What Exactly is Revenue-Based Financing?

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If you’re seeking financing for your business, revenue-based financing, or RBF, can be a great option for businesses with less-than-perfect credit or lack of collateral that other forms of financing require. While every form of financing has its drawbacks, this type of financing offers a unique way for businesses to secure capital without the demanding requirements of traditional loans. In this guide, we’ll help you understand exactly what revenue-based financing is, if it’s the right fit for your business, and much more.


What is it Exactly?

Revenue-based financing is a unique form of financing that uses your business’ revenue as collateral for your financing. This means that instead of needing physical assets to be approved for financing, you can still get approved by using your business’s revenue. Also known as royalty-based financing, this type of financing can be advantageous for businesses that need capital but don’t meet all of the requirements for traditional financing methods. 

For example, if your business has a less-than-stellar credit score, you might still qualify for revenue-based financing, whereas with a traditional loan, you might not be approved.


How Revenue-Based Financing Works

To get a better idea of how this type of financing works, let’s consider this example.

If you operate a retail business that needs capital to expand to a new location, revenue-based financing could be a viable solution. In this example, we’ll assume your store averages $100,000 in monthly revenue and you need $80,000 to open your new location. With revenue-based financing, you could often get approved for up to $120,000 in financing. Then, a factor rate is applied to the financing amount. This will vary from lender to lender and will ultimately be determined by your business’s creditworthiness and credibility. In this example, we can assume a factor rate of 1.25x. This means that the cost of your financing would amount to $100,000 ($80,000 x 1.25). Financing companies may also charge administrative fees, so it’s important to analyze the total cost of your financing before making any decisions. Finally, you will agree to pay back a certain percentage of your card sales. For example, the financing company may require that you pay 10% of your weekly card sales towards your financing.

For this example, we’ll assume 10% of your weekly revenue is paid towards your financing. This means that if your business’s revenue amounts to $50,000 in one month, you would pay $5,000 to the financing company. You will continue to make payments until the financing is paid in full. 

The cost of revenue-based financing will depend on the company you work with and your business’s credibility. For businesses that have strong, stable revenue with a reasonable credit rating, you might find that revenue-based financing can be more affordable than other types of financing. However, if your business lacks a strong history and has less-than-stellar credit, it can be quite costly.


Revenue-Based Financing vs Merchant Cash Advance?

You might be wondering about the difference between revenue-based financing and a merchant cash advance. While there is significant overlap between the two, there are some minute details that distinguish each of them.

Firstly, a merchant cash advance utilizes your business’s card sales instead of overall revenue to get approved. This means that you cannot use cash sales or other types of income to get approved. Only your card sales can be used to satisfy revenue requirements set by the lender.

In simplest terms, a merchant cash advance is a type of revenue-based financing, but not all revenue-based financing is a merchant cash advance.


Pros of Revenue-Based Financing

Revenue-based financing can be advantageous for a few reasons.

First, the more lenient and flexible terms of your financing can allow businesses that may not otherwise be considered to secure financing, to be approved. Because there is less of a focus on your business or personal credit score and more of a focus on your revenue, you may be able to overcome some of these setbacks with strong revenue to secure the capital you need.

Another benefit is the flexible payment options. Because your payment will depend on your business’s revenue, there is a lesser chance of being “underwater” on your debt. Because of this, there is also no set payback period for your financing. In some cases, it may take a few months to repay your financing, while others may require a year or more to fulfill the repayment amount.

Some financing companies like Specialty Capital even offer prepayment discounts that can lower the overall cost of your financing. If you’re able to repay the original amount of your financing quicker than the terms of your agreement, you could save a substantial amount and preserve your future cash flow.

In addition to prepayment discounts, Specialty Capital also offers a multi-draw advance product that allows you to use your business’s future revenue to secure a revolving amount of financing for a set period of time. This allows you to maintain an open amount of capital that’s perfect for businesses that have large fluctuations in income and expenses.

Finally, revenue-based financing does not disrupt your business’s capitalization table. Financing companies do not take any equity in your business, so you keep complete control of your company. There’s no need or reason to raise capital by taking advantage of revenue-based financing, which is a decisive benefit to most entrepreneurs.


Cons of Revenue-Based Financing

The obvious drawback to revenue-based financing is the cost. Because it’s not a loan, there is no direct interest rate associated with revenue-based financing, but you can determine your APY by using a simple calculator. Instead, a factor rate is applied to the amount of your financing that can vary depending on a multitude of factors. In most cases, this factor rate will be between 1.2x and 1.4x – depending on the stability of your business and the lender you work with.

In some cases, your interest rate can exceed 20% annually – but this will ultimately depend on your business’s circumstances and the lender you work with.

Another con of this type of financing is that you must have a history of sales in order to be approved. In many cases, if you’re a startup or lack significant revenue, you won’t be approved for this type of financing. There are some unique cases where you can secure revenue-based financing for startups, but it’s much more difficult if your business is in the pre-revenue stage.

Finally, revenue-based financing can intensify short-term cash flow problems that can cause a cycle of debt for your business. This is not limited to revenue-based financing specifically, as this can be a serious problem for any type of small business financing.  


Is Revenue-Based Financing Right for Your Business?

If you have gross revenues exceeding $200,000 – revenue-based financing could be a great option worth exploring. While the costs can sometimes be substantial, the more lenient approval process can be critical to getting the capital your business needs.

When compared to a traditional business loan, revenue-based financing can be more cash-flow friendly because your weekly or monthly payment is determined by your actual revenue instead of a lump sum amount. This means that if you have a month with lower revenue, your business won’t be strapped to make payroll because of your financing agreement.

Another huge advantage is the lack of collateral required. Whereas most forms of financing will require some sort of collateral to back your financing, revenue-based financing does not – offering greater flexibility for businesses.

That said, the interest costs of this type of financing can be excessive. Because no collateral is required, financiers are forced to use your business’s monthly revenue as a form of collateral, which can cause the total cost to be higher than some other forms of financing. 

Overall, revenue-based financing is a tremendous option if you want to raise funding without giving up any ownership and control of your business. As with any form of financing, you’ll need to weigh the pros and cons to see if it makes sense for your business to reach your goals.

That said, if you have an established business with stable revenue, reach out to Specialty Capital today to explore all of your options so you can secure the capital you need to grow your business. We understand that every company is unique, which is why we take a hands-on, tailored approach to financing to help you get the best rates and terms available.


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