If you own a small business, you know there are plenty of challenges associated with day-to-day operations. But did you ever consider that growing too fast could be a potential problem, as well?
When you experience tremendous growth, you can quickly run out of resources to keep up with increasing demands. Your next step would be to search for business funding—and that’s where revenue-based financing comes in handy.
As a rapidly growing business, you need a financial plan that adapts to you. We’re going to answer some of the top questions we get about revenue-based financing: the pros, the cons and, more importantly, what is it?
What Is Revenue-Based Financing?
Short answer: it’s a type of small business loan that fluctuates based on your monthly revenue.
Revenue-based financing, also known as royalty-based financing, allows you to pay back loans based on your company’s monthly revenue. Unlike a traditional commercial loan with a strict payment or amortization schedule, you won’t have a set installment each month; your repayment is entirely dependent on your growth rate and will increase or decrease every month.
These loans have a broad range, starting from around $50,000 up to $3 million. Instead of accruing interest, revenue-based lenders will charge a fixed amount for repayment, which is, on average, one to three times the amount borrowed. Payment amounts are agreed upon at signing, usually falling between 2-8 percent of your monthly income.
Is a Revenue-Based Loan Right for My Business?
Revenue-based loans are tailored to the success of your business. The faster your business grows, the quicker you can repay and move on. Your most substantial payments coincide with your most profitable months—which means you’ll have lower payments and, therefore, more breathing room during slower months.
These loans are best suited for businesses with high gross margins or subscription-based models that have consistent, easily forecasted revenue. The most successful of these companies are often software as a service (SaaS) businesses, due to their ability to scale quickly.
However, revenue-based financing could benefit your small business regardless of industry depending on your current situation.
Businesses Too Small for Venture Capitalists
Some small businesses are too small to gain the attention of venture capitalists—and that can work in your favor.
Revenue-based lenders usually aren’t concerned with the massive returns—up too 100x— that venture capitalists chase.
If your business has a consistent revenue stream and a sustainable model built for modest growth, a revenue-based loan could be the right fit.
Business Owners Looking to Keep Control
If your business has growth potential and has been propositioned by venture capitalists, you might still want to shy away from that type of financing option. You’ve worked hard to get your business where it’s at, and may not want to risk sacrificing your vision or grant control to another entity.
Revenue-based loans are a potential solution. These loans are repaid directly to a lender, one who does not require the release of an equity stake in your business that venture capitalists seek.
Businesses Unable to Secure Financing
If you do not qualify for other traditional working capital loans despite solidly recurring revenue, a revenue-based financing option might work for you.
Some lenders are hesitant to offer traditional funding products if a company doesn’t show a long, strong positive history of creditworthiness. If they do, interest rates can be jacked up and make monthly payments skyrocket.
Fortunately, revenue-based financing creates many advantages over other funding options if you find yourself in this situation.
What Are the Benefits of Revenue-Based Financing?
There are a lot of positive attributes of revenue-based financing. If you’re looking for a fast, flexible way to grow your business and other options aren’t available, they may be your best bet.
Qualifications Are Easy
Traditional lenders like banks require a lot up front, including high credit scores, high annual revenues and a certain amount of time in business.
Revenue-based financing is based on current monthly revenues and potential growth. As long as you’re bringing in cash now and have a solid business plan for the future, you have a chance of approval.
Repayment Is Flexible
Since the loan repayment is based on your monthly revenues, you can avoid fixed payments that might be too high at any given time. When your revenue increases, so do your payments. If you’ve had a rough month, you won’t be on the hook for more than you brought in.
Funding Is Faster
Traditional financing, such as highly sought after SBA loans and venture capital financing, can take months to hit your bank account. Revenue-based lenders can provide funding within just a few weeks, making them an excellent choice for those who need cash to fund projects with an immediate timetable.
What Are the Disadvantages of Revenue-Based Financing?
As with all small business loans, there are some drawbacks to revenue-based financing. Since they’re repaid a bit different and are targeted at businesses that may not qualify for other options, they come with some riskier terms.
Conventional business loans use interest to calculate repayment and give lenders a good return on their financing risk. This allows a borrower to potentially reduce some of those costs by paying down their principal faster.
Much like a Merchant Cash Advance that uses factor rates, revenue-based financing has a set amount that must be repaid no matter what. Given your business’s creditworthiness, this could end up being as much as three times the amount that you borrow.
Uncertain Repayment Periods
Because repayment is based upon a percentage of your revenue, you have no way of telling exactly when your loan will be paid in full. This could work out great if your business takes off and you pay it off in months. But, it can turn into a burden if it takes years to bring in enough revenue to satisfy the loan.
How Do I Get a Revenue-Based Loan?
Since it’s considered a niche market, it may be tough to find a lender for this type of financing. When you do, you need to make sure you have what it takes to qualify for a revenue-based loan.
Find the Right Lender
Banks and other traditional financiers don’t offer these types of loans, so you’ll have to search elsewhere. There are some out there, and many of them specialize or even exclusively offer revenue based loans.
Start your search online, and make sure to go over the standard terms and requirements to see if they’ll be a good match.
If you’re unsure of how to find the right financing product for you, contact one of Fast Capital 360’s business advisors to learn how to get the funding you need today.
Ace the Application
Once you’ve found a potential lender, submit an application online that includes both your business and personal information. They will ask to see your business’s financial documents (balance sheet, profit and loss statement, etc.), and might even look at your personal credit score.
The lender can connect directly to your bank accounts to verify revenue before determining a suitable loan amount and repayment terms. Be ready to provide 3-12 months of business bank statements, plus a business plan for review.
Demonstrate Growth Potential
Generally, your business must have a gross profit margin of at least 50 percent. Your business plan should include the strategy you’ll enact to grow that revenue and, therefore, pay back the loan.
Specify How You Will Use Funding
Show a lender how you plan on utilizing the loan. They need assurance that the money will be well spent in helping your business grow. Present your plan to indicate just how the loan will be used; marketing and sales are always a great indicator of growth, as well as developing or launching a new product.
Consider Lenders You Want to Work With
If you have multiple options, go with the investor that can best help you grow your business—not just the best deal. Some lenders will even act as mentors, ensuring they recoup their investment by giving you valuable insight.
If the partnership is mutually beneficial, the repayment process will be smooth and can set you up for an ongoing relationship with the lender.
Don’t Cut Off Your Cash Flow
Do the math. If you can’t afford repayments, revenue-based financing isn’t for you. Make sure your sales and revenue flow is sufficient enough to sustain your business during your repayment period.
What Are My Next Steps?
By now, you should have all the information you need to begin to determine whether revenue-based financing works for your small business.
If you’re achieving consistent revenue and have plenty of room for growth, they could be the perfect fit for you.
If you’re unsure where your business is headed, or the terms just don’t fit what you’re comfortable with, take a step back and consider your other options.
If you need help, consult an expert. See all of your business loan options in minutes when you apply for a business loan through FastCapital360.