Businesses of all sizes and models need outside capital to reach their goals. Whether it be for a new business that wants to purchase preliminary equipment or for a more established company that is looking to expand into a new market or develop a new product, capital is king.
One financing model that is growing is revenue-based financing, which works exactly as it sounds: the amount you pay depends on your monthly revenues. In this post, we will talk more about how the model works and explain how to set repayment caps in revenue-based financing.
How Does Revenue-Based Financing Work?
While business loans, bank loans, and other debt financing options have fixed monthly payments, revenue-based financing involves payments based on a percentage of your monthly revenue. This means that the amount due will change every month.
If you have a hot month with lots of sales, your monthly payment will increase to match. If your business experiences a cold spell where your cash flow decreases, your payment will drop accordingly.
Revenue-based financing differs from venture capital. While venture capital involves giving up some equity or ownership in a business in exchange for financial assistance, in revenue-based financing a business promises a percentage of its future revenues.
One way to think of revenue-based financing is like a longer-term merchant cash advance with monthly payments, higher dollar amounts, and slightly higher interest rates.
Generally speaking, businesses seeking a revenue-based loan will not be able to obtain more than ⅓ of their annual revenue and will be required to pay anywhere between 2 and 8 percent of their monthly revenue.
Lenders who offer revenue-based financing are looking for companies that have strong growth potential. If a company grows quickly, the deal will be beneficial for both the lender and the borrower.
On the other hand, if a business seriously underperforms its expectations, revenue-based financing could result in a large balloon payment at the back end of the term. Since there is so much fluctuation in payments, however, most lenders who provide this niche financing model implement a range of time for the term limits.
Who Uses Revenue-Based Financing and What Do They Use It For?
Businesses seeking revenue-based financing generally have these characteristics:
- Are fast-growing with high growth potential
- Have a detailed plan about how they will use growth capital and scale their company
- Maintain minimum gross margins of 50%
- Maintain monthly revenues of at least $25,000
The ideal candidate for revenue-based financing is a technology or software as a service (SaaS) company with serious recurring revenue and scalability.
Most borrowers are medium-sized companies. Small businesses usually don’t have that level of recurring monthly revenues, while larger businesses usually need a larger amount of capital.
To obtain a loan with revenue-based repayment plan, you will need to demonstrate a specific plan of how you will use the money to generate more revenue. Generally, lenders prefer companies that will use the money to grow their business, as this theoretically increases the company’s revenues, and therefore their monthly payments.
Here are some common purchases that companies make with their growth capital from a revenue-based financing lender:
- Hiring new employees
- Expanding into a new market
- Conducting a sales initiative
- Developing a new product or service
What Are Repayment Caps and How Do I Set Them?
A repayment cap is the total amount that you will have to pay, which includes the principal and interest. Generally, you will multiply the principal with an integer ranking from as little as 1.3 to 1.8, and that final number is your final cost.
The equation: principal x cost of capital integer = repayment cap
The more money that you borrow, the lower your repayment cap will be. Additionally, the better your credit history and the more monthly revenue you bring in, the lower your cap will be.
For instance, if you want to borrow $100,000 from a revenue-based financing model, your repayment cap will likely be closer to 2 and end up paying in excess of $200,000.
On the other hand, if you are able to obtain a loan for $2 million, your repayment cap should be toward the lower end of that range, since the actual amount will greatly exceed what you would pay in the $100,000 example.
While the cost of capital tends to steer higher with revenue-based financing than other alternatives such as debt financing or venture capital, it is worth it for many companies. It provides financial flexibility without requiring equity or collateral.
What Does RevTek Capital Offer?
RevTek is a revenue-based lender for a wide array of growing tech companies. We provide a combination of capital and freedom that can help you expand your business.
Our model is simple: we provide the capital, and you pay it back in manageable monthly payments based on your monthly, recurring revenue. Our repayment caps usually fall between 1.3 and 1.8.
To be eligible, you do not need to be profitable, but you should have a predictable recurring revenue of at least $50,000 a month.
Whether you are a young startup looking for venture capital or a mature company interested in obtaining growth capital, RevTek can help. Contact us today to schedule a consultation with one of our experienced team members.