Revenue-Based Loan Explained: Is It Really a Loan?

Taking out a business loan could be scary.
 
While it gives you much-needed capital to fulfill your business goals, debt could end up being a ball and chain for your company. Scheduled repayments in fixed sums, in particular, will likely be a heavy burden on your company’s cash flow.
 
If you are looking for non-dilutive funding, revenue-based financing (RBF) is an alternative to loans — with fewer restrictions and more flexibility.
 
Despite the different terminology, many people think that RBF is just a revenue-based loan. In fact, the difference between revenue-based financing and loans is more than semantics.
 
Read on to find out how they differ:

• Revenue-based financing: What is it?
• Revenue loan: Where does the name come from?
• Revenue-based loan: Is it really a loan?
• Loan vs. revenue-based financing

Revenue-based financing: What is it?

It is an alternative financing solution where businesses receive funding based on future revenue.
 
Providers of funding, known as RBF platforms, would share a certain percentage of the recipient company’s revenue until a predetermined amount is paid back. Total repayment is usually determined at the capital plus a flat fee.
 
Learn more: What is Revenue-Based Financing? Here is Everything You Need to Know‍

Revenue loan: Where does the name come from?

Despite its popularity in the West, revenue-based financing is still a budding area of business financing in Asia.

Amongst many other misconceptions around the topic, many people think that revenue-based financing is a ‘repackaged loan’. Hence the shorthand revenue-based loans (sometimes revenue loans) and revenue-based lending.

As the leading revenue-based financing and growth platform in Asia, Choco Up works closely with fast-growing startups, e-commerce companies and SMEs. Apart from providing RBF funding, we also talk to founders to truly know their businesses, challenges and thoughts.

On the topic of financing, below are some interesting views held by business owners before they learnt about us:

1. If equity is not on the table, it must be a loan.

Traditionally, debt and equity financing are two major financing methods for businesses.

The former usually takes the form of commercial loans. The latter involves giving up equity in exchange for capital.

In some deep-rooted notions, business financing is an ‘either or’ decision. To get extra money for your business, you could either go for debt, or give up partial ownership to investors. There is no middle ground.

Since RBF platforms do not take any equity from companies, it seems sensible to say that they provide revenue-based loans. If equity is not on the table, it must be a loan, right?

‍Myth debunked: Today’s world sees a broad range of financing instruments for businesses. Debt and equity financing are but some of the available options. Choosing a source of external capital for your company is no longer an ‘either or’ decision between debt and equity.

To give an example, revenue-based financing is a non-loan alternative. It is not equity financing because RBF platforms do not get equity from your company (or warrants, for that matter). However, it is not a debt either (more on this later).

2. If the amount must be repaid, it is a loan.

According to the Cambridge Dictionary, a loan is “an amount of money that is borrowed, often from a bank, and has to be paid back, usually together with an extra amount of money that you have to pay as a charge for borrowing."

In simple terms, a loan involves a transaction in which the borrowed amount must be paid back with interest. If RBF funding must be repaid, it is essentially a revenue loan, right?

‍Myth debunked: Borrowing entails obligations to repay, but an amount that must be repaid is not necessarily a loan. While we are on the subject, let’s dig deeper to understand why revenue-based financing is not a loan.

Revenue-based loan: Is it really a loan?

Different expressions such as “revenue-based loans”, “revenue loans” and “revenue-based lending” are somehow derived from the term revenue-based financing.

However convenient these shorthands are, they are inapt descriptions of RBF because it is, in fact, not a loan. Here is how revenue-based financing compares with a loan:

1. Repayment structure

Loan repayment schedules are fixed in date and amount. Regardless of how much money you make (a lot or very little), you repay the same. This could cause serious issues when your company is tight on cash.

According to a survey on small business credit, making repayments on existing debt is the second most common reason for businesses to take out loans.

If not properly managed, one loan could lead you to another, trapping you in a vicious debt cycle. That’s why loans could be really scary.

Revenue-based financing erases concerns about keeping up with repayments.

Unlike loans, repayment of RBF funding is tailored to your cash flow cycle. All you need to do is share a small percentage of your revenue with the RBF platform.

The revenue-sharing model allows for flexible repayment. When revenue performance is good, you will repay more in that particular month. When the next month’s revenue performance drops, so does the repayment amount.

‍We have a blog on how revenue-based financing works. Check it out for details and a numerical example on how RBF funding is repaid.‍

2. Application process

The application process for conventional loans is notoriously tedious and complicated.

There are lengthy application forms to fill, manual preparation of extensive documentation, and back-and-forth correspondence like a ping pong game.

Applying for revenue-based financing is much easier.

For example, Choco Up has a data integration platform where you can quickly and securely connect your financial systems (e.g. Stripe or PayPal).

Upon sharing some quick information about your business, our algorithm will let you know whether you are eligible for RBF funding. You could also get a preliminary offer (if applicable) in less than 10 minutes.

‍Try it out: If you are looking for non-dilutive growth funding, click here to get your preliminary offer. It will only take a few minutes.‍

3. Turnaround time

RBF platforms rely less on manual work and more on automation.

Applying for funding at Choco Up, for example, is a data-driven, quick and streamlined process. If all goes well, funding could be available in as little as 48 hours.

That is a huge jump from loan processing times, which typically last for weeks or even months.

‍4. Assessment criteria

RBF platforms assess applicants differently from loan providers.

Under the long-standing framework of credit assessment, lenders look at your company’s credit history to determine whether a loan will be granted. Your personal credit record will be factored in, too.

Some lenders also have a ‘time in business’ requirement. For instance, your company must have operated for at least 2 years to be eligible for a loan. Very often, young businesses find it hard to get a loan via the traditional route.
 
While lenders look at your past, Choco Up looks to the future. 
 
We get the measure of your company’s growth potential based on factors such as unit economics, recurring revenue, and monthly transaction rate. Once we see that potential, we will help you realize it.
 
Without credit history in the equation, growth capital is much more readily accessible by young and fast-growing businesses. In many instances, RBF funding is available for companies when they are not qualified for loans.

5. Collateral

When you obtain a loan, collateral is almost certainly part of the package.

Bank lenders usually require that you use cars, equipment or property to secure the loan. Inventory loans are collateralized by inventory.

One problem with collateral is that you will put your business (sometimes personal) assets at risk. This is because in the event of default, the collateral will be seized and sold to cover any unpaid amounts.

Another limitation is that debtors may not have the requisite assets to use as collateral. This problem is particularly common among asset-light, e-commerce companies.

On the other hand, revenue-based financing is collateral-free. If you have concerns about putting up assets as collateral, revenue-based financing is an option you can consider.

6. Interest and fees

Lenders charge interest on loans, but the rates vary from lender to lender. For commercial loans, interest rates could be as low as 2% (bank loans) and as high as 100% (online lenders).

But interest is only part of the picture. Many lenders also charge a handful of fees for lending to you. So if you are taking out a business loan, you could wind up repaying more than 2X of what you get.

Here are some fee items to be aware of:

• Origination fee (also known as handling fee or application fee)
• Late payment fee
• Prepayment fee
• Service fee

The fee structure of revenue-based financing is quite different.

To begin, RBF platforms do not charge any interest on outstanding balances. Instead, a fixed rate fee is added to the repayment sum. Alternatively, you will be asked to repay a multiple of the funding given to you.

Below is a numerical illustration of the two different approaches to paying back RBF funding:

‍Fixed fee approach (example)

• RBF funding: $600K
• Fixed fee: 8% of funding

The repayment sum under this approach is $600K x 8% = $648K.

Multiple approach (example)

• RBF funding: $600K
• Multiple: 1.1X of funding

With this approach, you will have to repay $600K x 1.1 = $660K.

Choco Up is an RBF platform that takes the fixed fee approach. It is our promise — that only a small flat fee will be added to what you repay. There is no need to read the fine print for hidden fees, or do any complicated math to calculate your cost of capital.

7. Covenants and warrants

Covenants and warrants are commonly incorporated in loan agreements to protect lenders.

Debt covenants are certain rules governing your financial behavior that you must comply with.

With covenants in place, you may be required to take certain actions. For instance, you must achieve certain thresholds for stipulated financial ratios, and regularly submit audited financial statements to the lender.

You may also be prohibited from performing certain activities, such as borrowing money from other lenders or selling specified assets.

Warrants are terms that give the lender the right to purchase your company’s shares at a pre-determined price upon occurrence of specified events, such as late payment or default.

Put simply, having warrants in the contract means there is a possibility that your lender will get shares in your company — at a price set by the lender at the time of lending. This could hurt a lot if your company’s valuation and share prices go up.

Fortunately, covenants and warrants are uncommon in revenue-based financing. And if you work with Choco Up, there will be no covenants or warrants at all.

Loan vs. revenue-based financing

This section delves into the issue of loan vs. revenue-based financing, detailing the differences between these two financing solutions.

Below is a quick recap of what has been discussed so far:

Some last words

Obtaining growth capital used to be a dichotomy between debt and equity financing. But this is no longer the case today. Revenue-based financing is a case in point.

As a non-loan financing solution, revenue-based financing does not have the drawbacks of debt. Perhaps its most distinguishing feature is the absence of a fixed repayment amount and schedule, so that you can grow your business without the ball and chain of debt.

It is also non-dilutive, enabling you to preserve equity for later funding rounds. To learn more about how you could use revenue-based financing to grow and scale your business, check out our client success stories or apply for funding now!