What Is Revenue-Based Financing?
Business financing comes in multiple forms, from traditional business loans to business-friendly revenue-based financing. Are you an eCommerce merchant looking for financing? Are you asking what is revenue-based financing? The global revenue-based financing market is expected to grow by an estimated 61.8% CAGR by 2027. As a result, businesses need to consider revenue-based financing to stay functional and productive.
The concept of revenue-based financing has been around for centuries. However, it is not until recently has it gained traction in the eCommerce industry. What is revenue-based financing and how does it help eCommerce businesses? This article defines revenue-based financing and highlights how it works as well as helps the growth of eCommerce businesses.
Revenue-Based Financing: Definition
Also known as royalty-based financing, revenue-based financing is a capital-raising method for businesses from investors or revenue providers who expect and receive a percentage of a business’s ongoing gross revenue in exchange for the funds they invested. In a revenue-based financing/investment model, the investors receive regular business income shares until the business pays a pre-determined amount of money. In most cases, this pre-determined amount is a multiple of the original investment amount.
How Does Revenue-Based Financing Work?
Revenue-based financing differs heavily from debt financing for several reasons, although in both cases, a business is required to make regular payments to pay an investor’s capital. For starters, revenue recipients don’t have to pay interest on outstanding balances.
In addition, RBF doesn’t have fixed payments. This is largely due to the nature of revenue-based financing, which requires that a business should make regular payments directly proportional to how the business is performing.
It is worth noting that revenue-based financing isn’t a loan. However, some businesses consider it a hybrid between equity and debt financing. Unlike in equity financing, investors in revenue-based financing lack direct ownership of the enterprise. Unlike revenue-based financing, investors may require holding business assets as collateral in debt financing.
Related: Financing ECommerce Tips for Small Businesses
How do revenue-based financing providers determine funds eligibility? Banks and traditional lenders take into account factors like credit history and the ability to repay funds to determine eligibility. On the other hand, RBF providers evaluate an applicant’s historical and projected revenue to determine eligibility and the amount to be financed. An ecommerce business with positive unit economics stands a higher chance of getting revenue-based financing than one with less.
Why Do You Need Revenue-Based Financing?
What is revenue-based financing to an entrepreneur, startup or small business? It is a practical option to consider if you want to scale your business growth. Here are a few best-case scenarios to consider revenue-based financing for your eCommerce or physical business:
- Your business is growing rapidly, and you need more cash for revenue-linked expenditures like inventory and ad spending.
- Your business has enough cash flow to match working capital needs and plans on expansion, but metrics don’t favor your plans to mobilize funds from investors, yet you don’t plan on diluting your business equity.
- Your business receives a significant order but lacks the requisite capital to fulfill the order. Additionally, you may also want to maintain sufficient capital for optimal liquidity.
Revenue-Based Financing and Ecommerce Businesses
Do ecommerce businesses need revenue-based financing? Generally, businesses require access to funds to complete their daily operation, such as inventory acquisitions. Ecommerce businesses regularly face working capital shortages, according to The Techcrunch. With eCommerce retail businesses having received $16.8 billion in funding in the second quarter of 2021, there is an expected need for more funding, as eCommerce businesses are becoming the norm.
Yes, eCommerce businesses need funding. But practical methods of getting business funding are limited to debt financing and equity financing, which involve an intensive funding-application process. What is the alternative?
Revenue-based financing is the next best funding method for eCommerce businesses looking to get fast funding. You no longer have to constantly gamble on the possibility of getting alternative financing such as loan financing. Revenue-based financing increases your business’s chances of getting cash must faster.
Why Do Ecommerce Businesses Need Financing?
Ecommerce businesses often face massive cash flow setbacks. These businesses need cash constantly and should have easy access to funding. Despite the several forms of eCommerce funding, revenue-based financing is more practical and is less likely to place you among the 90% of eCommerce businesses likely to fail due to lack of funding. But why do eCommerce businesses really need funding?
Related: Everything You Need to Know about ECommerce Cash Flow
One of the biggest costs an eCommerce business typically experiences is purchasing inventory. Ecommerce businesses typically source products from Asia for relatively low and affordable product prices. One of the most prevalent benefits of purchasing inventory from the Far East is the possibility of a higher gross margin.
As an eCommerce business owner, you need constant funding to match the hectic nature of dealing with international product suppliers. Most suppliers have unfavorable payment terms, which is why your eCommerce business needs quick-access funding.
Some suppliers typically demand 30% payment on order and the remaining 70% on shipment. Such poor payment plans and terms can create cash flow challenges for your eCommerce business. Unfortunately, the financial woes don’t end there.
At the cost of scaling up and rapid business growth, you may need to purchase more inventory to meet the rising demand for your products. This translates to an increased demand for more and quicker financing. During peak seasons and holidays, the need for quick and sufficient working capital proportionally rises with the need for seasonal products.
Does Revenue-Based Financing Help Ecommerce Businesses?
Yes, it does. Revenue-based financing is an alternative to traditional debt financing and equity financing. As a rapidly growing eCommerce business, you need to purchase inventory at a moment’s notice. While they have their place in a capital stack, debt financing, equity financing, and other financing options won’t provide you with the convenience of revenue-based financing.
Benefits of Revenue-Based Financing or Ecommerce Businesses
There’s a reason so many eCommerce sellers are asking what is revenue-based financing? It’s a smart way to solve your cash flow problems fast and effectively without subjecting your eCommerce businesses to the setbacks of traditional funding options. Here are the reasons (benefits) an eCommerce business should consider revenue-based financing.
More Working Capital
As previously noted, cash flow is the biggest reason a business needs financing. Revenue-based funding conveniently provides you with funding to help you fulfill working capital needs. Consequently, you don’t have to use personal funds or attempt to economize on the growth expenses.
RBF Prepares an Ecommerce Business for Peak Seasons
Peak seasons translate to a massive increase in product demands and revenue. You need to be able to pay for inventory upfront at a moment’s notice. Your business’ cash reserves influence how much you can spend on ads and marketing and how much inventory you can acquire, and, ultimately, your profit margins. Revenue-based financing helps you monetize seasonal opportunities effectively.
No Collateral Required (Protect Your Equity and Maintain Control)
Traditional funding options such as equity financing come with strings attached, such as giving up partial ownership and control of your company. This way, investors can make major company decisions that may not be entirely favorable to you.
Fortunately, revenue-based financing doesn’t need you to give up board seats, shares, or warrants. Revenue-based financing doesn’t require you to submit collateral typical with bank loans.
Simple Application Process and Quick to Fund
A simple one-page application is all you need to apply for revenue-based funding. You may only be required to submit the last three months’ bank and merchant service statements to access the funding.
Some revenue-based financing providers connect to your bank and eCommerce store for easy access to information they use to determine eligibility amounts. This was, you don’t have to submit endless documents and information besides personal and business information. Fortunately, once your application goes through, funding takes place in a few days at least. It is a fast and convenient way to get funding for your eCommerce business.
RBFs are Easily Accessible Unlike Bank Loans
Banks and traditional lenders will happily provide financing to well-established businesses with clean track records. This isn’t the case for eCommerce businesses. Banks and conventional money lenders are risk-averse. This means they lend money strictly to reputable, low-risk businesses.
They also demand collateral to cover their losses in case a borrower defaults. Asset-light ecommerce businesses mostly lack the assets such as cars, real estate, or equipment to meet collateral needs.
Banks and other financial institutions offer unreasonably high-interest rates and even higher rates for high-risk businesses. They also offer teaser rates and dramatically increase after the initial promo period. Revenue-based financing providers offer low and favorable rates to businesses.
Ecommerce is a risky and somewhat volatile business, particularly because of the fast-changing, highly competitive environment for eCommerce business owners. Performance metrics for such businesses are relatively newer to banks and financial institutions. Fortunately, revenue-based spending doesn’t consider your credit history or high risk-return profile.
What is the Cost of Revenue-Based Financing?
RBF providers make money by charging their clients a percentage fee on the funds they provide. The fee usually ranges from 2% to 8%, depending on business size and performance. Here is a short demo:
If you want $100,000 in funding, and you agree on a 5% fee with the RBF provider, the fee you pay will be $5,000. Is the $ 5,000 fee worth it?
If you buy inventory worth $100,000 and sell it at 2x markup, you will make a $200,000 gross revenue and get a $100,000 gross profit. The $100,000 gross profit is 25 times higher than the $4,000 fee you pay the RBF provider.
Therefore, besides being a convenient mode of getting fast funding, revenue-based financing can also help you realize an impressive Return on Investment. Some providers charge fees as low as 1%.
Should You Get Revenue-Based Financing?
Revenue-based financing solves the major challenge for most eCommerce businesses—cash flow. Most ecommerce businesses lose sales due to poor cash flow, thus affecting the business’ bottom line. Like traditional, physical businesses, eCommerce businesses also need to spend on marketing, branding, and legal issues.
If you run an eCommerce business, you will need access to funding to cater to purchasing inventory at a moment’s notice and pay for marketing, branding, or any arising expenses. There are several options to help you source funding for your eCommerce business, from loan financing to equity financing.
Unfortunately, none of these is as reliable as revenue-based financing. The application is faster and more friendly for any business model with RBF. More importantly, revenue-based financing has minimal credit requirements and short financing terms, making it perfect for a small to medium-sized eCommerce business.
Get started with Onramp today and get the cash you need without all of the risks.