Funding is never far from an entrepreneur’s mind.
It pecks away at your confidence, undermining decision-making…
What happens when the cash runs out?
Where will I find new investors?
How much equity must I give up to scale my business?
I’m sure you’ve thought out about it once or twice. Maybe a thousand times.
Traditional VC funding comes with a bunch of strings attached. A seat at the board, a transfer of equity, and an unwanted voice at the decision table. It’s a true double-edged sword.
Revenue-based financing, on the other hand, may change that. Indeed, if you own a SaaS business, it might be the best source of funding that gives you the cash you need without having to cede ownership or control over your business.
What Is Revenue-Based Financing?
Simply put, revenue-based financing, or revenue-based investing (RBI), is where an investor funds your business in return for a share of its future revenue. In this sense, the investor shares in your success but doesn’t interfere with your business. You pay a fixed share of revenue each month, usually 3-8%, for a predetermined period or until you hit a cap. These repayments include both a portion of capital lent and a pre-agreed amount of interest.
Caps generally come in two forms. One, a multiple of 1.3x to 3x applied to the funding amount (the principal) or a target IRR (Internal Rate of Return). When the limit is placed on IRR, you’re agreeing to share revenue until the investor reaches a certain return on their investment, which might be sooner or later depending on how well your business performs. Most RBI deals, however, follow the multiple model as it’s simpler to administer and has a certain predictability on the part of the investor.
Let’s say you want $100,000 in RBI funding, for example. Your investor agrees to a multiple of 1.5x on the principal and a monthly repayment of 6% of revenue, which works out at $3,000 per month. If we also assume you generate $50,000 every month of the repayment period, it would take just over 4 years (50 months) to repay the amount due. Once repaid, the deal ends and revenue is yours alone.
Why Is Revenue-Based Financing Such a Good Fit for SaaS?
For investors, high-growth, revenue-driven businesses like SaaS offer exciting alternatives to traditional finance structures. This is reflective of a broader trend towards the securitization of SaaS – the creation of financial products built upon digital, B2B, subscription-model businesses. What’s more, since SaaS businesses tend to operate similarly, investors can take a more holistic view of risk, as noted in this report from Bootstrapp Inc:
“Customer acquisition costs, coupled with standardization of metrics and analysis of B2B software companies, which often deliver their product via a SaaS model, result in the ability for investors to compare companies in a like-for-like manner. This means that investors can
reduce the risk associated solely with the investee, and take more risk by experimenting with new structures.”
From “2020 State of the Industry: Revenue Based Investing”, by Bootstrapp Inc
Bootstrapp estimates around $2.1 billion of RBI deals have already been made, with “7 Kapitus, United Capital Source, Clearbanc, and Braavo … executing investments at a pace which is far and above the other firms by an order of magnitude.” Demand is growing and VC firms, never ones to shirk an innovative investment opportunity, are clearly willing to meet it.
Why Should SaaS Founders Choose RBI Over Alternatives?
#1 No Dilution of Founder Equity
Investors normally want a slice of equity before they hand over any money. This is a lifetime deal (well, unless you buy them out later). When you give away a share of your business, all future proceeds from the sale of that business get split between more people, which means less in the pockets of you and your founding team.
With revenue-based financing, you give up a share of revenue, not equity, and for a limited time only (until the multiple or IRR cap is reached). You could repay in as little as five years or so, depending on the deal and performance of your business. While you should expect to pay handsomely for this type of financing, you still retain ownership, which could be worth a hell of a lot more in the long term.
#2 You Stay in Control
Without relinquishing equity, your investor has less say in how you operate the business. You needn’t stress about another voice on the Board, another person to whom you must justify your actions. Too often funding comes with investors meddling where they ought not get involved – even the best of intentions can mean stress for you. With revenue-based financing, your investors have no control over your business. Provided you’re making the agreed-upon repayments, they’re happy.
#3 No Need for Collateral or Personal Guarantees
It goes without saying you want your business to succeed, and revenue-based financing ties your interests to those of the investor. As a result, there’s less need for personal guarantees or collateral. You might negotiate such terms, but then the arrangement is more like a typical financing deal and will involve a lot more legal and compliance work. Instead, try to settle on an RBI offer that works for both you and the investor. The key here is proving beyond reasonable doubt that your business will continue a strong track record of generating revenue.
#4 You Don’t Need to Be Profitable
While profitability certainly helps get a good RBI deal, it’s not critical, and you can still raise funding before you’ve turned a profit. This is particularly useful if you’re gearing up for or partway through a growth push or need a cash injection to scale. You will, of course, need to demonstrate a viable business model and present a roadmap to profitability. Without this, your investor would be unable to quantify whether you were a risk worth taking.
#5 Faster Than Traditional Financing
Traditional financing often requires lawyers, financial covenants, and a forest of paperwork. RBI structures, however, are much simpler, and usually don’t require any (or as much) form-filling. This should make obtaining funding a little faster, but the investor will still want to know everything about your business. Corl, for example, hitches to your business systems to collect over 10,000 data points. Then its proprietary algorithm gives you a funding decision in as little as 10 minutes, with approvals taking around 24 hours. That’s lightning-fast in the funding world.
#5 You Can Still Sell
If you find a buyer for your startup before you finish repaying the investor, you have a couple of options available to you. One, the buyer takes on the financing deal. Most investors won’t be keen on this as your buyer is an unknown quantity that could impact their return on investment. Your second, more likely option is converting what’s left of the repayment amount into equity. Not ideal, but at least you can grab a great acquisition offer when you get one and probably won’t be giving away as much equity had you raised funding the conventional way.
Does Your Business Qualify for Revenue-Based Financing?
RBI criteria vary from VC firm to VC firm. Most want to see 3-5 years of solid revenue generation in excess of $200,000 (per year). As I wrote earlier, high-growth SaaS businesses are first in line given their recurring-revenue business models. However, you need to persuade the investor your business is gathering steam on an upward trajectory and won’t tumble down from the sky a year from now.
Revenue-based financing isn’t for struggling businesses nor is it right for those still finding their feet. It’s best thought of as an accelerant, “turbo” mode for businesses already racing to the top of their verticals. You needn’t use all of the funding at once, either, but instead draw on what you need to outpace the competition, which avoids wasteful spending.
For more specific requirements, check out this list of the top RBF vendors:
Before you rush into a revenue-based financing deal, consider this: do you really need funding? It’s tempting to spend your way out of problems or burn cash to achieve scale. But will this help you achieve a life-changing acquisition? Perhaps, and if so, revenue-based financing presents a uniquely attractive package for the right businesses. You get the cash you need without giving up equity, and that means a bigger share of the proceeds from an acquisition when you move on to your next adventure.
