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Revenue-based financing is a flexible, collateral, and equity-dilution-free form of financing that’s addressing the current INR 20-25 lakh crore credit gap in India.
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Sustainability, profitability, uninterrupted cash flow, and efficient operation management are highly critical to every business operating in the Indian market today. While large and many medium enterprises are able to manage these functions, the major challenges lie for micro and small companies.
According to various news reports, micro, small, and medium-sized enterprises (MSMEs) contribute about 30% to India’s GDP. Yet, there lies an INR 20-25 lakh crore credit gap.
Many MSMEs fail to pass through the tedious and lengthy process to get a line of credits from financial institutions like banks, NBFCs, angel investors, and venture capitalists (VCs). So, how to reduce this ever-increasing and sustaining credit gap?
Enter, revenue-based financing (RFB).
RFB is a new and promising financing option that enables budding and aspiring online-first businesses to,
- Obtain substantial funds instantly
- Streamline their operations
- Contribute immensely towards growth, innovation, and employment
But, what do you exactly mean by revenue-based financing? How is it different from other forms of financing? Why is it gaining momentum in India? Let’s find out!
What is revenue-based financing?
Revenue-based financing is a newly introduced fund-raising concept that enables online-first enterprises to get funds/loans based on their current and future revenue models.
In other words, it’s a royalty-based financing scheme wherein an investor or financier gets a royalty on the loan they’ve given to the borrowing company. The latter ideally pledges a part of their annual revenue against the capital received and enjoys uninterrupted cash flow.
- No need to mortgage collateral to get a line of credit or dilute equity
- Just give away a portion of the company’s yearly revenue to the investor or financier
How Does Revenue-based Financing Work?
Let’s take an example to explain how the revenue-based financing arrangement works.
Suppose Madhav, an owner of a small online clothing business, approaches XYZ Financials to raise INT 40 lakhs under the revenue-based financing model.
- Madhav presents his company’s,
- Fixed and recurring expenses
- Past revenue records
- Future earning forecasts
- XYZ Financials evaluates Madhav’s online business and sanctions a loan for a period of 12 months equivalent to a certain percentage of Madhav’s company’s estimated
- XYZ Financials also charges a 2% processing fee + 18% GST
- In total, Madhav gets INR 39,05,600, which he uses to meet his business-related requirements
- At the end of 12 month loan tenure, Madhav pays an agreed percentage of 10% of his revenue to XYZ Financials along with the principal amount to clear the debt.
Here’s a working of the above mentioned example
- Loan Amount – INR 40,00,000
- Fee – 2% + 18% GST
- Tenure – 12 months
- Revenue Share – 10%
This means,
- Madhav gets, INR 39,05,600 upfront to manage his business operations
- XYZ Financials gets, principal amount + 10% of the company’s revenue share
Owing to the example, listed below are three primary types of revenue-based financings that a borrower can opt for.
- Take up the loan and pledge to pay back a percentage annually or as agreed up
- Pledge to pay back and give a small portion of the equity to the financier
- Convert the liability into straight equity at a certain stage, such as during a future fundraising round
Each of the three types has its own pros and cons. Borrowing companies can evaluate their options based on their current and future growth prospects and make a decision.
Why Is Revenue-based Financing Gaining Momentum in India?
Revenue-based financing offers many advantages to the online-first MSMEs. Let’s take a look at some of them in the section below.
Serving The Growing Number Of MSMEs
As of March 27, 2022, India is home to 7.8 million MSMEs. Of these, many are online-first and asset-light companies operating at a nascent stage. Neither do they have collaterals to mortgage against bank loans nor very high-profit margins to get NBFCs, angel investors, or VCs lure for fundings.
For such companies, revenue-based financing serves as an ideal option. The financing model gives online-first MSMEs an opportunity to get credit lines without making heavy sacrifices. Remain fundamentally functional, always have enough cash to support business operations, and dream scalability.
Excellent Alternative To Growth Capital
Growth capital or otherwise known as expansion capital is usually granted to relatively mature companies that are undergoing transformational changes with the potential to register dramatic growth.
MSMEs are usually not eligible to apply for growth capital up till a certain stage.
However, revenue-based financing opens such avenues for all organizations. It enables them to plan and achieve their transformational goals and also achieve high-profit margins.
Large Funding Amount
Fundings are typically linked to the borrowing firm’s growth potential and past performance. If a firm has a good track record and shows the necessary potential, revenue-based financiers are ready to give away large fundings.
Low-risk, No Equity Dilution
As mentioned above, revenue-based financing provides loans against royalty on revenue and eliminates the risk of losing the equity in the process.
Its model helps company stakeholders maintain complete ownership and save it for when the company is big enough and ready to dilute its equity share.
Flexible Repayment Plans
Another best thing about revenue-based financing is that it offers the utmost flexibility in terms of loan repayment. Meaning that the amount to be repaid gets adjusted as per the quantum of revenue the company is generating.
For instance, if the company registers high revenue, the repayment amount is high. Meanwhile, if it hits marginal revenues in a particular year, then the repayment will be done accordingly.
Immediate Disbursal Of Funds
Compared to many fund-raising schemes, investors and financiers usually sanction loans within a week of application in the case of revenue-based financing. This means that borrowing firms can address their immediate cash requirements and even plan future business activities without hesitance.
Stakeholders That Will Benefit From Revenue-based Financing
MSMEs, SaaS, And D2C Startups
Working capital crunch largely affects the growth of online-first, asset-light MSMEs and startups since existing financial means do not offer effective funding solutions.
Revenue-based financing ensures such businesses scale quickly without giving up equity or collateral against loans.
Alternate Financers
Banks are usually hesitant to offer loans to businesses with limited revenue track records, can’t provide collateral, or have borne losses in the past.
However, many Fintechs, NBFCs, and high-net-worth investors who’re keen to back MSMEs and startups are coming forth to help. They bet on the company’s past and future growth prospects and provide loans against a marginal portion of their annual revenue.
Regulators
The Reserve Bank of India is trying to streamline and simplify the KYC requirements which will further facilitate smooth digital onboarding of businesses. The introduction of Open Credit Enablement Network (OCEN) by the authorities in the coming time will further brighten the future of revenue-based financing in India.
This means a reduced credit gap and a higher contribution to the Indian GDP.
How Revenue-based Financing Is Different From VC Funding And Bank Loan?
Here’s a small table explaining how revenue-based financing is turning out to be a better option than VC fundings and bank loans in today’s day and age.
| Revenue-based Financing | VC Fundings | Bank Loans | |
| Loan Acquisition Ease | Easier to get loans from revenue-based financiers | Long, tedious, and tiring process to pitch VCs for funds | Lengthy and offline process to seek loans from banks |
| Equity Dilution | No equity dilution needed | May ask for a portion of equity to have skin in the game | No equity dilution needed |
| Ownership and Control | Maintain complete ownership and control | Need to consult the VCs on every major business decision | Maintain complete ownership and control |
| No Collateral Needed | No need to mortgage collateral to get funding | No need to mortgage collateral to get funding | Need to mortgage collateral to get a loan |
| Flexible repayment | Flexibility in repayment of principal amount based on revenue earned by the company in the FY | Ideally a fixed repayment structure. However, may offer flexibility in some specific cases | Fixed repayment structure |
| Large Funding Amount | Get large fundings based on past and future growth prospects | Large fundings are ideally only given to hyper-growth startups | Comparatively smaller loans are disbursed |
| Faster loan disbursal time | Funds are usually dispersed within a week of applying | VCs usually take one to three months to disburse funds | Banks disburse loans within a couple of hours post due-diligence |
| Alignment towards growth | Financiers help companies achieve high revenue growth | VCs provide necessary guidance to ensure high revenue growth | Do not offer any such assistance |
How To Evaluate Revenue-based Financing Options?
Many Indian financial entities today are offering revenue-based financing options. However, always evaluate your options before making a decision.
Listed below are some aspects to consider when evaluating a revenue-based financier or investor.
Carefully Evaluate The Financing Terms
While the very concept of revenue-based financing is enticing, carefully evaluate the funding details. Because, even the smallest of terms mentioned in the policy document can greatly affect the company’s financial position and future growth.
Look beyond the basics and get into the nitty-gritty of things. Some of them are listed below.
1. Repayment Ability And Timelines
Confidence is good. Overconfidence is harmful.
Ensure that repayment terms are drafted in such a manner that the company is able to
- cover its debts (in any)
- save a portion of funds for future investment
- Easily pay back the financier’s promised percentage
2. Look For Any Attached Warrants
Warrants stand for the rights reserved by the financier to buy the company’s equity in the future at an agreed price today. For instance, a revenue-based financier may ask for a 5% stake in the business once it reaches X percentage of yearly revenue, diluting ownership. So, ensure to read through the lines and agree only if it seems like a feasible option.
3. Future Funding Options
Ensure that the lending terms mentioned in the agreement keep future funding options open. For instance,
- Ability to get additional funds in the future
- Ability to raise additional funds from other financiers
- Any hidden costs or prepayment terms attached to the revenue-based loan disbursed
Choose The Right Financier
The relationship between a financial institution and a borrowing firm is long-term in revenue-based financing. Ensure to have a financier that,
- Has already given investment to other MSMEs or startups
- Has a good reputation in the market
- Has the authority to provide funding
- Has a strong financial backup to provide funding (currently and in the future)
What Does The Revenue-based Financing Landscape Look Like For India?
The number of MSMEs and startups are increasing at a rapid pace in India today to address many ever-evolving customer needs. However, not all of these are able to bootstrap themselves or prove their worth to the banks, angel investors, or VCs to get substantial funding to scale their businesses.
Alternative funding concepts such as revenue-based financing are boosting the morale of MSMEs and startups by providing them with large chunks of cash to run their business and achieve targeted goals.
At present MSMEs and startups can raise about USD 25,000 to USD 2,80,000 through revenue-based marketing.
More so, the current revenue-based market in India sits at a USD 5.8 billion mark. Owing to the increased adoption, it’s no surprise that the market size will soon touch the USD 40-50 billion mark in a couple of years.
Revenue-based financing is becoming the future of alternative funding options for anyone and everyone willing to start and scale a business. In fact, the introduction of Open Credit Enablement Network is further expected to boost this financing module as the most suitable fund-raising option for online businesses. It’s only a matter of time before other financiers and investors revisit their funding terms to compete with revenue-based financing and stay put in the lending game.
