Revenue-based financing now has its seat at the table of popular funding options for tech companies. Where there were only a handful of revenue-based financing funds a few years back, there are now 25+ in the marketplace, meeting the surge in demand globally.
Much of this demand comes from the fact that revenue-based financing provides an innovative, flexible solution for the needs of tech entrepreneurs in certain common scenarios. Here, we’re going to look specifically at what these scenarios are and when revenue-based financing is right for your tech company.
Before we get into it, let’s first understand the basic mechanics of revenue-based financing.
How revenue-based financing works
With revenue baked into the name of this type of funding, it shouldn’t come as a surprise that revenue-based financing revolves around leveraging early-stage tech companies’ cash flow for growth.
For consumer or enterprise SaaS companies with paying customers, revenue-based financing involves capital is provided in exchange for a percentage of ongoing revenues.
Unlike venture capital investments, returns for investors are determined in advance in each funding agreement. And compared to typical fixed-payment, interest-based loans, flexible royalty payments allow your repayments to scale with your cash flow.
So in the case that your revenues dip momentarily, you don’t have to worry about a fixed payment cutting deep into your cash reserves, prohibiting you from reinvesting or covering basic operating costs.
How this works for us, in concrete terms, we cap our returns at 1.2x to 1.9x the invested capital, and typical royalty payment terms are between 4% and 9% of gross monthly cash receipts. To dive even deeper into revenue-based financing 101, check out our other article here.
Scenarios where revenue-based financing shines
With a high-level grasp of what revenue-based financing is and how it works, when is it the best fit for your tech company? What scenarios are better for revenue-based financing than others?
Here are some specific situations where this type of financing can make a huge, positive impact on your company’s growth.
1. You want to hire someone but don’t have cash to do so
You’ve probably felt the tension between cash on hand and the desire to hire more talented team members. Whether you run a bootstrapped or venture-funded tech company, sometimes it’s a challenge pulling together the capital required to expand the sale or marketing teams.
This is especially true if you’re trying to do so quickly. There’s often simply no way to fundraise a new round of capital for the hiring of a single new, high impact team member, and traditional loan applications are bureaucratically tedious and time-intensive as well.
In this situation, revenue-based financing is a great option due to its speed. As is the case with our operations, we make our investment decisions in about 15-30 days. That means we’re happy to run alongside you to get the financing you need to grow.
With new capital invested within a reasonable timeframe, you can hire new team members to fuel growth and continue to reinvest money back into your team. In this scenario, revenue-based financing can help get this virtuous growth cycle off the ground without having to wait long.
2. You want to increase the size of your round without selling more equity
If you have in the past or are currently in the process of fundraising venture capital, you know success is found between securing the most capital possible while doing so with the best possible terms. This is a common tightrope act for many founders, but it doesn’t necessarily have to be.
Revenue-based financing can enter rounds beside venture capital investors and angels. This allows you to increase the overall size of the round without any further dilution.
As was the case with Rentable, one of our later-stage tech company partners, founders raised a combination of equity from venture capital firms as well as revenue-based financing from us. The revenue-based funding arrived in the company’s accounts quickly, allowing Rentable to hire new, mission critical members of the sales team to propel growth.
3. You operate in a niche market
If you’re in a niche market and have tried fundraising venture capital, then you probably already know how difficult it can be. To work your way around this issue, you probably had to find ways to justify the market opportunity.
This comes from the fact that venture capital requires massive upside, meaning you’re either trying to disrupt an already huge market or you’re in a market poised for exponential growth. Beyond those two options, there isn’t a lot of room in venture capital for small to mid-sized tech companies in small to mid-sized markets.
Here, revenue-based financing is an exceptionally good fit. Since we earn our returns through a monthly royalty payment based on your company’s cash collected on sales, there is no pressure from us to become a unicorn, get acquired, or go public.
If you want to become one of the world’s biggest companies, then we’re here to support that. If you don’t want that for your business, then that’s a-okay with us as well! Revenue-based financing can deliver the funds you need without pushing an exponential growth imperative onto you and your business.
4) You need a bridge between rounds
For venture-backed, early-stage founders, the term “bridge round” can make the hair on the back of your neck stand up. They can be quite messy and difficult to navigate. You don’t want to sell equity to existing investors in a way that is extremely expensive for you. You don’t want to see your company’s valuation drop either, creating potential red flags for future investors.
Navigating this situation can be quite tricky, especially when you’re primarily focused on closing venture capital funding. Here though, revenue-based financing is a great solution to side step these challenges.
Revenue-based financing can effectively fly below the radar of venture capital investors to provide you with the capital you need to get to your next round. That’s because revenue-based financing prevents more dilution, keeping current and future investors happy as well as maintaining your equity stake as founder.
Without shedding equity and altering the valuation of your company, revenue-based financing can lend you what you need to continue improving your company performance metrics.
5) A customer acquisition opportunity is there, but the budget isn’t
You’ve found a great customer acquisition opportunity and are itching to pursue it with your team. Only issue is, you don’t have as much of a budget for this growth campaign as you wished. And the last thing you want is your growth to be restricted primarily by cash.
Whether it’s through marketing, advertising, or increased outbound sales, revenue-based financing is a prime candidate to help you solve budgetary constraints.
There’s no one-size-fits-all funding solution
Each one of these scenarios leverages the core advantages of revenue-based financing. It’s generally fast paced, flexible on repayment terms, and doesn’t dilute founders or other existing investors. Any situation where one, or all, of these three things are a priority for you, then you should consider revenue-based financing.
That said, these are all particular scenarios. We don’t want to paint the picture here that there is a one-size-fits-all type of funding for every tech company. There certainly is not.
In some scenarios, venture capital can certainly be a much better option. Specifically for businesses in the pre-revenue stage, revenue-based financing won’t act as a good fit.
Or if you’re running a capital intensive, research-oriented tech company, revenue-based financing, at least at this stage of its evolution, is not going to provide that needed $50-100m+ in funding for long research and development cycles.
Helping you get to the right funding solution
Getting to the bottom of when revenue-based financing will be the best option for your company is no easy task. We know how difficult finding the right answer for funding can be because we’ve been in your shoes and have lived through many of the scenarios above as founders.
Each member of our team has experience with early-stage technology companies and the day-to-day challenges of running a tech company.
That’s why we prioritize transparency in the funding process and close relationships after money hits your bank account. We make our funding decisions quickly, usually within 15-30 days, and often work closely with our portfolio to provide support in our areas of expertise: sales, strategic planning, and hiring new talent.
If you find yourself in one of these scenarios or are thinking through how revenue-based financing can help drive growth, then let’s talk about it. Reach out to us by completing the Get Funded form on our homepage, and we’ll get something on the calendar.