What is Revenue-Based Financing?

Revenue-Based Financing is a funding model where businesses receive capital upfront and repay the loan (plus a fee) via regular payments of a percentage of ongoing monthly revenues. Unlike conventional debt financing, which requires fixed monthly payments irrespective of how well a business is doing, RBF payments fluctuate with its revenue stream. The fixed-fee model has an attractive simplicity to it. RBF is also “non-dilutive”, meaning that the owner does not have to give away any equity, as is the norm with equity financing. This makes it a popular choice of fast-growth funding for direct-to-consumer (DTC) and Amazon FBA brands.

Advantages of RBF for E-commerce Businesses

1)     Synchronised with Sales Cycles

E-commerce businesses often experience seasonal fluctuations in sales. Traditional loans with fixed monthly payments quickly turn into financial burdens during slow months. RBF aligns with your business’s natural ebb and flow, allowing for proportional repayments, which can be advantageous during slow months. However, this can mean significantly higher financial obligations during peak seasons.

2)     Aligned Incentives

Both the investor and the business owner stand to benefit from the business’s success, fostering a partnership dynamic rather than the typical lender-borrower relationship. It’s worth noting that if your business does exceptionally well, you may repay the loan quickly at a high effective interest rate (see below).

3)     No Personal Guarantees Required

Unlike certain traditional lending models where the business owner’s assets may be at risk, RBF generally does not require personal guarantees. This aspect makes it especially attractive as a funding option for ecommerce businesseswho are still in the scaling phase. With no personal assets on the line, business owners are more likely to take calculated risks essential for growth, focusing on long-term objectives rather than immediate repayment pressures.

4)     Non-Dilutive

RBF is a source of non-dilutive funding for ecommerce businesses. Debt financing does not require the owners of the business to give up equity for the investment.

5)     Funding for Non-Profitable Businesses

Many traditional financing options require businesses to be profitable. RBF, however, allows companies to secure funding even if they are not yet in the black. This is particularly useful for DTC brands that are in a high growth but cash intensive phase, shifting the focus from immediate financial performance to long term growth potential.

6)     Quick Turnaround Time

While traditional bank loans often involve lengthy application forms, meticulous preparation of business documents, and extended periods of back-and-forth communication, the RBF model offers quick funding for ecommerce businesses. Applicants can typically expect to receive approval within a matter of days or weeks, rather than the months it can take with traditional retail financing options.

However, it's not all smooth sailing with RBF; there are nuances and potential drawbacks to consider as you navigate this financing option.

Evolving Landscape: Is RBF a Sustainable Model?

Recent developments indicate that some financial institutions are pivoting away from RBF despite its rapid rise in popularity in financing DTC and Amazon FBA businesses. For instance, Uncapped, originally built on the RBF model, has officially stopped offering RBF loans as of 2023.  Their rationale is that fast-growth businesses pay a significantly higher effective interest rate due to rapid repayment, while lower-performing companies experience a longer loan period, making it cheaper for them. This dynamic (penalising higher-quality businesses and rewarding lower-quality ones, from the lender’s perspective) has prompted Uncapped to switch to fixed-term loans, arguing that they provide more predictability for clients and align better with the interests of growing businesses.

During the RBF boom, Amazon and Shopify launched their own versions of the model (both opting for Merchant Cash Advance*), aiming to capture market share in this new market among merchants on their respective platforms. Both are still offering these loans, although they do not appear to be marketing them as aggressively, suggesting a potential de-prioritisation. Others have tweaked their approach. RBF innovator Clearco, the largest of the independent RBF providers with a $2 billion valuation, has been downsizing its team since 2022 and testing other business models, although RBF financing remains its core offering. The macro environment is currently more difficult for RBF lenders, since having a portfolio of unsecured loans during a recession is risky. It is also more difficult to offer low fixed interest rates in a high interest rate environment.

While some providers have shifted away from the model or adjusted their approach, many others continue to successfully operate within the RBF sphere. Dublin-based Wayflyer recently secured additional financing of up to $1 billion from investment management firm Neuberger Berman. Clearly there is still appetite in the market for RBF loan assets.

Nonetheless, businesses considering RBF should be keenly aware of both the immediate benefits and the long-term uncertainties associated with this financing model. The evolving landscape underscores the importance of due diligence when selecting a lender.

Risks and Considerations

1)     Cash Flow Commitment:

Managing cash flow becomes critical with RBF. Because you’re committing a fixed percentage of your revenue to repayments, you need to be extra cautious about other expenditures. If your revenues surge unexpectedly, your repayment obligations will climb in tandem, accelerating your debt clearance but also straining your liquidity if you’re not prepared. Conversely, a revenue dip eases repayments but will stretch the loan’s lifespan, potentially delaying other growth investments. This system, while flexible, demands that business owners not only have their financials in order, but also a well thought out strategy for scaling alongside this commitment.

2)     High APR:

The effective APR for RBF can indeed be higher compared to other forms of financing, which some view as a trade-off for the flexibility RBF offers. This aligns with the concerns raised by Uncapped, where businesses that experience strong growth may end up repaying the loan quickly, effectively facing an astronomical interest rate. Conversely, slower-growing businesses may take longer to repay, reducing their effective interest rate but also prolonging their financial obligations. Therefore, it's important to deploy the capital into high-ROI activities to mitigate the impact of potentially high APRs. Businesses best suited for RBF are those that can balance rapid growth with the cost of this form of capital.

3)     Built-in Buffer Needed:

Having healthy gross margins is crucial, not just for the viability of your business but also for managing RBF payments. With thin margins, dedicating a significant percentage of your revenue to RBF payments can put a strain on cash flow, limiting operational flexibility and hampering growth opportunities. A built-in financial buffer ensures that the repayments remain a sustainable aspect of a company’s revenue cycle, rather than an excessive financial burden.

Navigating the Terms: Cost, Rates, and Qualifications

Before diving into RBF, consider your business’s qualifications. Typically, lenders look for companies that have been in business for at least six months and generating a minimum of $10,000 in monthly revenue.

It’s also essential to scrutinise the terms, including fees and revenue sharing percentages. While RBF lenders are often transparent about their fee structures, make sure you understand how it works, how quickly you’ll be able to repay based on your revenue projections and calculate an effective APR. Unlike some other ecommerce funding models that come with a plethora of hidden charges like late fees, RBF lenders usually charge a single flat rate, ranging from anywhere as low as 2% to as high as 12% of the advance amount. The revenue sharing percentage can vary greatly as well, so make sure you understand what you’re committing to.