WHAT IS INCOME FINANCING?
Revenue-based financing (RBF), also known as royalty-based financing, is a unique form of financing that RBF investors provide to small and medium-sized enterprises in exchange for an agreed percentage of the business’s gross income.
The capital provider receives monthly payments until the return on its invested capital, together with a multiplier of that invested capital.
Mutual funds that provide this unique form of financing are known as RBF funds.
– Monthly payments are called royalties.
– The percentage of income paid to a business capital provider is called the royalty.
– The multiplier of the capital invested, which the company pays to the capital provider, is called the ceiling.
Most RBF capital providers achieve a return on investment of 20-25%.
Let’s use a very simple example: if a company gets 1 million. USD from the RBF capital provider, the company is expected to repay $ 200-250,000 per year to the capital provider. This ranges from about $ 17,000 to $ 21,000, which the company pays to the investor per month.
Thus, the capital provider expects to recoup the invested capital within 4-5 years.
WHAT IS DATA RIGHT?
Each capital provider determines its estimated fee. In the simple example above, we can work backwards to set the rate.
Suppose a business gets 5 million. USD gross income per year. As mentioned above, they received 1 million from the capital provider. USD. They return $ 200,000 to the investor each year.
In this example, the royalty rate is $ 200,000 / $ 5 million. USD = 4%
VARIABLE KINGDOM STATUS
Royalties are proportional to the top line of business. Everything else is equal, the higher the income generated by the business, the higher the monthly royalties the company earns to the capital provider.
Traditional debt consists of fixed payments. Therefore, the RBF scenario seems unfair. In a sense, business owners are punished for their hard work and success in developing their business.
To address this, most royalty financing agreements include a variable royalty rate scheme. In this way, the higher the income, the lower the applicable royalty rate.
The parties concerned shall negotiate a precise rolling scale schedule and shall be clearly set out in the time sheet and in the contract.
HOW DOES THE BUSINESS FINISH THE REVENUE MAIN FINANCING AGREEMENT?
Every business, especially a technology business that is growing very fast, will increase their need for this form of financing in the long run.
As the business balance sheet and income statement strengthen, businesses will rise up the funding ladder and attract the attention of more traditional financial decision providers. A business may become eligible to get traditional debt at cheaper interest rates.
Each revenue-based financing agreement specifies how the company can buy or redeem the capital provider.
The business owner always has the option to purchase a portion of the royalty agreement. The specific purchase option conditions are different for each transaction.
Typically, a capital provider expects to receive a certain percentage (or a few) of the capital invested before the business owner can exercise the call option.
The business owner can take the opportunity to make one payment or several lump sum payments to the capital provider. Payment buys a certain percentage of the royalty agreement. The capital invested and the monthly royalties will be reduced proportionately.
In some cases, a business may decide to redeem and terminate the entire royalty financing agreement.
This often happens when a business is sold and the acquirer decides not to renew the financing agreement. Or when a business has become strong enough to access cheaper sources of financing and wants to restructure itself financially.
Under this scenario, the business has the option to redeem the entire royalty agreement for a pre-determined multiplier of total invested capital. This repeater is commonly referred to as a cap. The specific redemption option conditions are different for each transaction.
USE OF FUNDS
There are usually no restrictions on how a business can use RBF capital. Unlike a traditional debt agreement, there are no very restrictive debt agreements on how a business can use the funds.
The capital provider allows business managers to use the funds as they see fit to grow the business.
Many technology companies use RBF funds to acquire other companies to accelerate their growth. RBF capital providers encourage this form of growth as it increases the income that can be subject to their royalty rate.
As a business grows through acquisitions, the RBF Fund receives higher royalties and therefore benefits from the growth. Thus, RBF financing can be a great source of acquisition financing for a technology company.
BENEFITS OF REVENUE FINANCING FOR TECHNOLOGY COMPANIES
No property, no personal guarantees, no traditional debt:
Technology businesses are unique in that they rarely own traditional heavy assets such as real estate, machinery, or equipment. Technology companies are driven by intellectual capital and intellectual property.
These intangible IP assets are difficult to value. Traditional lenders provide little benefit to them. This makes it very difficult for small and medium-sized technology companies to access traditional financing.
Revenue financing does not require the company to provide financing with any assets. Business owners do not need personal guarantees. With a traditional bank loan, the bank often requires guarantees from personal owners and seeks personal property from owners in the event of default.
The interests of the RBF capital provider are agreed with the business owner:
Technology businesses can grow faster than traditional businesses. Revenue can increase quickly, which allows businesses to pay royalties quickly. On the other hand, a poor product placed on the market can also quickly destroy business revenue.
A traditional creditor, such as a bank, receives fixed debt payments from a business borrower, regardless of whether the business is growing or declining. In easy periods, the business pays the same debts to the bank.
The interests of the RBF capital provider are aligned with the business owner. If business income declines, the RBF capital provider receives less money. If the business income increases, the capital provider gets more money.
So the RBF provider wants the business revenue to grow fast so that it can split up. Business revenue is growing for all countries.
High gross margins:
Most technology businesses generate higher gross revenues than traditional businesses. As a result of these higher margins, RBFs become available to technology companies in many different sectors.
RBF funds seek companies with large margins that can afford to pay royalties on a monthly basis.
No equity, no board seats, no loss of control:
A capital provider shares success in a business but does not receive equity in the business. Thus, the cost of capital under the RBF agreement is cheaper in financial and operational terms than a similar equity investment.
RBF capital providers have no interest in participating in the management of the business. Their active involvement is the review of monthly income statements received from the business management team to adjust the appropriate RBF fee rate.
A traditional equity investor expects to have a strong voice in how to run a business. He expects board space and some level of control.
A traditional equity investor expects to receive a significantly higher ratio of invested capital when selling a business. This is because he takes on more risk because he rarely receives financial compensation before selling the business.
The RBF capital provider receives monthly payments. You don’t have to sell a business to make money. This means that the RBF capital provider can afford to accept a lower return. That is why it is cheaper than traditional capital.
RBF, on the other hand, is riskier than traditional debt. The bank receives fixed monthly payments regardless of the financial condition of the business. The RBF capital provider may lose all of its investment if the company fails.
In the balance sheet, RBF is between the bank loan and the equity. Thus, RBFs are generally more expensive than traditional debt financing, but cheaper than traditional equity.
Funds are available within 30-60 days:
Unlike traditional debt or equity investments, the RBF does not require months of due diligence or complex valuation.
The turnover period between the delivery of the financial term to the owner of the company and the funds paid to the business can be from 30 to 60 days.
A business that needs money immediately can take advantage of this fast turnaround time.