REVENUE-BASED FINANCING: THE NEW FINANCING MODEL FOR VCS

Until recently, start-ups and growing organizations could only raise capital through equity financing, i.e., the sale of company shares to investors. Revenue-based financing, which is becoming increasingly popular, is a non-dilutive financing method that does not require new shareholders or investors. It can also benefit business angels who have already invested in a company. Revenue-based financing, or RBF, is a more attractive model for both investors and companies. On the investor side, revenue-based financing provides them getting exposure to early-stage opportunities in startups. On the company side, revenue-based financing eliminates the need for costly debt while providing additional cash flow and upside potential. 

 How does RBF work?

So, what is revenue-based financing working methodology? The investor gets a portion of the firm’s earnings in exchange for his or her investment. The company receives a loan and, instead of stock, pays back a portion of the monthly sales over an agreed period of time. The amount of current payback is therefore flexible and depends upon the company’s sales performance. The financed firm must demonstrate healthy, expanding sales before financing. It is important that there is no interest in RBF, only a revenue share. In reality, an imputed interest can be calculated, but it is directly related to sales performance and changes a lot. As a consequence, a conventional financing rate is of limited value. Since RBF is sales-dependent, the risk borne by its entrepreneurial investors and return expectations are usually higher than those of a bank (which provides a fixed, guaranteed return), but significantly lower than those of an equity investor. The investor’s use case, financing model, and terms determine the repayment amount. 

Working methodologies of venture capital?

Many firms, particularly those requiring large amounts of capital, are able to achieve outstanding success through equity financing. The VC firm will extensively research business background and ensure that the team has sufficient resources to execute the business plan. The VC firm will also check the firm’s clean financial records. If the venture capitalist is satisfied with the team and the business plan, they will offer to fund. The firm’s funding will depend on the performance of the company. 

What are the Disadvantages of Venture Capital?

Additionally, there are major drawbacks to VC funding:  

  1. Secondly, as a result of losing significant control over the firm, existing shareholders lose a substantial amount of control due to the dilution of their stock as well as the usual special rights of new minority investors.
  2. Financing can be difficult. Due diligence and contract negotiation are laborious, making decision-making time-consuming.
  3. The founders lose some control and independence when they sell company shares. 

Non-dilutive financing, which is financing that does not require a company to sell shares, was previously only accessible to big and established businesses. Banks would lend them money. In recent years, startups have benefited from expanding financing options. Entrepreneurs and shareholders of young growth firms now have a real alternative to equity financing or a supplement to it.

How are both Revenue Based Financing and Venture Capital associated?

Unlike venture capital, revenue-based financing is solely based on revenue sharing, which makes it intriguing to businesses that aren’t on the “traditional venture capital path” or aren’t seeking an IPO. RBF can also be of use to VC-backed firms. For example, between two financing rounds, RBF can be used as a non-dilutive alternative to extend the time until the next financing round and optimize its conditions. Alternatively, it can be used in conjunction with an equity offering to maximize the amount of capital available for expansion without diluting it to the maximum.

Revenue-Based Financing as Equity Financing

Entrepreneurs may secure a revenue-based loan to avoid being involved in a bad deal. The investor does not receive company shares, but rather participates in the turnover. An entrepreneur may avoid a poor deal with revenue-based financing by capping the repayment at a certain percentage of the company’s turnover. Entrepreneurs can prevent a bad deal by setting a repayment amount that will be repaid in small bits as a result of monthly sales participation. This process prevents any excessive burden on liquidity by enabling flexible repayment. Entrepreneurs keep total control of the company while they receive full control and decision-making freedom.

Summary – If you are building a business that you believe can generate cash flow and sustain itself beyond the initial funding round, we recommend applying for velocity revenue-based financing. Velocity is India’s largest revenue-based financier. They typically fund ecommerce and D2C businesses with healthy revenue streams. They have a completely online process so the founders can get term sheets in just 30 seconds and the disbursals happen within 7 days.  

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