Revenue-based finance: the essentials

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, repayments 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 repayment 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 repayments 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 royalty-based financing - is an agreement that allows businesses to raise capital by pledging a percentage of their revenue back to the investor as regular repayments.

How does a revenue-based finance agreement work?

In a revenue-based finance agreement, an investor pledges a sum to a business in return for monthly repayments that are directly based on the business' revenue. This means there are no fixed payment figures and repayment instalments fluctuate alongside business performance, peak trading periods, and more.

Repayments 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 - 3x the investment.

Why is revenue-based finance popular?

Revenue-based finance is popular because repayments are proportional to the success of the lender’s business.

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. pledges $100,000 (USD) for an agreed return of three times the investment figure ($300,000) in monthly instalments of 5% of eCommerce Ltd.'s revenue - until the repayment figure is paid in full. As per a standard revenue-based finance agreement, these monthly repayments are based on the business' performance.

For example the first three months of the agreement look like the following:

Month one - revenue $100,000 - repayment $5,000
Month two - revenue $150,000 - repayment $7,500
Month three - revenue $50,000 - repayment $2,500

eCommerce Ltd. continues to repay Investor Co. at an average monthly repayment of $5,000 (with the exact figure fluctuating each month) and repays the agreed figure of $300,000 after 60 months. Once this final repayment is made, the debt is settled and there are no further long-term repayment fees.

How does revenue-based finance work?

Revenue-based finance (RBF) allows businesses to improve cashflow by receiving cash upfront. 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 repayment amount
The fee or discount fee

The repayment plan is simple, with the business pledging a percentage of its revenue each week or month until the agreed repayment amount is met.

How to manage your repayments

It's important to maintain accurate revenue forecasting and allocate a portion of income for repayments. This requires a disciplined approach to financial management, ensuring the business's growth trajectory and repayment capacity are balanced. Challenges in repayment 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 repayment 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 repayment obligations, even when unexpected challenges arise. This plan outlines the strategies and actions your business needs to take to manage revenue fluctuations and maintain repayment 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 repayment 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 repayments 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 repayment 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 repayment 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 repayments 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 repayment figures, meaning businesses only make repayments 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

Several advantages of revenue-based finance make it preferable for some when compared to invoice finance.

Performance-based

Weekly or monthly repayments are directly proportional to the business' revenue, meaning payments are reflective of what the business can afford.

No fixed repayments

The performance-based model means monthly repayments scale up and down with the business' revenue.

Modest interest rates

Compared with alternative investment services - such as angel investors - the repayment amounts are more affordable.

Zero collateral

RBF agreements are based on performance and therefore pre-empt that some months may be slower. For this reason, the business does not need to pledge any collateral or assets against the agreements.

Quick and simple application

Compared with traditional loan agreements, RBF agreements are quick to process and businesses can access capital within 48 hours of documents being signed.

Alternatives to revenue-based finance

Businesses may benefit from alternative financing agreements depending on the investment amount, repayment models, and whether they’d qualify for alternative loan agreements.

Some common alternative loans for eCommerce businesses include:

Debt financing

Debt financing is similar to revenue-based finance in that it allows businesses to access an initial investment sum. 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 - paid in full - that is not related to its performance or revenue.

Another way debt financing differs is in its collateral requirements - often requiring a personal guarantee against the loan.

Equity financing

Similar to revenue-based finance, equity financing acts as a vehicle for businesses to access growth capital and investments are driven by performance. The exact repayment structure differs from a royalty-based finance agreement, though.

In an equity financing agreement, the borrowing business agrees to hand over a share of its ownership to the investor. This model is therefore more complex for the business, which agrees to more than just repayments - giving the 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 loan models. In an invoice financing agreement, the business is effectively advancing money it is already owed - 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 pledge a percentage of their revenue each week or month in return for investment. As it’s a performance-based financing agreement, the exact repayment amount fluctuates each month but the proportion of revenues stays the same.

The exact details of an agreement depend on various factors, including the financial history of the business, perceived risk to the lender, and the amount of finance requested.

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 maximise 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 repayment percentage, total repayment 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 repayments with business cycles

Leverage the flexibility of a revenue-based finance agreement by aligning repayments with your 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 repayments closely

Regularly track your revenue and repayment 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 repayment 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 borrowing business paying back a percentage of its monthly revenue. This protects businesses against the risks associated with fixed monthly repayments - which can be risky during slow periods.

Q) How much funding can I get?

The finance amount will depend on the business's financial history. Investors will review the applicant's finances to determine how much they're willing to loan and the repayment terms.

Businesses must remember that the greater the finance amount, the larger the performance-based payment instalments and total repayment figure are likely to be. This is because the repayment fees are designed to reflect the risk undertaken by the lender.

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 48 hours of a successful application.

Q) Does my business need to be making a profit?

Lenders typically review a business' financial history before offering RBF services. For this reason, businesses are likely to be required to be profitable, as repayments are directly based on their revenue.

Q) How can I apply?

To qualify for alternative 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, alternative financing services are quick and simple to apply for and funds are often paid within 48 hours of a successful application.

Boost your cashflow with revenue-based finance solutions from Stenn

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.

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