A revenue-based loan is a more flexible funding model than traditional debt financing, with payments tied to a percentage of revenue instead of an interest rate.
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Key Elements
- Structured as a flexible debt product
- Recurring payments tied to a percentage of revenues
- Total repayment capped at a multiple of principal amount
Product Scorecard
- Business Stage Supported Ranging from pre-revenue/idea stage businesses (low) to mature stage/acquisition stage businesses (high)
- Cost to Entrepreneur An approximate measure of the blended short and long term costs a business may incur as a result of this capital type
- Risk for Investors Representing the downside risk in worst case scenarios of default on repayment obligations
- Potential Returns for Investors The greatest potential income an investor capital provider could earn by deploying funds with this product method
- Liquidity for Investors Ranging from lowest liquidity (capital providers wait a long time to receive repayment from their investment) to high liquidity (repayment begins immediately and is fully repaid quickly)
What is a revenue-based loan?
A revenue-based loan is like a flexible loan with no fixed interest rate. Revenue-based investors give a company capital in exchange for a percentage of the company’s ongoing revenues.
Similar to traditional debt financing, investors collect monthly or quarterly payments. Rather than payments set at an interest rate, revenue-based payments fluctuate with revenue.
If revenue slows down, then the payments will be lower; if the revenue is higher, then the loan is repaid more quickly. Payments are made until the investor receives a predetermined multiple of the original investment or return cap. Typically, the company does not have to provide collateral for a revenue-based loan because its revenues are essentially collateral.
A revenue-based loan blends features of bank debt and venture capital, and founders should expect the cost of capital to fall within that range. Revenue-based loans are non-dilutive growth capital to bridge the path to sustainable profitability for revenue-generating businesses that do not fit the VC model.
What are the Typical Characteristics of a Revenue-Based Loan?
- Structured as a loan
- Principal amount is fully funded at closing
- Monthly payments equal a set percentage of monthly revenue (typically 2-8%)
- Monthly payments continue until a set dollar amount has been paid back, usually 1.4-2x the amount of the financing (this multiple is called the “cap”)
- At maturity, which is typically 3-5 years, any unpaid amount of the cap is due
- No collateral or restrictive covenants
Case Studies
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Novel Capital Case Study
Sage Growth Capital Case Study
Onshore Technology Case Study
Revenue Based Loan FAQ
They are often cheaper than selling equity, but more expensive than bank loans. They typically cost 10% – 20% IRR compared to <10% for bank loans and 50%+ for VC. If founders can get access to a cheaper fixed-rate bank loan and are willing to secure the loan with personal guarantees and collateral, then they should take it.
A revenue-based loan is a debt product. Similar to traditional loans, taxable investors — including family offices and high net worth individuals — will have their gains taxed at their ordinary income rate, not the long-term capital gains rate.
If the company plans to raise more capital, there may be difficulty with S Corp and LLC business structures. LLCs take on the tax liability and collect 1099s annually. Investors have a strong preference for C Corps.
There are potential usury law issues for revenue-based loans depending on the state jurisdiction.
RBI provides equity-like returns with better liquidity than traditional equity. Investors do not need to rely on an acquisition or public exit because of the self-liquidating returns for RBI. Founders pay back the investment from their company’s revenues until reaching the return cap.
Deeper Dive
Revenue-based loans are common among companies that use a subscription model (particularly companies selling software-as-a-service), but they are also useful for non-tech businesses, like food and manufacturing, where revenue can fluctuate. Advocates of revenue-based loans are increasingly encouraging businesses and funders to consider this model for a variety of industries. For a business growing at a moderate pace with recurring revenue in need of growth capital (like hiring, buying inventory or conducting a big marketing campaign), revenue-based loans can be a good option.
What types of businesses are a good fit for a revenue-based loan?
Profitability: Businesses do not need to be profitable, but investors like to see a path to profitability within three to five years. Businesses need to be at least EBITDA (earnings before interest, taxes, depreciation, and amortization) positive.
Recurring Revenue: Businesses need to average at least $10K in monthly recurring revenue (MRR). Investors like to see somewhat predictable revenues with repeatable or recurring customer contracts and customer diversity.
Annual Revenue Growth: 25%+
Gross Margins: 40%+
Future Value: $10M+ business within 5 years
Financials: 2+ years of financial statement
What types of businesses are not a good fit for a revenue-based loan?
Too Young: If a business does not have at least two years of financial statements, then it is difficult for a revenue-based investor to underwrite and make an investment.
No Revenue: If a business does not have any revenue, then it is difficult for a revenue-based investor to underwrite and make an investment. Most investors like to see $10K+ in monthly recurring revenue (MRR) for several months.
Heavy R&D: Businesses that are capital intensive and require a large amount of upfront funding to build large-scale projects or bring breakthrough technology to market.
Blitzscalers: Businesses that require rapid growth to take over an entire market or create a new market and need large amounts of VC funding to scale. These “Blitzscalers” typically focus on speed and growth over cash flow and profits.
Fundraisers: Founders always focused on raising the next round of funding for their businesses. Investors want to write checks to builders, not fundraisers, and do not want to have to spend a lot of time convincing founders not to take the traditional VC funding path.
Misaligned Cap Table: If founders have raised $5M+ in traditional VC funding, then their existing investors most likely will be focused on raising another VC round at a larger valuation. Revenue-based investors do not want to compete with the different return and fundraising expectations of prior or potential co-investors. On the debt side, investors do not like to navigate a crowded and complex cap table with a bunch of lenders who are more senior to them and have expensive rates and warrants
Benefits to Entrepreneurs: Why would founders want to choose a revenue-based loan?
- Non-Dilutive & More Control: Founders maintain more ownership and control over their business than traditional VC. Once the investment is paid back by founders, the investor is not on your cap table permanently. Investors typically do not take a board seat.
- Flexible Payment Schedule: A revenue-based loan provides more flexible payment terms based on a percentage of revenues than term loans with fixed payments that do not fluctuate with revenues. Payments scale up and down along with revenue growth.
- No Restrictive Covenants: Unlike traditional bank loans, revenue-based loans typically do not require the borrower to agree to any restrictive covenants where the borrower must manage their business in a specific way — such as maintaining minimum liquidity levels or hitting revenue milestones. For example, venture debt lenders will require borrowers to also agree to stock warrants for upside participation in exit scenarios. Factoring or merchant cash advances also come with more restrictions and need to be paid daily or weekly compared to monthly or quarterly for a revenue-based loan.
- Cheaper than VC: A revenue-based loan is often cheaper for founders than selling preferred equity to VCs. Founders may believe that traditional equity costs less with no expected payments until an exit, but a revenue-based loan is most likely cheaper over the long-run on both total dollar amount and IRR basis. Revenue-based investors cap their investment at a ~2x return instead of aiming for 10x+ returns like VCs.
- Fundraising Optionality: Founders do not need to follow the VC funding path of raising larger follow-on rounds of dilutive equity capital. Revenue-based loans offer cheaper, non-dilutive growth capital that can enable businesses to scale and eventually raise VC funding or access cheaper bank debt. These loans provide founders the optionality to pursue the funding journey that makes the most sense for their business.
- Access to Capital: Revenue-based loans are more accessible for underrepresented founders because the underwriting process is based on the company’s revenue, margins, and other financials, not the owner’s credit score, income, or personal real estate assets. Traditional debt financing continues to use outdated and discriminatory lending practices that limit access to capital and increase the cost of capital for underrepresented founders. Revenue-based loans have improved the investment process with a more inclusive underwriting approach.
What should businesses be aware of with a revenue-based loan?
- Less Predictable Payment Schedule: Revenue-based payments fluctuate with revenues which can provide flexibility for founders but also be harder to predict for financial projections than traditional loans with their fixed monthly payments. Revenue-based loans have a variable interest rate instead of a fixed interest rate.
- More Expensive than Bank Loans: Most founders seek revenue-based loans because they cannot access bank loans or VC. Revenue-based loans usually cost between 10% and 20% IRR compared to bank loans at <10% IRR and VC at 50%+ IRR. If revenue grows quickly, then payments will also. This leads to a shorter payback period, but also a higher cost of capital. Founders need to be comfortable with the fixed return cap or total payment, regardless of their revenue growth rate.
- Gross Margins > % of Revenue: Founders need to be comfortable giving up the percentage of revenue to pay back the investment. Gross margins need to be sufficiently high enough to support the financing costs or else the investment will start to reduce the growth potential of the business.
- Personal Guarantees & Collateral: It depends on the revenue-based lender, but founders may need personal guarantees and potentially pledges of personal collateral. However, revenue-based loans tend to have more founder-friendly terms than traditional bank loans.
- MCA Disguised as RBF: There are a rising number of FinTech platforms and lenders that claim to make “revenue-based” investments for founders, but their products are closer in structure and costs to merchant cash advance (MCA). These FinTech platforms offer speed and access to capital for small businesses but can be misleading on the actual costs and financing terms for founders. Typically, these “revenue-based” products appear to be much cheaper than a revenue-based loan with return caps around 1.2x, but there is no grace period and businesses are making daily or weekly payments instead of monthly or quarterly. The APR likely is 50%+ compared to revenue-based loans at up to 30% APR. Founders may end up taking on expensive debt that does not actually help them grow.
Benefits for Capital Providers: Why would fund managers choose to offer revenue based loans?
- Payment Flexibility: Repayment flexibility can be a benefit for funders as well as for entrepreneurs. Affixing payments to revenue results in borrowers who are more likely to make their payments.
- Risk/Reward: RBF represents a class of investment that typically offers greater returns than traditional debt financing but lower risk than VC investing, offering a potential sweet-spot of risk/reward.
- Liquidity: RBF loans can provide consistent returns and liquidity with a lower risk profile for funders that do not want to spend all their time and energy searching for “unicorn” businesses.
- Founder Alignment: Greater alignment between entrepreneurs and RBF capital providers based on shared goals of revenue maximization and profitability can lead to potential for follow-on investments and cheaper debt capital.
What should capital providers be aware of with a revenue-based loan?
- By fixing returns at a cap, RBF investors experience limited upside on their investments, potentially missing out on the exponential VC-like returns.
- Lack of collateral from RBF borrowers reduces the likelihood of capital providers collecting on non-performing loans or bankruptcies.
- Lack of familiarity with RBF terms may keep entrepreneurs from applying for RBF funding.
Terms: What do investors typically charge businesses for a revenue-based loan?
- Investment Size (Principal): up to 1/3 of annual revenue or up to 3x monthly revenue (typically $50K to $3M check sizes)
- This is the total amount invested in the round.
- Ownership (Equity): 0%
- Percentage of Revenue (Payment): 2-5% (though it can go as high as 10%)
- Revenue can be defined as Total Revenue (Gross Revenue), Net Revenue (Net Cash Receipts), or Revenue minus COGS (Gross Profit)
- Return Cap (Total Payment): 1.5x to 2.5x principal
- Payment Schedule: monthly or quarterly
- Grace Period: 0 to 12 months
- This is the date founders will begin making revenue-based payments. These start dates can range widely given the intent of the founders and investors. Some investors might choose to set the start date to begin immediately while others may set it at 12 months post-investment.
- Maturity (Term): 3 to 5 years
- This is the due date by which time the total payment (return cap) must be paid. If the company still owes capital at the due date, then investors typically have the option to either demand payment or to convert any unpaid capital into equity.
- Equity Warrants: None
- Personal Guarantee: None
- Financial Reporting: The investor has access to the company’s financial statements, including monthly balance sheet (plus YTD), monthly cash flow statements (plus YTD), monthly bank reconciliation report, monthly bank statements, and monthly compliance certification certifying the information delivered.
- Board Seats: None
| Bank Loan | Revenue Financing | Venture Captial | |
|---|---|---|---|
| Retain Equity | Yes | Yes | |
| Maintain Control | Yes | Yes | |
| No Personal Guarantees | Yes | Yes | |
| Flexible Repayments | Yes | ||
| Ease of Access to Capital | Yes | ||
| Large Funding Amounts | ✓Yes | Yes |
Resources
The Rise of Revenue-Based Financing
Discover why startups are increasingly turning to alternative financing options like revenue-based financing. This report was created by Lighter Capital.