Eps 1519: Why revenue based financing is taking over the world

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Levi Franklin

Levi Franklin

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Revenue-based funding, also known as royalty-based funding, is a method of raising capital where investors agree to supply capital to the business in return for a percentage of the ongoing gross revenues of the business. Revenue-based financing refers to the practice of raising capital from a source of investment, who, in return, receives a percentage of a companys total gross revenues in return for his or her investment into the source. Revenue-based funding, or royalty-based funding , is a type of finance capital provided to small or growing businesses where investors invest capital in a business in exchange for a fixed percentage of continued gross revenues, with payments increasing and decreasing according to a companys revenues, usually measured as either daily or monthly revenues.
Startups that engage in revenue-based funding, however, collect lots of information about the businesses they are funding, which they use to refine their risk assessment algorithms, as well as offer services in addition to funding. Because revenue-based investing is new, there is not much public data, industry standards are yet to fully set, and, similar to equity investing markets, little transparency around what cost of capital investors actually pay in return for taking a return-based investment. Through extensive data analysis, we were able to determine the total number of investment firms and the volume of capital comprising the RBI sector, the specific verticals and business models most heavily utilising revenue-based investing , and the typical profiles of companies accessing this form of capital. In terms of applications best suited for RBI, B2B Software-as-a-Service companies come out on top, mostly because it is possible - essentially - to securitize revenues generated by the business, and thus to lend capital based on that theoretical security.
RBF works best with subscription-based business models, which in the start-up world usually means eCommerce businesses or Software-as-a-Service businesses. The clue is in the name, but an RBF start-up works best for companies that are earning regular - and hopefully growing - revenues, along with a healthy margin. With revenue-sharing arrangements, an RBF platform actually offers a hedge against downside risks to a companys investments.
Most competing RBF providers provide companies an advance credit, so that they can guarantee the subscription revenues up front. Their proprietary algorithms will assign every startups payment to a fixed percentage of its future revenues each month until the upfront loan is paid back, and most competing RBFs charge fees ranging from 5% to 15% on the amount borrowed . More on this in a moment -- but basically, this is so the RBF companies can easily calculate loan sizes and terms, based on both their current revenue and their future revenue.
Then, the life of the loan is variable: It can take longer or shorter to pay off, depending on how much revenue the business is earning, month-to-month. Rather than accruing interest as in debt funding, or giving up part of ones business as with equity funding, an upfront investment is paid back from business profits until the advance is paid off completely.
You cannot get a loan from banks, and shareholders are not eager to erode their ownership in a smaller SaaS company while courting new investors using equity-based funding. Among non-dilutive options, equity-based financing is especially appealing because of its flexibility and because the payback is based solely on revenue generated by the business. In fact, revenue-based financing is different from borrowing in several ways, i.e., the RBF platforms do not charge interest on the outstanding balance, the repayments are not fixed, but instead are based on the revenues, and recipient companies do not have to submit any collateral to the funding providers.
Revenue-based funding does not include interest charges Interest charges Interest charges come out of the business funding via debt or equity leasing. Unlike traditional bank loans, in which fixed payments are made on a monthly schedule, in a revenue-based model, companies pay nothing if they do not generate sales, an obvious advantage to businesses facing supply chain challenges. Unlike VCs or angel funds, making money happens through payments over time, rather than in one liquidating event, such as selling to a larger firm.
For companies with recurring revenues and a clear path for growth, a revenue-based funding is a way to raise working capital fast and kick off a marketing campaign that has been a pipedream until now. Revenue-based funding is yet another tool in an entrepreneurs toolbox, and can help companies at growth stages get their legs under them and get to the next level; all without putting any personal assets at risk and selling a piece of the company.
As a revenue-based funding platform, Choco Up provides growth funding to fast-growing startups, SMBs, as well as eCommerce companies, which allows for rapidly growing startups to use funds to grow and scale, and then repay them with a small percentage of their revenues. While revenue-based funding has been used for raising money for SaaS products globally via players such as Novel Growth Partners, Big Foot Capital, Earnest Capital, Lighter Capital, it is now being used for D2C businesses too. Startups including GetVantage, KredX, Velocity, Klub, and N+1 Capital are capitalizing on this opportunity, offering RBF.
Our whole focus is to build Founder-friendly financial products, and we are starting with giving companies a short-term infusion of capital, building off of strengths that they have already demonstrated. We are focused on making short-term investments that are income-generating, mostly around digital marketing and sales spend. We are looking at these companies marketing expenses, and then looking at how much revenue they are likely to bring in from more investments, so we can negotiate the percent of the revenue that is going back to us in order to pay off an investment within 6-9 months.