What is revenue-based financing?

Revenue-based financing is a broad term that covers several types of small business financing. Some use it to refer to investor financing — where your business applies for a venture capital fund or pitches to an angel investor. Other business lenders may use the term to refer to business loans mostly based on your business’s past revenue rather than your creditworthiness.

Revenue-based financing can be a solid option if you have a steady stream of revenue but don’t quite match up to a traditional lender’s qualifications. You might want to use your revenue as collateral to secure a loan. There’s a host of ways you can use revenue-based financing.

What is revenue-based financing?

Revenue-based financing is any financing that bases repayment on the number of sales coming in, often taken as a percentage of the revenue or sales. It may also base approval more on the volume of sales rather than your business’s creditworthiness. This fact can make revenue-based financing easier to qualify for if you don’t have prime credit.

Types of revenue-based financing

Revenue-based financing can come in a few different forms, including:

Revenue-based financing vs. merchant cash advances

Many lenders use the term revenue-based financing and accounts receivable financing or merchant cash advances interchangeably. If you read through the lender’s description of revenue-based financing, you’ll find that they require you to repay a percentage of your sales until the loan is paid back. Accounts receivable financing is another similar, common term referring to any financing you’re eligible for based on your accounts receivable amounts.

Revenue-based financing vs. equity financing

Revenue-based financing isn’t exactly the same as equity financing. Equity financing is when you sell equity in your business in exchange for funding. This is the case when you use a venture capital fund or angel investors. But other types of revenue-based financing, like merchant cash advances, don’t sell shares of your business to investors. Those types would be considered debt financing instead of equity financing because your business is taking out a loan it must repay.

How does revenue-based financing work?

While any lender will look at your business’s revenue, revenue-based financing may consider your revenue more than the creditworthiness of your business. The lender will require you to submit your bank statements, financial statements and invoices if applicable. It will then determine you’re eligibility for funding and how much it can offer.

Some forms of revenue-based financing will advance you a portion of your revenue, such as 80 to 90 percent. You then repay the funding as your sales or revenue come in.

In the case of venture capital financing or angel investing, the investors will consider your business’s overall potential. You will still pay them using equity in your business, but the financing is less based on the exact amount of revenue and current cash flow and more on your business’s high-growth potential.

When should you get revenue-based financing?

Revenue-based financing is helpful when you don’t qualify for traditional business loans, possibly because you have poor credit or are a new business.

You may also choose revenue-based financing if you prefer to get investors involved in your business. Venture capital or angel investors will often mentor you while providing capital to grow your business.

The exact type of revenue-based financing you choose may depend on whether you want to keep equity in your business and simply use revenue as collateral. Or you might prefer equity financing because you’re willing to work hard to make your business successful.

Alternatives to revenue-based financing

Revenue-based financing isn’t the only type of business financing you may qualify for, even if you have subprime credit. Look into lenders with these types of business loans:

• Term loan. A term loan looks at your business’s financial statements and determines an amount that you qualify for. You then pay a fixed payment plus interest until the loan is repaid. The payment is usually a monthly payment, which provides flexibility in your business budget.
• SBA loan. SBA loans are designed to help businesses that don’t qualify for a conventional business loan. The easiest type of SBA loan to qualify for may be the SBA microloan, which is usually offered through nonprofits with more lenient requirements, such as a 500 personal credit score.  
• Business grant. A business grant is a form of funding you don’t have to repay. That said, every grant has different requirements, such as being in a specific industry or having a winning pitch to a board or investors. As grants don’t require repayment, they’re very competitive.
• Crowdfunding. Crowdfunding for business may involve raising capital that you repay. You can also use traditional crowdfunding platforms that don’t require repayment and instead offer equity or rewards to investors.
• Business credit card. Business credit cards don’t have the same stringent revenue requirements as business loans. You can charge small to moderate expenses to the card, and if you pay in full monthly, you’ll avoid interest payments.

Bottom line

Revenue-based financing relies on your revenue more than your creditworthiness to determine your eligibility for a loan. In some cases, it may be repaid through a percentage of your sales. But, revenue-based financing can come in many forms, including debt or equity financing. The exact amount you repay will depend on the terms of your financing agreement.

Frequently asked questions

• What percentage of revenue do you give for revenue-based financing?

  The percentage of your revenue that you give depends on the type of revenue-based financing. It can vary significantly, such as requiring 10 to 20 percent of your future sales for a merchant cash advance. But an investor may want a higher percentage. You’ll want to see what you qualify for when you apply for financing and determine whether you can handle that amount.

• What is the difference between invoice factoring and revenue-based financing?

  Invoice factoring could be considered a type of revenue-based financing. With invoice factoring, you sell your invoices to the factoring company, which pays you 80 to 90 percent of the invoice amount upfront. Once your customers pay the factoring company, you’ll receive the remaining amount minus any fees.

• What is the difference between venture debt and revenue-based financing?

  Venture debt could be considered a form of revenue-based financing. Venture debt is a loan typically reserved for high-growth startups or businesses that are venture-backed. It can help businesses with working capital and additional funds until their next round of funding. Like other types of revenue-based financing, venture debt is based on the business’s potential for growth and equity instead of current cash flow.

• Is debt or equity financing better for a startup?

  Either debt or equity financing can be helpful for a startup, but it depends on your goals and what you qualify for.<br /><br />If you want to keep equity in your business, you’ll need to go the debt financing route. But if you want to raise funding that you don’t have to repay immediately but are willing to work to make your business successful, you might use equity financing through investors.