John Borchers is the cofounder and Managing Director at Decathlon Capital Partners, a revenue-based financing firm.
As the global economy continues its transition out of a long era of ultra-cheap capital, many growth companies are looking closely at revenue-based financing as an important element in their capital stack.
Revenue-based financing—funding repaid through a percentage of the borrower’s revenues—is typically far more flexible than bank financing and doesn’t require founders and existing shareholders to dilute their ownership in exchange for the capital needed to grow.
It’s not surprising, then, that the market for revenue-based financing —RBF in short—is growing rapidly. RBF, which totaled an estimated $2.8 billion in 2022, is projected to grow at a 60% annual clip during the next five years. Even so, as someone who heads an RBF firm, I have seen how many executives of growth companies are still learning how to use this valuable tool.
A Streamlined Process
The process of tapping RBF is typically streamlined and straightforward, especially compared with the reams of paperwork required for bank financing or the slow-moving complexities of an equity transaction.
RBF providers generally require applicants to initially provide basics about the business—name, address, employer identification number—and financial statements that accurately reflect revenues, expenses and future projections.
When applying, it’s important that your financial statements are in order. Beyond just showcasing proof of stable revenue, RBF providers and firms will want to talk with executives to gain a deeper understanding of the borrower’s business. It’s equally important that you communicate a clear vision of your path forward during discussions with lenders.
Finding The Right RBF Provider
Most RBF providers serve a clearly defined market. These markets are generally defined by profit ranges like $4 million to $10 million in annual sales. Other parameters include company age—one example being companies in business for at least two years—are led by well-seasoned management teams, post stable revenue growth of a predetermined percentage and have laid out a clear path to profitability.
Other providers work with smaller or larger companies, specify certain gross margins from borrowers or serve borrowers in specialized sectors such as software as a service. And maximum and minimum loan amounts vary among RBF providers.
What doesn’t heavily factor into an RBF application is the industry your company works in. Since the determining factor for an approved RBF plan is the profitability and stability of the business, companies in any industry can take advantage of this model. Stable industries such as healthcare and manufacturing are ripe for opportunities in RBF.
Borrowers, however, need to look beyond the basics when selecting an RBF provider. Because the lender will succeed only as the borrower succeeds, RBF lenders will want to stay in close contact with the borrower. Some even may request observer seats at board of directors’ meetings. A comfortable relationship—something akin to a partnership between the borrower and the RBF provider for the duration of the loan—is essential.
Because the relationship is so important to the future of the business, borrowers should undertake careful diligence when it comes to potential RBF providers. They can look at providers’ portfolios of current clients (often listed on the provider’s site) and talk with a few about their experiences. A quick online search can often turn up basic information about the RBF’s investors and spotlight any past problems.
RBF Term Sheets
Negotiation of an RBF deal generally gets serious with a non-binding term sheet. Along with the amount of the loan and repayment terms, a typical term sheet is likely to detail what revenues will be included in calculating the repayment. Proceeds from insurance settlements or litigation, for instance, often are carved out. The term sheet also is likely to spell out the borrower’s reporting requirements and whether they are regular financial statements or a monthly call with the RBF provider.
Everything in a term sheet, of course, is open to negotiation. RBF providers will look at the status of the borrower, the nature of its business, and most importantly, the perceived risk of the financing as they spell out their terms. Borrowers will seek to reduce the cost of the funding.
In most RBF transactions, the repayments from monthly revenues end up totaling anywhere from 1.5 times to three times the amount of the original borrowing. Online calculators can help show you the effective interest rates of the required repayments. Four states—New York, California, Utah and Virginia—have adopted disclosure requirements to help RBF borrowers understand the costs and fees of the financing. Each of the four states, however, sets a different standard for disclosure, and the vast majority of states don’t get involved in oversight.
Signed Deals, Long Relationships
When growth companies find the right RBF providers, the day the deal is signed can be the start of a long and mutually rewarding relationship. The borrower puts funds to use in initiatives that drive solid sales growth. The growing revenues, in turn, allow the financing to be repaid more quickly. Together, a growing company and an interested and supportive financial partner can use RBF to create thriving businesses.
The right revenue-based financing can make a significant difference in the future of a growing company. Borrowers who do their homework and understand this innovative tool have the opportunity to create a powerful advantage for their businesses.
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