As the start-up ecosystem in India strengthens, many new classes of capitals are being introduced. And of all the capital classes, both investors and entrepreneurs find revenue-based financing a distinct solution.
Since its adoption in India in 2020, more and more start-ups and small enterprises (SMEs) are pivoting towards this financing option. That’s because it allows businesses to obtain a sizable funding without liquidating their equity.
But before discussing why RBF is a better capital choice for start-ups, let’s clear the air around it.
What is Revenue-Based financing?
Revenue-based financing, also known as royalty-based financing, is a type of capital-raising method in which investors agree to provide capital to a company in exchange for a certain percentage of the company’s ongoing total gross revenues. It is an alternative investment model to more conventional equity-based investments, such as venture capital and angel investing, as well as debt financing.
How Does Revenue-Based Financing Work?
Revenue-based financing is a means of obtaining credit by leveraging estimated earnings. Borrowers need to pledge a specific percent of their income, also known as revenue share, to the investor or lender. Thereafter, they need to repay the principal amount + revenue share to the lender.
For better understanding, take this example. Suppose company A’s monthly average earnings stand at Rs 30 lakh. Therefore, their projected earnings for the year is Rs 3.6 crore. It provides this estimate to an RBF provider and a proposition to obtain Rs 30 lakh against it. After an assessment, this lender extends the sum against a revenue share of 12%. Thus, company A must repay Rs.336000, i.e., Rs.3000000 + Rs.360000 (finance cost or revenue share).
RBF companies look at several parameters like cash flow, revenues, operating margins, growth potential, and scalability, among others, as a part of their audit or due diligence. Once convinced, the lender will forward the agreed-upon amount to the borrower’s account.
What are the advantages of Revenue-Based Financing?
The advantages are manifold. The biggest advantage is that promoters of the borrowing entity do not need to dilute any stake or bring any collateral even while getting access to the much-required funds. This is just not possible when raising funds from angel investors or venture capital firms. Incidentally, this also ensures that promoters continue to enjoy complete freedom in managing the affairs of the company. Typically, entities like private equity or VCs insist on a board seat and are known to interfere in the way businesses are managed in their investee companies. Secondly, revenue-based financing can be helpful to ventures that cannot get bank funding due to lack of collateral or profitability or any other reason that could act as a hindrance.
How is Revenue-Based Financing picking up in India?
There are firms that specialise in revenue-based financing. Some of the prominent names in India include GetVantage, Klub, Velocity Finance and N+1 Capital among others. The growing popularity can be gauged from the fact that the last 5-6 months have seen nearly 100 revenue-based financing deals in the country. The ticket size could be as low as Rs 5 lakh while going up to a few crores depending on the specifics of the deal.
Why do you need Revenue-Based Financing?
If you are looking for growth capital and/or maintaining liquidity for your company, revenue-based financing is an option to consider. Below are some use cases of revenue-based financing:
- Your company is growing quickly, hence needing more cash for revenue-linked spending, such as ad spend and inventory;
- Your company has sufficient cash flow to meet working capital needs and is planning to expand. However, metrics are not favourable to raise capital from investors, and you do not want to dilute your equity;
- Your company receives a huge order but lacks the capital to complete fulfilment, or you want to maintain abundant capital for optimal liquidity; or
- Your company has raised a seed round of investment. It is reserved as a runway to meet your company’s working capital needs until the next round. Yet, you need extra capital for growth.
Why Should I Take Revenue Based Financing?
The revenue-based financing model is a pioneering asset class in India that took off during the pandemic as start-ups struggled drastically to raise funds. Revenue-based financing is a hybrid capital instrument that combines the best of both equity- and debt-based financing options.
When opting for a revenue-based financing model, borrowers must remember a few things, including-
- RBF is a debt offered to start-ups and SMEs but is not as structured as a loan.
- In this, investors get a fixed share of the business’ revenues on a monthly basis. This signifies that if a company earns higher income a month, the investor simultaneously gets back a greater share. This repayment is inclusive of the principal and returns decided upon during the investment time.
- To access revenue-based financing, a company does not have to dilute equity to meet working capital requirements.
- There is no need to pledge collateral as securities for revenue-based financing, making it a less risky proposition for borrowers.
- For businesses that can carefully assess and predict their revenue flow, revenue-based financing is highly attractive. Though a start-up may not be absolutely profitable, they do have a regular stream of income.
- With RBF, entrepreneurs can raise funds anywhere between Rs 5 lakh and Rs 15 crore. Borrowers will have to repay the debt with a profit share ranging between 2% and 15% instead of paying EMIs or equity dilution.
- RBF usually comes with repayment tenure of up to 12 months. Companies can repay the borrowed sum + revenue share within this period or earlier, depending on their revenue scale.
Thus far, growth capital has been an exclusive concept in India because of the extensive cost and time required. Revenue-based financing mitigates these issues to provide fledgling businesses, especially SaaS-based and D2C, with a quicker and easier means to fund their investments. Companies can opt for a revenue-based financing solution, which offers to finance against nominal, 100% digitised documentation, and within just a few working days.