What is the best option for a small business owner with bad credit who needs capital to grow their business? During the current financial climate, many small business owners with poor credit history who were considered “un-bankable” by traditional bank lenders have found Revenue Based Financing as their best option. This kind of funding, also know as Royalty Based Funding has been around for a while in non-tech industries like raw mineral mining, movie production and pharmaceutical development, but it’s recently gaining strong popularity for financing small business growth.
What is Revenue Based Financing (RBF)?
Revenue based financing is also known as royalty based financing. Revenue based financing has been used for decades. Through an alternative lender, investors will provide funding for a business and in exchange, the business agrees to repay the loan with a small percentage of it’s revenue. In a revenue based financing investment, a predetermined financing amount is set and investors receive a cut of the businesses sales until both the borrowed amount and financing fee is paid back. Usually, this predetermined amount is a percentage of the principal investment. The finance fee is taken in the form of a “royalty” which can vary from a percentage of the gross sale of each specific item or the gross monthly sales of the entire business.
If you’ve ever watched ABC’s “Shark Tank”, Kevin O’Leary, AKA Mr. Wonderful, is notorious for soliciting revenue based financing offers he wants to invests in. The reason Mr. Wonderful loves revenue/royalty based funding so much is because it is usually a win/win for the business and the investors.
What are the Top 10 Benefits of Revenue Based Financing?
Generally speaking, business owners get the funding they need to grow without sacrificing any ownership of their company, and the added benefit of not adding any debt to their personal or business credit history. Royalty based funding gives a business the freedom to grow with flexible payments structured around revenue and no fixed payment schedules. Since the royalty fee is based on business revenue, past bad credit history of the business owner is usually never a factor when an alternative lender whether to provide revenue based financing.
No Loss of Business Equity
Revenue based financing is not venture capital. In a venture capital investment deal, the business sells part if it’s equity. Selling off equity to raise capital, can place a pressure on both business owners and investors. If the business doesn’t succeed after the funding is provided both the business owner and the investors can be at risk. Revenue based funding provides entrepreneurs the security of not risking the loss of ownership, or collateral. In general, revenue based financing companies work more closely with you than banks, but exercise a more hands-off approach than a venture capital firm.
Flexible Payment Terms
Revenue based financing models are usually structured with a multi-year repayment term where a company agrees to pay a fixed percentage (typically 1% to 3%) of the monthly revenue they generate. This is known as an “incentivized payment structure”. It means, to payoff a revenue based financing agreement, a business makes monthly payments until a pre-defined return called the Internal Rate of Return (IRR) is reached or a loan termination date is reached. Ideally, the structure of the revenue based funding agreement incentivizes both the company and the investor to support future business revenue growth. If the businesses sales grow faster than expected, the loan is paid back in a shorter time period. However, if the business hits a sales slump one month, it won’t be crippled by having to pay back a fixed payment amount as with a traditional small business loan.
Minimal Credit Score Requirements
Revenue based financing is based on the current health of a businesses income and because of this past credit blemishes, or low FICO scores most often don’t effect an alternative lenders decision to fund you. Private alternative lending institutions vary in their credit score requirements but the minimum FICO score is usually around 500 to qualify. This enables a business owner with bad credit a great option to find the funding needed without all the challenges of applying for a traditional business loan from a bank.
No Collateral Required
Unlike traditional small business loans, revenue based financing doesn’t require any form of personal collateral. With a traditional lenders, even if you’ve business is a LLC or S-Corp, most banks will require some type of personal guarantee before they approve your loan. That means if you are unable to make your payments, many of the personal assets separated with your incorporation are left unprotected. An alternative lender doesn’t care how long you take to repay the money you borrowed, how much you repay, or even if your payment is lower than expected each month. That means businesses with uneven revenues through out the year can continue to pay their loan back without the fear of a bank coming to take their personal or business collateral assets. The no collateral required benefit of royalty based financing is another big advantage to business owners with poor credit history and little or no personal assets. However, business owners should be aware that no personal collateral requirements doesn’t alleviate the business owner from all obligations. If repayment fails, and your business goes under, lenders may have the right to come for your businesses assets including equipment or even intellectual property rights.
Simple Application Process
Based on the most recent financial crisis, banks and traditional lenders have tighten there approval process and with this comes time intensive, document lengthy business loan applications. Even The Small Business Administration that offers higher-risk business loans in the form of the SBA 7(a) Loan still require a formal business plan, up to 2 years of financial statements, insurance, criminal background check, and other legal documents during application. (See this article “Can I Get a SBA Loan with Bad Credit?” for a detailed examination of why business owners with bad credit are not able to qualify for a SBA loan). This is in direct correlation to the loan application from an alternative lender which is typically completed online in a a simple one page application. Other than the initial application, alternative lenders usually require only the businesses past 3 month’s bank or merchant account statements as proof of revenue. Most alternative lenders can also pre-qualify a business owner using public and privately available records such as Dunn & Bradstreet without every having to do a formal credit check.
Quick Funding Time
Revenue based financing loans are not only convenient, but also one of the fastest ways to achieve much needed capital in a hurry. These loans are all very convenient and fast. As mentioned above, pre-qualification can be done instantly online, business loan applications can be filled out online in a less than 30 minutes, and final approval can be given in a few hours. If the business owner approves the lenders agreement, the entire amount requested can be delivered into a business account using ACH direct deposit in 1-2 business days. This makes revenue based financing one of the best, fastest, and most convenient ways to get access to capital in a hurry.
No Addition Fees or Ballon Payments
Unlike traditional lenders and banks who charge loan origination fees and/or ballon payments at the end of the loan term, most revenue based financing agreements don’t have any additional costs or hidden fees involved. Payments are directly tied to the businesses revenue which allows business owners to get an accurate prediction of the total cost of the funding they borrow.
No Business Too Small or Too Big
Companies with revenues from $15,000 all the way in excess of $100 million take advantage of revenue based financing befits. Although each alternative lender has different minimum revenue threshold requirements, the mechanics of revenue based financing is simple in structure and will work for virtually any business size if organized the right way.
Short Financing Terms
With this type business funding payment terms can range from 4-48 months allowing the business to pay off the loan in a much shorter period of time. Payments on a traditional business loan are set to a fixed amount based on the loan principal and annual percentage rate (APR). Banks amortize payments, which means the payments are equal and regardless of your businesses financial health, the same amount is paid every month. With revenue based funding, you could have it paid off in six months or six years, depending on the success of the business. Also keep in mind that with with the acceptance of bad credit history, no personal collateral requirements, and no fixed payment schedule, the risk to an alternative lender is much higher than of a bank. For this reason the long term finance cost of taking revenue based financing is much higher. APRs on traditional loans can be as low as 6 percent, but on the very high end they can reach 28% percent if the borrower falls in the sub-prime category. Be that as it may, the speed, convenience and flexibility of a revenue based financing is still attractive to many low credit score borrowers even though the costs may be higher.
No Exit Strategy Needed
Venture capital companies that provide funding will typically require that an exit strategy be in place before funding is provided. Revenue based funding programs don’t require one. The majority of small businesses in need of funding operate as small, standalone businesses. Raising money from venture capitalists who expect the big exit payouts can misalign a businesses goals. A revenue based loan has the potential to better align incentives for investors and founders in these cases.
Is Revenue Based Financing Right for Your Business?
Whether a business is looking to buy new equipment, expand, acquire market share, or finance business operations revenue based financing can be a good option for business owners with where traditional banking institutions might not. However, it’s important to note that some businesses industries may not qualify or find revenue based financing to not be the right fit for their immediate and/or long term needs and goals.
Overview: Revenue Based Financing
|Borrowing Amount||$10,000 – $1,000,000+|
|Minimum Monthly Revenue||$10,000|
|Average Gross Profit Margin||50%|
|Total Cost of Capital Received||1x – 3x amount borrowed|
|Finance Rate||16% – 30%|
|Funding Speed||Average 2 – 7 business days|
|Terms of Payment||3-8% of gross revenue paid weekly or monthly|
Revenue based financing are best for businesses that already generate revenue which excludes most startups. By nature, these types of business lack but hard assets typically required for traditional bank business loans. Business that have hard to predict monthly revenue, such seasonal sales spikes also find this type of financing to be extremely beneficial. Revenue based financing is often used for product development, marketing, or expanding an existing business.
Here is a list of other factors and requirements to consider before applying for Revenue Based Financing:
- Businesses should have an established revenue stream and business bank account from which the lender will deduct payments from.
- Businesses should have already established a minimal market share which has been relatively stable for at least 3 months.
- Businesses should have all financials in order. You must be able to show with solid documentation that your business generates revenue. Business owners should be prepared to have a ready a generally accurate summary of debt, revenues, operating expenses, and future revenue projections.
- Business owners don’t need a perfect credit score, but a minimum FICO score of 450 is typically required for funding.
- Business owners must not have any pending bankruptcies, although most alternative lenders will still provide revenue based financing if there has been bankruptcies is the past.
- Business owners can typically expect to borrow up to one-third of the businesses annualized revenue rate. Although alternative lenders vary, at least $15,000 per month in gross revenue is the average minimum needed. Since the requirement is based on gross sales and not net, you don’t need to be profitable to qualify for revenue based financing.
- Businesses that have large gross margins and have recurring revenue streams such as membership, subscription, service and/or supply contracts are ideally fitted for this type of loan.
- Revenue based funding can only be used for business purposes. Unlike a bank, alternative lenders won’t ask for a detailed business plan outlining how you intend to spend the funding. However, most will ask you to declare only that you will not use the funds for any personal reasons.
If you are a business owner with bad credit history searching for a best option between the traditional bank small business loan, and the highly complex world of venture capital private equity investment, revenue based financing might be right for you. Revenue based funding offers profitable companies a quick and straightforward way to raise capital without dilution of business ownership, change of control, or a personal guarantee.