financialtreat – will explain about the Pros and Cons of Revenue-Based Financing that you will get in the following article. let’s see this article carefully!
Revenue-based financing is a tedious, time-consuming and laborious process. With the complexity of loan applications and the trade-offs of equity financing, it is not surprising that more and more companies are turning to undilutive funding options, such as income-based financing.
With the growth of the global revenue-based financing market at an estimated CAGR of 61.8% (2020-2027), it is time for executives to understand well this revenue-based financing method for better strategic planning and informed decision-making. To know this, it would be nice, you know the pros and cons behind revenue-based financing below.
What is revenue-based financing?
Before knowing revenue-based financing, let’s first get to know the following definition. Revenue-based financing is a loan on which a business agrees to repay over time by promising a portion of its future income to the financier until a fixed dollar amount is reached.
- Fixed repayment targets: Income-based financing is a loan with a fixed repayment target achieved over several years.
- Flexible repayment period: With income-based funding,
- flexible repayment period; pay back the agreed amount sooner if you can or later if you must.
- No loss of equity: With income-based funding, business owners don’t sell equity or relinquish control.
- More hands-off approaches than private equity: Income-based finance firms work closer to you than bank lenders, but take a more hands-off approach than private equity investors.
- Not all finance companies handle income-based financing in the same way.
“Everyone does it a little differently, but the way we use income-based financing is to provide some money… which companies approve to pay [back as] a percentage of their revenue until they pay a certain amount, said BJ Lackland, co-founder and chief investment officer of the IBI Spikes Fund.
Target dollars can still help when a small business outlines operations in its business plan. However, it is important to know that payments will come out of your business’s revenue stream and plan accordingly.
Why do you need revenue-based financing?
If you are looking for growth capital and/or maintaining liquidity for your company, income-based financing is an option to consider. Below are some of the use cases of income-based financing:
- Your company grows quickly, so it needs more money for revenue-related expenses, such as ad spend and inventory;
- Your company has sufficient cash flow to meet working capital needs and plans to expand. However, metrics are unprofitable for raising capital from investors, and you don’t want to cash out your equity;
- Your company receives large orders but lacks capital to complete the fulfillment, or you want to maintain abundant capital for optimal liquidity;
Your company has increased the initial round of investment. It is reserved as a cornerstone to meet your company’s working capital needs until the next round. However, you need additional capital for growth.
When do companies look for revenue-based financing options?
Income-based financing appeals to
- Growth stage companies want to hire additional salespeople.
- The company is at the peak of a large-scale marketing campaign.
- A company with an established market but not large enough for VCs.
- Owners who do not want to personally guarantee loans or sell equity.
Debt financing: While debt financing allows owners to remain in full control of their business, sometimes they have to provide personal assets as collateral – and even then, usually for a relatively small amount.
Private equity financing: With private equity financing, founders often refuse to lose full control of their companies. However, in exchange, they get the resources, network, and experience of their financing partners.
Income-based financing is a middle ground between these two options. While investors are unlikely to sit on the board or intervene in operations, they maintain a stake in the company’s success and growth in a way that banks don’t.
They make money at 10x returns; They continued to look for home runs. We were in the middle; we like to call ourselves ‘VC lite.’ We were there to help and talk, but we didn’t ignore you.”
Pros and cons of revenue-based financing
Like other funding options, income-based financing has advantages and disadvantages to consider.
It is cheaper than the alternative. Income-based financing is cheaper than alternatives involving equity. Other funding methods, such as angel investors and venture capitalists, require 10 to 20 times more returns.
Plus, those who provide income-based financing are invested in your success as the number of monthly payments they receive increases along with your company’s success.
You can maintain control. With income-based financing, you will retain ownership and control of your company and retain your equity. Investors will not gain power through board seats, etc., so you determine the direction of your business.
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Flexible monthly payments. Since monthly payments are based on income, slow months won’t hinder your ability to pay. Your costs are related to your income and, with good planning, should remain affordable.
You don’t have to guarantee the loan personally. Financing options such as bank loans require you to guarantee a loan, putting your personal assets in danger. Income-based financing doesn’t require that commitment.
You will raise funds faster. With income-based financing, you don’t have to do multiple promotions to get the money you need. Most lenders will make a decision and offer financing within a month.
You have to generate income. A business must earn money to use this financing option, so it is not suitable for beginners without a regular income stream. Less money is available compared to other financing options.
Some funding options, such as VCs, are known to invest heavily in businesses. Income-based financing provides approximately three to four months of the business’ monthly recurring income. Monthly payment is required. No matter what, you have to make monthly payments. Businesses that lack money should consider this factor.
This sector lacks regulation. Since there is little oversight of income-based financing, you should do careful research before entering into any agreements, to avoid predatory lending. Well, that was a little bit of exposure about Pros and cons of revenue-based financing.
Hopefully it will be useful, especially for those of you who want to do revenue-based financing. Looking at the pros and cons of revenue-based financing will help you to use revenue-based financing easily.