Income-based financing: compare the best options
If your business has significant recurring income, income-based financing can provide growth capital without sacrificing equity. Find out if it’s right for your business.
What is revenue-based financing?
Income-based financing, also known as income-based investing or revenue share financing, is a form of financing that enables small businesses to obtain financing and repay it from future revenues. Payments are based on a weekly or monthly percentage of earnings until the funding is paid back along with the fee, which is usually in the range of 3 to 7 times the initial investment.
This is how revenue-based financing works
Income-based financing, or income-based investing, typically describes an arrangement where investors fund companies with strong ongoing revenues. Often times, the companies that provide these loans specialize in certain types of high-growth industries such as software as a service – also known as Saas companies. It can be an alternative to traditional venture capital or angel investment structures that require the company to give up some of its equity in exchange for financing.
Unlike a traditional small business loan that requires fixed monthly payments (or sometimes weekly payments), income-based financing offers more flexible repayment terms. The financing investors or the financing company receive a percentage of the future income until the agreed total repayment is reached. When receipts are lower, payments get lower, and when they increase, payments go up.
There will be a repayment cap that will determine the total cost of the financing. It can be up to 1.35% of the initial investment amount or up to 10%, although there is no legal limit that limits the amount of fees these companies can charge.
Advantages and disadvantages of revenue-based financing
- More flexible eligibility criteria than loans
- The owner can avoid a personal guarantee
- Payments fluctuate with income
- No dilution of equity
- Fast financing
- Cost of capital higher than traditional commercial loans
- Requires significant recurring revenue
- Not available for all industries
Income-based financing is usually more flexible than standard small business loans, which require at least a few years in business, good credit history, and strong income. The entrepreneur can also waive a personal guarantee.
This type of funding doesn’t require the small business to give up equity, but it is likely more expensive than a traditional small business loan such as a commercial bank loan or even an SBA-guaranteed loan.
Income-based financing vs. debt and equity-based financing
Leverage is another term used to describe a business loan. With this type of financing, business owners borrow money and pay it back over time with interest, usually through monthly payments. The cost of finance can be described in terms of an interest rate, fee, or other terminology. (In most cases, small business lenders are not required to provide an annual percentage (APR).
Some small loans have very low interest rates. Traditional bank loans and SBA loans guaranteed by the Small Business Administration often have the lowest interest rates, although microloans and some online loans are also relatively cheap.
The advantage of a small loan over RBF is usually the cost. Borrowers who qualify for a small loan at a low interest rate are likely to find this option cheaper than an income-based financing arrangement.
On the other hand, small business loans require regular payments that are difficult to afford, especially for a new and growing business that is subject to fluctuations in sales.
Equity financing enables companies to obtain financing from investors, be they private equity investors, angel investors, or venture capitalists. There is even some kind of crowdfunding that enables companies to raise money from a large number of investors.
The advantage of equity investments is that they can be structured without payments. Investors pay out when a liquidation event occurs (e.g. an IPO or an acquisition). However, the advantage of RBF over this type of financing is that it does not require the company to forego equity. The business does not give up control of the business
Tariffs and conditions of revenue-based financing
Income-based financing can be structured in a number of ways, but the key feature is that payments are linked to gross receipts. When revenues go down, so do payments. Increased revenue will allow the company to repay the funding faster, but this will likely not reduce the total amount owed.
Here is an example of how this funding can be structured:
Lighter Capital, a leader in this type of financing, provides loan amounts of up to $ 3 million to technology companies with monthly recurring revenue (MRR) of at least $ 15,000 in the last three months and at least five customers receiving products or services. Borrowers can qualify for a loan of up to 33% of the annualized earnings term. (To illustrate, the example on their website shows that a company that has $ 1 million in revenue this year could get a loan of about $ 330,000.) Payments are based on a fixed percentage of income, which is between 2 and 8%, but not more than 10%.
How to qualify for income-based financing
Real income-based finance has very specific requirements. The first and foremost requirement for this type of funding is that the company has sufficient recurring income. As mentioned earlier, it is typical with this type of financing that companies (or investors) look for companies in certain industries, such as technology companies, with a track record of generating recurring income and strong growth potential.
As part of the application process, the company must be able to confirm the source of income and possibly also document how it is using new funds to grow the company. Minimum recurring income requirements of at least $ 10,000 to $ 20,000 or more per month would not be uncommon. There may also be annual income requirements.
This is how you receive sales-based financing
Ideally, when looking for a small business, you should look for financing options that best suit your business needs and that you qualify for. Because RBF is available through specialized finance companies, your options may be very limited. You may find potential investors from the investment community or maybe from a trade association or network with other entrepreneurs in your industry.
If you don’t meet the rather narrow criteria for RBF, consider looking at other types of funding based on income. For example, companies with solid monthly earnings can qualify for a dealer cash advance or a business advance. Both products provide advances on future sales and rely largely on recent sales (often in the past 6-12 months) to make a subscription decision. MCAs and BCAs are widespread for many types of businesses as long as they have adequate income. The creditworthiness requirements are usually very low.
Another revenue-oriented form of financing is receivables financing or invoice financing (or factoring). With this type of financing, the company pledges income from sales that have already been made but not yet paid for.
Knowing which type of financing is right for your business can be confusing. One option is to partner with a small business finance marketplace that can tailor your business for finance based on your qualifications.
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