What is Revenue-Based Financing?
It seems that for small- and medium-sized businesses, getting a bank loan is getting harder by the day. It has been estimated that only 20% of requesting businesses are able to secure bank loans. With the advent of COVID and rising interest rates, that figure is bound to get worse. Enter revenue-based financing.
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The revenue-based financing (also known as royalty-based funding) is a way to raise capital for a company from investors who are paid a percentage of the business’s gross revenues.
Typically, for a company to obtain a revenue-based loan, it generally must have been in business for 6 months, have an established business bank account, make at least $5,000 bank revenue monthly, and have a 450+ credit score.
Investors receive a share of the revenue-based financing investment until a predetermined amount is paid. Many times, this predetermined amount multiplies the principal investment by three to five times (…between three and five times the original loan amount). There are some exceptions to this repayment regimen, however. of note, there are some companies that charge only 18-45%, depending upon the repayment term (6-24 months). One such company is listed >>HERE<<.
How revenue-based financing works
An enterprise that raises capital via revenue-based financing will have to make regular payments in order to repay the principal. However, this is different from debt funding for many reasons. Normally, there are no fixed payments and interest is not paid on outstanding balances.
The firm’s performance directly affects the number of investor payments. Because payments are dependent on the income of the business, they can vary. Investors will have their royalty payments reduced if sales drop in a given month. The investor will receive a higher monthly payment if sales increase in the next month.
Because the investor is not directly involved in the business, revenue-based financing differs from equity funding. Revenue-based financing can be seen as a mix of equity and debt financing.
In some ways, revenue-based financing is similar to accounts receivables-based financing, a type of asset-financing arrangement in which a company uses its receivables–outstanding invoices or money owed by customers–to receive financing. The company is paid an amount equal to the pledged receivables. The company’s amount of financing is affected by the age of the receivable.
KEY TAKEAWAYS For What is Revenue-Based Financing
1. Revenue-based financing allows firms to raise capital by promising a portion of their future revenues in return for money invested.
2. Investors will receive a portion of the revenues at a pre-determined percentage until they have repaid a certain number of their original investments.
3. Revenue-based financing is often distinguished from equity- and debt-based funding.
4. Municipal bonds are an example hybrid of revenue-based debt funding.
Revenue-Based Financing & Revenue Bonds
Revenue-based financing, although it is a different type of financing and has its technical details, is very similar to the cash flow structures found in revenue bonds. Many municipal projects will issue revenue bonds instead of general obligation (GO), bonds to finance specific projects such as infrastructure. One example is a toll road. These projects can be used to retire debt obligations and generate secured income from the asset or project. This is why revenue bonds are called.
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