Revenue based loans also referred to as royalty-based financing, are a method of raising capital for a business from investors who receive a percentage of the enterprise’s ongoing gross revenues in exchange for the cash they invested.
Revenue-based loans are a variety of small commercial loans during which your monthly payment increases and reduces your revenues. Loan sizes typically range from $50,000 to $3,000,000.
In revenue-based loans, investors receive a regular share of the company’s income until a predetermined amount has been paid. Typically, this predetermined amount is a multiple of the principal investment and typically ranges between three to five times the initial amount invested. It works well for businesses with stable revenue streams but without the collateral needed for a conventional loan. Interest isn’t paid on an outstanding balance, and there are not any fixed payments.
Revenue-based loans are generally expected to be used for growth capital to scale your business by expanding efforts, such as:
- Product development
- Sales and marketing initiatives
- Hiring additional employees
Providers will expect you to have an idea to increase your existing business revenue tenfold as a part of the appliance process. Because your loan relies on your current revenue stream, lenders will want to visualize potential growth opportunities for your business.
Because repayment of the loan is based on your revenues, the time it takes to repay the loan will fluctuate. The faster your revenue grows, the quicker you’ll repay the loan, and vice-versa. The proportion of monthly revenues committed to repayment is often as high as 10%. Your monthly payments will fluctuate together with your revenue highs and lows and can continue until you’ve paid back the loan fully.
The duration of the loan ultimately depends on the success of the business. The faster the business grows, the faster the loan is repaid. The revenue-based loans provider sees better returns the faster you pay the loan fully. This is often one reason the underwriting process is focused not only on your current revenues but also on your business’ potential to quickly increase revenues.
Revenue-based financing also differs from equity financing because the investor doesn’t have direct ownership in the business. This is often why revenue-based loans are often considered as a hybrid between debt financing and equity financing.
In some ways, revenue-based loans are comparable to accounts receivables-based financing, a kind of asset-financing arrangement during which a corporation uses its receivables—outstanding invoices or money owed by customers—to receive financing. The corporate receives an amount that’s adequate to a reduced value of the receivables pledged. The receivables’ age largely impacts the quantity of financing the corporate receives.
Revenue-based loans are most frequently employed by small to mid-sized businesses that otherwise cannot obtain more traditional types of capital. Because the sources of revenue-based loans become something of a business partner, the transaction costs are often considerably more than a standard loan.