Revenue-Based Financing vs. Debt Financing for Startups

Monday 19th April, 2021

Revenue-Based Financing vs. Debt Financing for Startups

Establishing a business can be intimidating but a rewarding process. While a well-strategized business plan is essential, financing is another critical aspect a company needs to succeed. Getting funds to finance a start-up or any small business is tricky — especially for those with bad credit scores. Fortunately, traditional lenders come in handy as an alternative if you are unable to get a business loan.

When it comes to start-up business financing, revenue-based and debt financing seem to dominate the industry. However, understanding how each of these financing options works, their advantages and disadvantages is imperative. Here is a comparison of revenue-based financing to debt financing for start-ups.

REVENUE-BASED FINANCING

Start-ups and small businesses may reach a point where capital influx is required to take the company to the next level. Besides debts and equity-based resources such as venture capital, Revenue-Based Financing (RBF) is another excellent option. Also referred to as royalty-based financing, RBF is the capital-raising method where investors agree to provide funding to the business.

However, the company has to offer a certain percentage of the existing total gross revenue to the investor. For instance, if you run a small SaaS company and need $1 million as capital, considering revenue-based funding helps you get funds fast at low-interest rates. This financing option is an alternative investment method to conventional equity-based investments such as angel investing.

PROS OF REVENUE-BASED FINANCING

• Founder retains control: RBF works almost like equity financing, where funding is secured through firms or investors. In return, founders have 100% control of the business, including decisions and ownership.
• No personal collateral: Because the financing option is similar to traditional bank loans, payments are made on a monthly basis. Thus, it does not require personal guarantees as collateral.
• Payments reflect revenue: RBF has a flexible repayment method based on the company’s monthly revenue percentage. That is, light businesses get fair amounts, and monthly payments may also vary.
• Swift capital: Revenue-based financing have a much faster approval rate compared to traditional bank loans. Besides, most approvals often depend on the business’s monthly recurring revenue (MRR).
• Mutual incentives: RBF includes a mutual ground that allows companies to generate revenues earlier on their investment. Here, investors get to enjoy a higher monthly percentage once the business receives a higher income.

CONS OF REVENUE-BASED FINANCING

• Rationed availability: Despite having less strict approval requirements, not everyone can qualify for RBF to provide capital for their businesses.
• Inadequate capital: The amount of funds secured is often lower, hence unlikely to provide adequate business growth and expansion capital.
• Monthly payments: A monthly repayment is an excellent option for start-ups and small businesses, but it leaves stress to companies hoping to evade operating at a deficit.
• New financing method: RBF is relatively a new business financing option with limited regulations that may lead to increased scam rates.

DEBT FINANCING

Primarily, start-ups and small businesses access capital from various sources to facilitate growth. Although most of them will use personal saving or other self-funding options, third-party borrowing — in this case, debt financing — has become common. Debt financing is a traditional lending method that offers companies capital in a variety of ways.

Debt financing involves businesses obtaining investment capital with the condition of repaying the principal amount plus interests within a specific timeframe. That is, repaying the total amount borrowed together with an agreeable interest rate. Debt financing is usually secured with collateral, where the lender uses it to recoup losses if the borrower defaults to pay back the loan.

PROS OF DEBT FINANCING

• Preserves company ownership: Like RBF, the business owner will continue to make independent company decisions as the amount borrowed does not signify business shares.
• Flexible repayment period: Here, a start-up can enjoy consistent cash flow essential to provide capital for the business while reimbursing the loan.
• Control over borrowed money: Once the lender disburses the funds, the founder can use it either for individual or business needs, provided it benefits the enterprise.
• Any time borrowing: Based on money usage and repayment period, a company can obtain debt financing any time.
• Available at fixed rates: Unlike equity financing, debt financing is profitable for entrepreneurs as it includes fixed rates. Investors are paid based on the interest rates agreed upon on the contract.

CONS OF DEBT FINANCING

• Repayment compulsions: Regardless of the company’s state, debt funds have to be repaid in total, including interests within the specified period. Whether the business has incurred losses or generated profits, the debt must be settled on time.
• Requires collateral: Borrowers have to provide collateral to secure the loan. Here, business assets are put as debt securities.
• Higher-interest rates: Generally, debt financing includes fixed and higher interests that are likely to impact the business’s investments in case of losses.

REVENUE-BASED FINANCING VS DEBT FINANCING: WHICH IS RIGHT FOR YOU?

Both revenue-based financing and debt financing can help you get the capital you need for your business. However, RBF seems to become ideal more for start-ups and small businesses. This is because they require no collateral, and repayments favour growing companies. On the other hand, debt financing accompanies exciting benefits that can attract business owners.

Which financing option you choose to obtain capital depends on your company goals and other factors. If you need a robust financing option to build your brand and avoid financial difficulties, we here at Betterbanc are always ready to help you. Contact us today to find out more!