Among the options available to small businesses, revenue-based financing (RBF) seems to be getting more attention recently. It’s structured like a loan and the repayment is tied to a percentage of the company’s monthly revenue. The main attraction for entrepreneurs, accordingly, is that it’s promoted as a way to finance rapid growth without giving up equity and control.
These loan products are marketed through niche lenders. And like much in the internet age, the promise is that the deal can be done quickly and with less documentation. But as we shall see, they are much more expensive than conventional financing through a bank or a nonprofit lender, such as CEDF.
I love creative financing concepts. I bought my first business using an arrangement somewhat related to RBF (but on much more reasonable terms). But, these costs reminds me a bit too much of the “easy internet lenders” that we warn about at CEDF.
Looking at some of the funders’ websites showed some variety in the terms. The minimum monthly revenue of the business might range from $15K to $30K. Maximum funding was listed as 1/3 of annual revenue in once case and six times monthly recurring revenue in another. To qualify, businesses have to have gross margins better than 50%. This is because if one has to budget 3% to 10% of monthly revenue (debited out of your bank account) to repay the financing, there had better be enough profit left over to run operations.
The term repayment cap is used to describe the total cost of capital. This can range from 1.3 times to 3 times the amount borrowed. On the low side that would mean repaying $65K on a $50K loan or even $150K on the same $50K financing. A three-year $50K SBA Microloan at 7.5% would have a total repayment of $55,991, which equates to only 1.12X the financed amount. The terms are said to be three to five years, which is comparable to an SBA Microloan. So one can see there is an enormous cost associated with the corner-cutting that an RBF might provide when it comes to the application and qualification process.
Of course, it might be comforting to think that as revenue fluctuates the repayment commitment will flex too. But the lenders have baked this into their own qualifications. That’s why they are offering to fund businesses with subscription-based or other stable revenue sources.
Bottom line is that old-fashioned loans from banks or alternatives from community lenders are still the least expensive way to borrow, unless of course, your Uncle Bob is simply willing to forgive your debt.