Revenue-Based Financing

What is revenue-based financing?

Revenue-based financing ("RBF") is a loan in which repayments are based on a percentage of the borrower's monthly revenue rather than a fixed amount. The payments fluctuate with the borrower's financial performance, going up when revenue is strong and down when it is lower.

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RBF originated in the oil, gas and mineral industries as a source of debt financing. From there, it expanded into the life sciences, movie, and energy industries. In recent years, it has expanded into other technology as well as non-technology sectors.

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RBF is known by many other names, which often leads to confusion. We have identified eighteen other names. The most commonly used alternatives are revenue loan, revenue-based funding, royalty financing, and royalty-based financing.

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The terms that begin with the word "royalty" are often used in the life sciences industry, partly due to the prevalence of licensing agreements. To minimize confusion, we use the word "royalty" and the name royalty-based financing exclusively for life sciences since that industry has unique characteristics and lenders that primarily or solely focus on the sector.

How does revenue-based financing work?

RBF can be structured in many different ways. The most common structure is a term loan. Typically, the full amount is not advanced up front. The drawdown can occur over multiple years so that interest expense is not incurred until the funds are needed. Payments (which include principal and interest) are based on a fixed percentage of revenue or cash receipts from the prior month or quarter.

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The structure is flexible; generally, payments are made until one of the following milestones occurs:

The lender receives a pre-determined multiple of the original loan;
The lender achieves a pre-determined internal rate of return (IRR); or
A terminal date is reached.

After the milestone is reached, the loan obligation is retired and no further payments are due.

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How does it compare to venture capital or other types of equity investment?

Revenue-based funding is non-dilutive or minimally dilutive so entrepreneurs or management can keep a much larger percentage of ownership. In addition, lenders do not require board seats or other direct involvement in the governance or operations of the company.

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How is it different than traditional debt?

Banks are subject to significant regulatory constraints. Therefore, revenue-based financing firms can often provide larger loan amounts and require fewer restrictive covenants than banks. The trade-off is that revenue loans are more expensive than traditional debt.

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How does it compare to an MRR line of credit?

RBF is often confused with MRR-based loans. RBF is a loan in which repayment is based on monthly revenue. MRR-based loans are lines of credit in which the amount available for borrowing is based on monthly revenue.

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What are the benefits?

RBF is non-dilutive (i.e. the lender does not require warrants or other equity that results in stock dilution or share dilution).
Lenders do not require board seats or other direct involvement in the governance or operations of the company.
Personal guarantee is generally not required.
Collateral is generally not required.
Minimal restrictive covenants.
No minimum monthly principal payments.
Borrower does not have to be VC-backed.
No valuation is required,
Due diligence process is simpler and faster than an equity fundraising.

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What are the drawbacks?

By definition, the borrower must be generating revenue.
The business should have strong gross margins since a significant percentage will be used for loan repayments.
There is no stated interest rate so the borrower must estimate the cost using an Excel model.
If company is required to borrow the entire loan amount up front, the cost may be higher than an MRR line of credit which is borrowed as needed. Some RBF lenders have addressed this issue by allowing borrowers to draw the loan as needed.
Companies with strong cash flow or substantial "hard assets" (e.g inventory, real estate, equipment) may have access to less expensive sources of capital. However, RBF may be a good complement if additional capital is required.
Depending on the structure, pre-paying or refinancing an RBF can be expensive.
Last but not least, it must be repaid! A company should not utilize debt financing if management or the board does not believe the company can repay it.

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What do lenders look for in potential borrowers?

Size: Minimum size varies widely by lender. One well-known lender requires annual revenue of at least $200,000; another requires $2 million. Lenders do not usually specify a maximum size but $50 million is a practical limit.
Recurring revenue: Lenders prefer subscription-based companies such as SaaS, but any company with reasonably predictable topline performance is a candidate for RBF.
Positive historical and projected growth
High gross margins: Since loan payments can be a significant percentage, the lender does not want the payments to put the company in a loss position.
EBITDA: Company should be cash flow positive or close to it.
Modest current debt obligations
Industry: Can be technology or non-technology sector.
Ownership: Borrowers are usually closely-held private companies that are not sponsored by a venture capital or private equity firm.

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What are the key provisions of a revenue-based financing term sheet?

Structure: Varies, but a common structure is a secured term loan, often subordinated to the rights of a senior creditor (e.g. bank, asset-based lender, or lessor). Also see answer above to "How does it work?"
Amount of loan: The maximum loan size depends on the borrower's size, profit margins, and other factors. A rule of thumb from one lender is that the loan cannot exceed one-third of your annualized revenue run-rate. Typical loan size ranges from $50,000 to $5,000,000, although some lenders can provide larger amounts.
Drawdown period: Varies.
Term: Usually 3 to 5 years.
Interest rate: There is no predetermined interest rate. Each payment includes both interest and principal.
Monthly payment: Payments depend on the loan term and other factors. The longer the term, the lower the payment as a percentage of monthly revenue. It is typically 1.0% to 3.0%, but can be up to 8.0%.
Payment cap: The cap varies widely depending on the term of the loan (longer period requires larger cap) and other factors. Typical cap is 1.5x to 2.5x of the original loan amount, which implies an interest component of 0.5x to 1.5x of the original loan amount.
Equity participation: Normally, the lender does not require warrants or kickers that result in equity dilution.
Collateral requirements: Varies. Hard assets are generally not required, but lender may require a security interest in all the company's assets.
Restrictive covenants: Generally, loans do not include financial covenants such as coverage ratios. However, lender may place restrictions on additional borrowings, disposition of assets, and other actions that may affect the company's ability to repay the loan.
Governance: Generally, the lender does not require a board seat.
Personal guarantee: Usually not required.
Access and audit rights: Lenders require access to financial statements and bank account data to monitor company's financial performance and verify compliance with loan agreement.

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What is the tax treatment?

Depending on the structure, RBF may be classified as debt or equity. In the U. S., it usually has a stated maturity date in order to comply with IRS requirements and ensure that interest expense is deductible.

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What companies provide RBF?

Non-bank lenders and investment funds.

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