What do startups and fleas have in common?
They tend to both rely on an outside source for survival. Dogs for fleas, and cash injection for start-ups. Especially right now in these tricky times- funding is pretty necessary for start-ups striving to reach their full potential.
As a start-up founder, considering the specific model of funding is incredibly important. It can affect your cash flow, control of the company, and more. When companies require funding, there are numerous options available, such as debt or equity-based finance. But revenue-based is often viewed as a third-party option that has direct benefits over other loan models.
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What is a revenue-based finance loan?
Loans approved for the revenue-based model are granted on the basis of regular repayments of a percentage of gross profits. Revenue determines the length of the payback period, with higher gross profits shortening the loan term.
What is an example of revenue-based financing?
In month 1, company X makes a revenue of $50,000, which means they pay back $5,000 of the loan. In month 2 they make a revenue of $85,000 and pay back $8,500, whereas, in month 3, they only make $30,000 in revenue and pay back $3,000.
In this way, it is clear that the company’s revenues determine the period of the loan. If your profits suffer, your loan amount decreases in accordance. It’s the big flexible feature of revenue-based financing and a pretty cool way to do business.
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Is revenue debt or equity-based finance?
Debt funding models do not take any equity from the shareholders but do put pressure on paying back a fixed amount with interest. There is no flexibility if performance changes between months, the fixed amount must be paid. Plus, in order to secure capital in a debt-based model, business founders, directors, and owners are often required to put up their own personal collateral in case of failure. Therefore, debt-based financing can be incredibly high-risk.
Why choose revenue-based financing?
As mentioned, there are other venture capital models available, such as debt-based financing and equity-based financing. These are the more traditional options that have been popular in times of economic security and strength.
However, in times of covid, venture capital is drying up. This is combined with systematic risk across other funding sources, such as the stock market, is pushing more and more start-ups into revenue-based financing. It is viewed as a more secure way to grow. Choosing a revenue-based finance source has a number of other advantages.
Added to this is the fact that no collateral is required to process the loan. This can relieve pressure on the overall operation, while also harnessing positive performance in a flexible way.
Other Considerations for Revenue-Based Financing?
Venture capital is a risk for any investor, but agreeing to pay back a multiple of the principal amount covers that risk to make this a fair way to invest. This is no doubt the largest downside- as revenue-based financing definitely has a higher upfront cost in exchange for access to capital.
What are other common sources of funding?
Now we know what revenue-based finance is in pretty straightforward terms. But to determine if it’s the right model for injecting growth into your business; it’s useful to know about more of your options.
Typically, there are six common channels of funding available to every company. Some of these may be unavailable in the early stages, while others are unsuitable during phases of growth. The six sources of funding are:
- Business Angels
- Venture Capital aka private debt or equity funding
- Crowdfunding aka friends & family
- Enterprise Investment Scheme
- Alternative Platform Financing (government-based or private)
- Stock Market
Depending on the growth stage of your business, one of these options may be more suitable than the others. Aspects to consider include the length of the payback period, interest rate, and level of control retained in the company.