Revenue-based financing is an alternative to the conventional debt- and equity-based financing models. If your business has recurring revenues, you can use it to generate capital without taking on fixed debt payments or giving up shares of your company.

Here’s what you should know about revenue-based financing to determine whether it makes sense for your business, including how it works, how much it costs, and how well it stacks up to the more traditional options.

What Is Revenue-Based Financing?

Revenue-based financing, also known as royalty-based financing, involves qualifying for business capital based on your projected gross earnings, then paying back your investors with a fixed percentage of monthly revenues.

The forfeited revenue percentage depends on the financing firm, but it often falls between 2% and 10%. Instead of accruing interest on the balance, the arrangement usually requires paying back between 135% and 300% of the initial advance.

As a result, revenue-based financing arrangements frequently last several years, but you can decrease your repayment term if your future revenue growth is faster than expected.

For example, say you qualify for $100,000 in revenue-based financing because of your $20,000 of monthly recurring revenue. Your provider might require that you pay 5% of your monthly earnings until they’ve received $140,000.

Like equity investors, revenue-based financiers are often interested in actively helping you scale your business and may provide additional support beyond financing. However, they usually won’t be as hands-on as a venture capital firm or angel investor.

How Revenue-Based Financing Works

To qualify for revenue-based financing, you’ll need to give the provider access to your sales data and prove that you meet the minimum monthly revenue requirements. Providers concern themselves with little else during underwriting.

You generally won’t have to share your business plans, undergo a credit check, or sign a personal guarantee. As a result, qualifying for revenue-based financing may be easier than getting a bank loan for startups.

You can expect to be eligible for funding up to a third of your annual recurring revenue. For example, you could qualify for $330K if you’re on track for $1 million in sales for the year.

Alternatively, providers may offer you a multiple of your monthly revenue, often around four to six times the amount. Either way, you should receive your funds faster than you would with debt or equity, frequently in just a few days.

Once you’ve received your funds, you’ll owe the investor a percentage of your revenues every month. Your repayment term depends on how effectively you deploy your funds to grow your business earnings.

The arrangement is a lot like a merchant cash advance, but the costs are significantly lower, and you’ll make monthly payments rather than daily or weekly.

Pros and Cons of Revenue-Based Financing

Revenue-based financing has several advantages that may make it an attractive option for your business. Here are the most significant reasons to pursue it:

• More flexible qualification requirements: As long as you have sufficient recurring monthly revenues, you can qualify for financing without worrying about your commercial credit score or signing a personal guarantee.
• Variable payments fluctuate with revenue: Fixed debt payments can be a significant financial burden during slow periods, but revenue loan payments decrease when your earnings do. In addition, you can pay off your balance more quickly during periods of higher revenues.
• No dilution of business ownership: Equity financing requires giving up shares of your company. Not only is that often the most expensive way to get funding, but you also lose some degree of autonomy.
• Fast funding: You can apply for revenue-based loans and receive funds much faster than you can with debt and equity financing. For example, Uncapped can give you a decision in 24 hours, and your funds should be available to spend the day after you sign an agreement.

Of course, no business financing option is perfect for every situation. Revenue-based financing does have some disadvantages and limitations that can make it problematic in some cases. Here are the primary reasons it might not be for you:

• Revenue and industry limitations: Revenue financing is most suitable for highly scalable startups in industries like tech. Small businesses with low recurring revenues or limited growth potential may receive less funding or fail to qualify altogether.
• More expensive than a top-tier business loan: While revenue-based financing is often more affordable than equity financing, it usually costs more than a traditional bank or SBA loan.

If you’re considering revenue-based financing, shop with multiple providers and compare your offers to your debt and equity options before committing.

Usual Rates and Terms of Revenue-Based Financing

You’ll usually need significant monthly recurring revenue to qualify for revenue-based financing. For example, Lighter Capital, one of the leading revenue-based financing companies, wants to see at least $15,000.

However, terms vary significantly between providers. Since there’s no penalty to your credit score for applying, there’s little risk to shopping around regardless of your current earnings.

If you manage to qualify for funding, you can usually expect to receive at most, 33% of your gross annual revenues. However, providers often have additional restrictions that can impact your funding amounts.

For example, Lighter Capital offers $50,000 to $4 million in growth capital, while Element Finance is willing to lend from $200,000 to $10 million.

Monthly payment percentages vary even more significantly. For example, Lighter Capital usually requires between 2% and 8%, though they may ask for as much as 10%. Meanwhile, Uncapped claims most businesses give them between 5% and 25%.

Notably, payments usually begin without delay, so you need to have enough cash reserves or monthly cash flow to make your payments when you apply.

Typically, you’ll receive a repayment cap that’s around 1.5 to 3 times your total loan amount. You’ll continue to make payments until you reach that number, no matter how long it takes.

Repayment terms are variable since payments fluctuate with your gross revenue, but providers usually expect you to reach your repayment cap in around three to five years.

Qualifying for Revenue-Based Financing

Typically, revenue-based investors prefer companies with high growth rate potential. Their ideal clients are often startups in highly scalable industries who need capital to expand their operations.

For example, Lighter Capital only works with tech startups offering SaaS, tech services, and enterprise solutions. Similarly, 8fig only funds private label businesses and e-commerce stores.

In addition to being in the right industry, you must meet minimum monthly revenue requirements to qualify for financing. Once again, these can vary significantly. 8fig only looks for $8,000 per month, which is just over half of Lighter Capital’s minimum.

Notably, you don’t have to meet the requirements every month. You can still qualify for financing if your average revenue is above the minimum during the necessary period.

In addition, it’s usually okay for your business not to be profitable yet. Providers recognize that startups often lose money at first before developing enough traction to scale, which is what revenue-based financing helps you do.

When Do Companies Seek Revenue-Based Financing Options?

Companies primarily seek revenue-based financing options when they want to scale. Since it can provide significant upfront capital, it gives businesses enough cash to make investments that facilitate aggressive expansion.

For example, that might include using the funds to:

• Develop innovative products or service offerings
• Expand the sales team by hiring top talent
• Conduct a large-scale marketing campaign

Startups may opt for revenue-based financing instead of taking on debt in these early stages of development because it doesn’t cause as much financial strain.

Fixed debt payments burn through your working capital at a steady rate, whether the initial influx of cash helps your business grow or not. However, revenue-based financing payments remain low until you gain traction and start to scale.

Similarly, business owners may choose revenue-based financing over equity options because they don’t want to give up ownership of their companies.

Ultimately, revenue-based financing is an idealized hybrid between debt and equity financing. You receive the primary benefits of each while neatly sidestepping most of their downsides.

Revenue-Based Financing vs. Bank Loans

Revenue-based financing is an attractive funding option for startups and superior to traditional debt financing in multiple ways. Here are the primary reasons to choose it over a traditional loan from a bank:

• Flexible repayment: Installment loans require that you pay the same amount every month, but revenue-based financing payments decrease when you experience periods of lower revenue.
• No credit requirements: To qualify for a bank loan, you’ll usually need a high personal and business credit score, but revenue-based financing providers don’t check either.
• No personal guarantee: You usually must agree to let the lender pursue your personal assets if you default to qualify for a bank loan. However, most revenue-based financing arrangements don’t require that guarantee.
• Faster approval and funding: Applying for a bank loan is an intensive process, and it can take weeks to get approved and receive your funds. Meanwhile, revenue-based funding can get you capital in as little as two business days.

These are all advantages of revenue-based financing, but bank loans have at least one significant redeeming factor. Namely, they’re often less expensive if you can qualify for a low-interest rate.

Learn More: How to Build Business Credit Without Using Personal Credit

Revenue-Based Financing vs. Equity Financing

Revenue-based financing has several advantages over equity financing that may make it a more favorable option. Here are the most significant ones to consider:

• Maintain ownership: The primary reason to choose a revenue-based arrangement over equity financing is to maintain control of your company. The equity route requires giving up shares to external investors, which dilutes your ownership.
• Less expensive: Equity financing is typically the most costly form of financing. Revenue-based financing isn’t the cheapest, but it usually costs less than giving up shares.
• Easier access: Getting the attention of venture capitalists and angel investors can be incredibly challenging, but you can qualify for revenue-based funding as long as you have sufficient monthly revenues. 
• Faster funding: Once again, revenue-based financing is surprisingly quick, often taking less than a few days to pay out. In contrast, equity financing requires significant negotiation and is a much more time-intensive process.

Ultimately, revenue-based financing is best for startup founders looking to grow their businesses aggressively without taking on fixed debt payments or diluting their ownership. Consider reaching out to a few online providers if that sounds like you.

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