Rather than utilizing conventional, equity-backed investment methods such as venture capital, angel investing, or debt financing, startups now have the option of employing revenue-based financing as an alternative investment model to support their businesses.
Follow along as Kruze Consulting breaks down revenue-based financing, how it works, and whether or not it would be beneficial to your startup.
What is Revenue-Based Financing?
Revenue-based financing is when a lender underwrites a startup’s revenue flow while also taking payments in return. Essentially, investors return their principal back out of a startup’s revenue.
Many companies are employing this newer financing tactic nowadays. Lighter Capital is one of the leading firms in the venture capital-backed startup space currently providing revenue-based financing, however, the practice itself has been around for quite some time.
How Much Interest Should You Expect to Pay?
Typically, lenders will take about 3 to 6 percent of a startup’s monthly revenue back, with this financing option usually getting paid back over the course of three years. The expected IRR (Internal Rate of Return) is between 10 to 20 percent annually which equals the cost of capital. So, if you are a startup borrower, chances are you’re paying around 10 to 20 percent interest on your financing option.
→ Keep In Mind: Revenue-Based Lenders are focused on revenue, specifically recurring revenue.
Lenders love SaaS businesses because they have recurring revenue flow that accrues money over time, all with minimized churn, allowing lenders to get paid back and make good money. If you are not a SaaS business with recurring revenue, this type of startup financing may be difficult to impossible to get.
What If You Have a High Churn Rate?
When looking at churn, lenders will often place covenants in the agreement that allow them to underwrite based on your churn. If a startup is growing, and they have a sustainable recurring revenue stream, it will have access to capital through revenue-based loans. However, if a startup has a high churn rate, the lender will bring the advanced rate amount down substantially. Churn is a significant metric for lenders when considering revenue-based financing.
My Startup is Backed by Venture Capital. Now What?
Revenue-based financing is less popular with venture capital-backed companies. This is because venture capital-backed companies usually raise significant amounts of money in equity. These companies don’t always need debt, but when they do, they will typically go with a bank, such as Bridge Bank, or Comerica for financing. Or they may also go to a venture debt fund such as WCI, TriplePoint, or Hercules because those lenders will not only underwrite the enterprise value of the company, but will also measure how likely the venture capital is to stick with the startup and write another check if things get difficult down the line. Therefore, startups who are backed by venture capital typically have better access to debt capital as opposed to a newer startup that has yet to raise venture capital.
→ Keep in mind: Revenue-based financing is financing new, pre-venture capital startups at a significant rate.
Kruze Consulting is seeing a large number of startups acquiring revenue-based financing despite being pre-venture capital. Companies that have a bit of traction, have made the conscious decision not to raise any equity, or have raised one or two million dollars worth of angel funding, can use revenue-based financing. You don’t have to wait for a venture capital institution to get behind you. Build to the milestone that will allow you to raise venture capital down the line because **once you have venture capital, venture lenders will become readily available to you, making revenue-based financing much less attractive, especially considering the IRR. **
If you’re a startup that is not yet ready to be venture capital-backed, but you have a solid idea and paying customers, check out your revenue-based financing options.
We hope this helps. If you have any other questions, hit us up. Kruze Consulting is happy to answer your questions on venture debt, revenue-based financing, or anything that may affect your startup, accounting, or taxes.
