBF for eCommerce working capital, as performance-based payments are attractive to new businesses and those with seasonal demand. However, these agreements can benefit a range of businesses - especially eCommerce and SaaS entrepreneurs needing an immediate cashflow boost.
Businesses working with delayed payment terms often need additional cashflow to cover their expenses - for example, to manufacturers and logistics partners - in the interim payment period. Similarly, startups or those without predictable performance indicators may benefit from revenue-based finance. This is because there are no fixed payment figures, meaning businesses only make payments based on their actual performance, not targets or projections. However, new businesses may struggle to qualify, with lenders typically reviewing financial history in the application process.
For those considering applying, it’s important to understand the pros and cons of the service.
Advantages of revenue-based finance
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Several advantages of revenue-based finance make it preferable for some when compared to invoice finance.
Performance-based
Weekly or monthly payments are directly proportional to the business' revenue, meaning payments are reflective of what the business can afford.
No fixed payments
The performance revenue-based model means payments schedule scale up and down with the business' revenue.
Modest interest rates
Compared with alternative investment services – such as venture capital – the payment amounts are more affordable.
Zero collateral
RBF agreements are a purchase of future receipts with payments based on revenue performance. The business does not pledge any collateral or assets or provide any guarantee to back the performance.
Quick and simple application
Compared with traditional loan agreements, RBF agreements are quick to process and businesses can access capital within 24 hours of documents being signed.
Alternatives to revenue-based finance
Businesses may benefit from alternative financing options to revenue-based finance agreements. These alternatives depend on the investment amount, payment models that the business is seeking. Some common alternative options for eCommerce businesses include:
Debt financing
Debt financing is similar to revenue-based finance in that it allows businesses to access an initial capital investment. However, debt financing is more like a traditional loan in that the business is expected to repay the investment at a fixed sum each month until the debt financing is paid in full. The payment amount is is not related to the business’ performance or revenue.
Another way debt financing differs is in its collateral requirements – often requiring a personal or corporate guarantee to back up the debt obligation.
Equity financing
Similar to revenue-based finance, equity financing acts as a vehicle for businesses to access growth capital and investments. The exact payment structure differs from a merchant cash advance. In an equity financing agreement, the borrowing business agrees to hand over a share of its ownership to the equity investor. This model is therefore more complex for the business, which agrees to more than just payments – giving the equity investor a stake in decisions and more.
Invoice finance
Invoice finance is similar to RBF as it gives small and medium-sized businesses access to liquid capital to fund growth. However, the two agreements differ in their assignment models. In an invoice financing agreement, the business is effectively receiving money it is already owed in advance – submitting unpaid invoices to be paid immediately in exchange for a small fee.
What fees are associated with revenue-based finance?
The fees associated with revenue-based finance are simple – businesses sell a percentage of their future receipts in return for upfront capital from the revenue-based finance provider. As it’s a performance-based financing agreement, the exact payment amount fluctuates each month but the proportion of revenues stays the same.
Best practices for businesses considering revenue-based finance
Securing revenue-based finance can be straightforward with the right approach.
Here are some best practices to help businesses maximize its benefits:
Prepare comprehensive financial documents
Before approaching potential investors, ensure your financial records are thorough and up-to-date. This includes income statements, balance sheets, cashflow statements, and any other documents that provide a clear picture of your business’s financial health. Transparent financial documentation helps build investor confidence and expedites the approval process. At Stenn, we make the process easier by getting a cash-based P&L from Heron. So when a business links its bank account, we typically can get all the information we need from that connection.
Select the right financing partner
Research and compare different investors to find a partner that aligns with your business goals and values. Look for investors with a proven track record in your industry and a reputation for fair and flexible terms. Personal referrals and reviews can also guide you in selecting a reliable partner.
Understand the terms and conditions
Thoroughly review the terms and conditions of the agreement before signing. Pay close attention to the payment percentage, total payment cap, and any additional fees or clauses. Understanding these details ensures there are no surprises down the line and helps you assess the true cost of the financing.
Align payments with business cycles
Leverage the flexibility of revenue-based finance with your revenue performance and business cycles. If your business experiences seasonal fluctuations in revenue, instruct your investor to agree on terms that accommodate these variations. This approach helps maintain healthy cashflow throughout the year.
Monitor revenue and payments closely
Regularly track your revenue and payment amounts to ensure they remain manageable. Implement a robust financial management system to monitor these metrics and adjust your strategies as needed. This proactive approach helps you stay on top of your payment obligations and avoid any financial strain.
Communicate transparently with investors
Maintain open and transparent communication with your investors. Keep them informed about your business performance, upcoming challenges, and any significant changes that might affect your revenue. Building a strong relationship with your investors can lead to more favourable terms and potential future financing opportunities.
Plan for growth
Use the capital obtained through RBF strategically to drive business growth. Invest in areas that will generate the highest return, such as marketing, inventory, technology, or talent acquisition. A clear growth plan not only ensures the effective use of funds but also positions your business for long-term success.
By following these best practices, businesses can effectively leverage revenue-based finance to support their growth while maintaining financial stability and flexibility.
Frequently Asked Questions (FAQs)
Q) Is revenue-based financing risky?
- Revenue-based finance agreements are directly based on performance, with the business selling its future receipts to the provider and paying back a percentage of its daily/weekly or monthly revenue. This protects businesses against the risks associated with a loan with a fixed term – which can be risky during slow periods.
Q) How much funding can I get?
- The finance amount will depend on the business' revenue (historical and projected). The RBF provider will review the applicant's business bank account to determine how much they're willing to purchase and the payment terms. Businesses must remember that the greater the finance amount, the larger the performance-based payment instalments and total payment figure are likely to be.
Q) How long does it take to apply?
- Unlike traditional loans, alternative financing is quick and simple to apply for, with businesses often receiving funds within 24 hours of a successful application.
Q) Does my business need to be making a profit?
- RBF providers typically review a business' revenue history before offering RBF services. For this reason, businesses are likely to be required to be profitable, as payments are directly based on their revenue.
Q) How can I apply?
- To qualify for revenue-based financing services, businesses should go directly to a revenue-based financing company. Applications are often simple to complete and, depending on the service, businesses may have to submit financial records.
Compared with traditional bank loans, revenue-based financing services are quick and simple to apply for and funds are often paid within 24 hours of a successful application.
Boost your cashflow with revenue-based finance solutions from Stenn
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We’re a leading provider of trade finance solutions, with revenue-based finance and invoice-based finance at the core of our practice. Our experts are well-versed in supporting clients in improving cashflow and mitigating risks. We’ll accommodate your financing options with expert support tailored to your business.
Contact us today to learn how our revenue-based financing solutions can support your business growth.
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About Stenn
Since 2016, Stenn has powered over $20 billion in financed assets, supported by trusted partners, including Citi Bank, Goldman Sachs, HSBC, and Natixis. Our team of experts specializes in generating agile, tailored financing solutions that help you do business on your terms.