You might have heard people talk about revenue-based financing as “royalty-based financing.” Put simply, a revenue based small business loan is financing with repayment terms based on your revenue. You don’t need to put down any collateral, and you won’t have to worry about your debt-to-income ratio.
Just because you’ve just started your business doesn’t mean you have to stay small. There are exciting yet practical financing options out there for you, and one of these is revenue-based financing. With these loans, you only make payments when you bring in revenue. Let’s discuss what’s involved in qualifying for a small business loan and how these financing options work.
What is Revenue Based Financing?
Perhaps you’ve guessed what revenue-based financing is based on the name. Instead of needing collateral (in other words, assets) to secure a loan, your business revenue is the basis of your financing.
In other words, you agree to pay the lender a set percentage of your revenue over a specific term, until your loan is paid off. When looking at revenue-based financing, find out the rates of prospective lenders. The largest amount you will usually have to pay is between three and five times how much you borrowed.
You will know the exact percentage rate you will pay when entering the loan agreement. As well as a percentage of your revenue, you must pay a set multiplication of the loan amount.
Why Revenue Based Financing Is Important
Revenue-based financing gives options to businesses that may not qualify for other kinds of loans. Alternatively, businesses may qualify for traditional loans, but the repayment burden may jeopardize their well-being.
Many businesses seek revenue-based financing for growing their business through activities such as expanding the team, improving marketing and sales, and developing new products.
How Does Revenue Based Financing Work?
Revenue-based financing is a fantastic tool for businesses with fluctuating revenue. You don’t have to worry that your monthly payment will be too much, as it will change with your revenue. When your business grows and you get higher revenue, you will make larger payments.
Payments will always be in line with the rate you agreed on in the revenue based financing agreement.
Its flexibility is the most attractive feature of revenue-based financing. Starting a new business brings a lot of uncertainty, and there are plenty of ups and downs. With other kinds of loans, you have trouble on your hands if you can’t make a payment. However, if you choose the revenue-based financing work, you only pay a proportion of the money you bring in.
Revenue Based Financing Pros and Cons
Make sure to consider all aspects of this type of financing while researching how to get a small business loan.
Like every other financing option, revenue-based financing has both pros and cons. Let’s begin with the many advantages.
You’ll never be faced with overwhelming or unaffordable payments if you go with revenue-based financing.
2. Focus on Growth
With revenue-based financing, you’re encouraged towards growth. However, you won’t end up with the toxic pressure that sometimes comes with traditional loans. With a revenue-based loan, you will only pay if you have the revenue.
3. No Collateral Needed
You won’t need to offer any collateral to get a revenue-based financing loan. This lends better peace of mind for many business owners.
4. Keep All Ownership
You always retain full ownership of your business and its assets throughout the revenue-based financing process.
5. More Affordable than Equity Funding
Maybe you’ve thought about looking for equity funding, such as funding from angel investors or VC funding. While the large amounts of money available on this route seem transformative, you will have to pay between ten and 20 times what you borrowed. This kind of burden is enough to bring down a business.
Like any other kind of loan, revenue-based financing does have some disadvantages. Let’s take a look at them below.
1. You Need Revenue
This sounds common sense, but it’s an obstacle for new startups that haven’t yet started bringing in revenue.
2. You Must Make Monthly Payments
Having to make monthly payments is a problem if you don’t yet have any revenue.
3. Less Money Available
You won’t get the kind of loan sizes from revenue-based financing that you may be able to from venture capital.
The Best Revenue-Based Financing Model for Startups
Startups sometimes combine revenue-based financing for startups with other kinds of financing to help reduce risk. While revenue-based financing lenders look for existing revenue, you may not need to be profitable.
If you have a start-up, look for revenue-based financing that fits your business. In other words, if you have limited revenue, look for a revenue-based financing model that will accommodate your current business reality.
Revenue Based Financing Interest Rates
Regarding revenue-based financing, information on interest rates is generally contained in the repayment caps. These caps tend to range between 1.35x and 3x. To find out what the total debt will be, you simply multiply the financing amount (also known as the principal debt) by the agreement’s repayment cap.
How to Prepare for Loan Application
Now, we’ll provide a quick guide on how to qualify for a small business loan.
Get all the necessary documentation ready for when you apply for any loan. Of course, your business revenue is the most crucial factor with a revenue-based loan. But you must document and prove this, and there are other kinds of documents you will probably need to produce, as well.
When you apply for your revenue-based financing loan, have all your business information on hand. Of course, lenders will require your revenue data when deciding on your loan application. Some of these may include:
- Business balance sheet
- Articles of incorporation, if applicable
- Business bank statements
- Personal bank statements
- Income statements
- Personal identification
- Business tax returns
- Personal tax returns
- Commercial leases, if applicable
There’s no doubt about it; revenue-based financing is an exciting option for many businesses, especially small businesses with established revenue. But remember, you need professional advice and guidance when making financing and loan decisions. That is where Business Financing Advisors come in with their expertise and experience. The best loan providers offer advice and information free of charge.