This Attractive Borrowing Option Offers Growing Businesses Strong Benefits
Recently, I was introduced to a new type of funding mechanism available to entrepreneurs that I found fascinating: financing with revenue sharing or loans with revenue sharing. In short, a revenue share loan is money received by investors in the form of debt issued to a company. Reimbursement terms are based on a percentage of recurring gross revenue.
This type of debt financing, also known as royalty-based financing, is a hybrid between traditional loans and equity financing and has a number of advantages that set it apart.
No capital is exchanged for the investment.
Companies are not required to provide guarantees, personal guarantees or other security.
The investment may be subordinated to future debt.
No interest is paid on an unpaid balance.
There are no fixed payments, but rather payments depending on the company’s income.
This last distinction is important because the payments are proportional to the performance of the company. During months of poor sales or seasonality, companies are required to make lower payments. On the other hand, when sales are strong, entrepreneurs should expect to pay more.
Of course, this type of financing depends on two very important aspects of the business.
The business has generated and is expected to generate ongoing and recurring revenue.
The company has gross margins high enough to allow for revenue sharing payments.
Again, this last distinction is important and, if ignored or underestimated, can have a very detrimental effect on business growth.
Since this type of financing presents a higher risk for investors, their expected return on investment is higher than traditional lending instruments. According to Zendesk.com, typical terms for revenue-sharing loans are as follows:
Revenue share payments: between 2 and 10%
Percentage of revenue to be applied to loan repayment as a percentage of primary revenue, i.e. revenue before any expenses or cost of goods sold.
Total return: 1.5x to 3x
The multiple of the amount invested that investors expect to receive. The range will depend on the level of risk assumed by investors.
Loan term: 3 to 5 years
The time it would take, based on the company’s financial projections, to repay the total return to investors. Revenue share payments are based on this assumption.
Maturity: 6 to 8 years
The time at which companies would make a full and final payment to investors for reaching their maximum total return, if that amount had not yet been reached.
Like any financial decision for your business, entrepreneurs should consult with their financial planners, accountants, and lawyers before taking on any type of financing to ensure it fits into their business’s growth strategy and capacity.
That said, for companies that have established revenue but may have found attempts to grow slow and tedious, using debt as a means to fuel that growth can be a good strategy, and equity financing income is a worthy hybrid.