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Explained | What is revenue-based financing and why it is becoming popular

Many early-stage ventures and even small businesses are opting for revenue-based financing (RBF) instead of approaching venture funds or angel investors. Below is a primer on how it works

May 07, 2021 / 06:59 PM IST

Many early-stage ventures and even small and medium enterprises (SMEs) are now opting for revenue-based financing (RBF) instead of approaching venture funds or angel investors. If you are wondering what is the fuss about, here is a primer.

What is revenue-based financing?

Revenue-based financing is a model for raising funds based on the ongoing revenues of the company. Simply put, a company can pledge a part of its annual revenues in return for growth capital. Typically, early-stage ventures and even SMEs nowadays prefer revenue-based finance as they can get access to funds without any form of collateral or equity dilution. It is considered to be a good source of capital raising for the smaller businesses as it is likely that the quantum of funds they might be looking at would not be significant and the VCs would not entertain pitches or proposals for such fund requirements.

How does revenue-based financing work?

There are firms that specialise in revenue-based financing. To start with, these companies look at parameters like revenues, cash flows, operating margins, scalability and growth potential among other things as part of their due diligence. Once convinced with the potential borrower’s prospects, they lend the required capital at a mutually decided rate of interest or fee. Interestingly, this is quite similar to how an angel investor or even a VC would function, but what makes revenue-based financing different is the manner in which the funds are repaid by the borrower. The borrower commits to sharing a part of the business revenue with the lender. In other words, both the principal and the fee or interest that the lender charges, is returned from the revenues that the company earns during the normal course of the business.

What are the advantages of revenue-based financing?

The advantages are manifold. The biggest advantage is that promoters of the borrowing entity do not need to dilute any stake or bring any collateral even while getting access to the much-required funds. This is just not possible when raising funds from angel investors or venture capital firms. Incidentally, this also ensures that promoters continue to enjoy complete freedom in managing the affairs of the company. Typically, entities like private equity or VCs insist on a board seat and are known to interfere in the way businesses are managed in their investee companies. Secondly, revenue-based financing can be helpful to ventures that cannot get bank funding due to lack of collateral or profitability or any other reason that could act as a hindrance.

How is revenue-based financing picking up in India?

There are firms that specialise in revenue-based financing. Some of the prominent names in India include GetVantage, Klub, Velocity Finance and N+1 Capital among others. The growing popularity can be gauged from the fact that the last 5-6 months have seen nearly 100 revenue-based financing deals in the country. The ticket size could be as low as Rs 5 lakh while going up to a few crores depending on the specifics of the deal.

“Revenue-based financing is essentially simplified venture financing without the hassles of collateral or stake sale. It is like founders helping other founders,” said Bhavik Vasa, Founder & CEO, GetVantage.

“We charge a flat fee for the financing and the borrower returns the principal and the fee in the form of sharing a percentage of the future cash flows. It is an excellent avenue for emerging businesses especially SMEs that are in abundance in India. Revenue-based financing may be looked upon as an alternate source of funding today but it is only a matter of time it would be mainstream,” said Vasa.

While revenue-based financing is a relatively new segment in India, it is a huge market in the US and European region with players like Bigfoot Capital, Uncapped, Lighter Capital, Fleximize and Decathlon Capital Partners among others.

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Ashish Rukhaiyar is a financial journalist