Revenue-based financing for startups: How it works

Funding for start-ups is in a cautious period.

According to data from Crunchbase, Q1 of 2024 saw global startup investment slump to its second worst quarter since 2018.

With venture capital holding back for the majority, and traditional bank finance remaining unattractive to many due to its strict lending criteria and fixed payments, alternative financing options are needed.

In this blog we explain how revenue-based finance can be the perfect finance option for ambitious startups.

What is Revenue-Based Financing?

Revenue-based finance is an agreement in which a finance company agrees to provide finance to a startup in exchange for a percentage of future revenue.

For example, a startup could secure $50,000 in funding, with an agreed return of $60,000 with payments totaling 10% of monthly revenue.

Compared to traditional funding methods, revenue-based finance carries certain advantages.

The main benefit being that payments fluctuate in line with revenue rather than being fixed.

Compared to other options, like equity finance, revenue-based finance is a non-dilutive finance method.

This means you don’t have to sacrifice equity in your company in return for the investment - you retain full control and make repayments as cash every month.

Plus, because the application process is much easier than traditional bank finance, revenue finance can be ideal for growth-focused businesses in need of fast funding.

How Revenue-Based Financing Actually Works

At its core, revenue-based finance is an alternative finance type for growth and early-stage startups to secure funding without sacrificing equity, or tying themselves into fixed monthly payments.

No fixed interest and fees and investors get a share of revenue

A highlight for many startups considering using revenue-based finance, is that the monthly payment amounts are linked to revenue.

If your revenue grows, your monthly payments rise. If your revenue shrinks, your monthly payments go down.

With this flexibility built in, it means startups don’t have to put short-term pressure on their balance sheets in order to get the funding they need.

Does Revenue-Based Financing for Startups work?

Business owners and finance companies are typically chasing the same goal of steady revenue growth as a result of any investment.

If revenue grows as planned, both benefit.

When examining whether a startup qualifies for revenue-based finance, investors will typically look at:

• Consistent revenue
• Strong customer base
• Potential for growth
• Market position

Unfortunately, startups in a pre-revenue phase won’t be eligible for revenue-based finance, as investors need to see a history of steady revenue.

But that doesn’t mean startups need years of financial history to be eligible.

If you have solid monthly revenue over a period of 12 months, or strong customer demand for your product or service, you could still be eligible for revenue-based finance.

"At Or & Zon, we used revenue-based financing (RBF) to tackle some key areas of business development. A big chunk of the funding went toward expanding our inventory, which was crucial for us. Our business thrives on offering a wide variety of handcrafted luxury goods, and growing our assortment was the only way to meet rising customer demand. For example, we added intricate Bidri metalwork from India and beautifully woven Okawa furniture from Japan—both incredible pieces that reflect the craftsmanship we’re proud to showcase."

- Guillaume Drew, Founder & CEO at OrZon.com

What the Application Process Looks Like

Unlike traditional bank finance, the application process for revenue-based finance is relatively straightforward.

The borrower and investor are essentially agreeing on three things:

1. Borrowing amount

2. Return

3. % of revenue for payments

However, the investor will need some basic information about your business and its finances.

This is likely to include:

Revenue history: You’ll need to provide proof of consistent revenue over a period of time. Your finance company may want to see your online accounts as proof that you’re generating revenue.

Growth metrics: You’ll need to satisfy a finance company that your revenue projections are realistic and based on historical revenue/sales data. Your projections will be used to assess the risk of any investment before an offer is made.

Putting Your Funds to Use

Once your application has been approved, your startup can receive its new funds within 24 hours.

At this point you might be thinking about how you can put that finance to work.

Every business is different, but we tend to see companies using this type of finance in a few ways.

Top Ways Startups Use Revenue-Based Finance

• Marketing: Fund marketing and promotional campaigns to attract more customers.
• Inventory Management: Build up stock to manage levels and meet current and future demand.
• Seasonal Campaigns: Prepare for seasonal demand by ensuring adequate stock and marketing efforts.
• Step Up Production: Ramp up production as your business grows.
• Test Markets & Products: Test the viability of new products or services in different markets before committing fully.
• Improve Operations: Upgrade equipment and processes to streamline operations, enhance efficiency, and reduce costs.

"One of the key areas where we leveraged RBF was in technology. We were one of the pioneers in implementing 'Virtual Try On' technology for eyeglasses, to enhance our customer's shopping experience. RBF allowed us to fund the associated costs and drive this innovation forward. It was also instrumental in securing two patents for a system and method for accurately superimposing images."

- Mark Agnew, Founder & CEO at Eyeglasses.com

"As the owner of The Trade Table, a business specializing in home products, I've effectively utilized revenue-based financing to scale my operations. Not too long ago, we found ourselves facing an increased demand, however, our existing capital couldn't fully support the expansion of our inventory. To address this, we secured revenue-based financing, which allowed us to increase our product range, maintain our high-quality standards, and continuously meet our customer needs."

- Forrest Webber, Owner at TheTableTrade.com

Repaying the Funding: How Does It Work for Startups?

The flexible payments built into revenue-based finance mean you pay a set percentage of your revenue each month until you’ve repaid the full amount.

This is compared to bank finance, which requires a fixed interest payment each month, regardless of how much you make.

For startups, revenue-based finance can be more beneficial because what you pay each month fluctuates with your revenue.

Here’s an example of how a 10% repayment rate might look over six months for a startup:

• Month 1: With $200,000 in revenue, the repayment would be $20,000.
• Month 2: Revenue increases to $230,000, and the repayment rises to $23,000.
• Month 3: Revenue jumps to $290,000, so the repayment adjusts to $29,000.
• Month 4: A dip in revenue to $260,000 reduces the repayment to $26,000.
• Month 5: Revenue spikes to $370,000, increasing the repayment to $37,000.
• Month 6: With revenue climbing to $400,000, the repayment reaches $40,000.

As you can see in the above example, your monthly repayments increase in the months your revenue goes up. But in the month revenue dips, your payments drop accordingly.

Pros and Cons: Is Revenue-Based Financing a Good Move for Your Startup?

RBF offers startups a flexible, non-dilutive funding option with payments tied to revenue, fast access to capital, and the freedom to use funds as needed.

However, it’s typically best suited for growth-stage companies with a steady revenue history, as it can be more expensive and limited compared to other funding options.

Pros of revenue-based finance for startups

Flexible payments

Payments are linked to revenue so rise and fall in line with revenue performance.

No equity dilution

Unlike equity funding you retain full control over your business.

No personal guarantees

Unlike traditional bank finance you don’t need to put down personal guarantees or collateral to secure your finance.

Fast access to finance

You could receive finance within 24 hours of your application being approved.

No fixed interest payments

Because payments are flexible you don’t have to worry about dealing with fixed payments in quieter periods.

Use the funds how you want to

Unlike some VC and equity finance, you have the freedom to use your finance however you see fit within your business.

Shared alignment of growth

You and your investor both benefit if your revenue rises as a result of your finance, so you’re more likely to be aligned on your success goals.

"At itutor.com, we leveraged revenue-based financing to accelerate our expansion plans without sacrificing ownership stakes. Specifically, we directed the funds toward scaling our marketing efforts and investing in advanced educational technology. By amplifying our marketing campaigns, we were able to reach a broader audience, which in turn increased our revenue and allowed us to repay the financing more efficiently."

- Dennis Shirshikov, Adjunct Finance Professor at City University of New York

Cons of Revenue-Based Finance

Not available pre-revenue

Because you need to demonstrate revenue history to secure revenue-based finance you can’t access this type of funding until you have a track record of at least 12 months.

Can be costly

Because your final payment amount is based on a multiple of the finance you apply for (for example 3:1) it can be more expensive than other funding sources in the long-term.

Funding limits can be lower

Revenue-based finance is typically based on a multiple of your monthly revenue (for example 1.5 times revenue). This can mean the amount of finance you obtain could be lower than what you could obtain through equity finance.

Typically reserved for growth companies

Because investors have their cash paid back quicker if your revenue grows, it can mean you’ll struggle to get revenue-based financing without a track record of sustainable revenue or strong growth potential.

Cash repayments

Although repayments fluctuate in line with your revenue, you do repay revenue-based finance back as a monthly payment. So you’ll need to think about how this will impact your cashflow if you go through an extended quiet period.

Is Revenue-Based Financing Right for Your Startup?

If you’re a growth-focused startup with an early track record of revenue and strong potential, then revenue-based finance could be exactly what you need to take your business to the next level.

By avoiding the equity dilution and loss of control of VC funding, as well as removing the pressures of fixed payments from bank finance, you can have a flexible form of finance.

And one that can get you the money you need to grow quickly.

With payments linked to your monthly revenue, you don’t need to think as much about balance sheet pressures while investing in inventory or marketing.

You can confidently test new markets for viability for fully investing.

And you can partner long-term with a finance company aligned with your growth goals.

Find out more about revenue-based finance for startups in our essential guide to revenue-based finance.