What is Revenue-Based Financing, and How Does It Work?
With revenue-based financing (RBF), SaaS companies agree to pledge a percentage of their gross revenues each month to an investor in exchange for their investment. These payments continue until a predetermined amount has been paid — typically a multiple of the initial investment of anywhere from three to five times the amount.
Revenue-based financing is often considered a hybrid between venture debt financing and equity financing. Unlike debt financing, revenue-based financing for SaaS doesn’t require interest, and payments are tied to how your firm is doing. Depending on how sales are doing each month, the investor’s payment will increase or decrease accordingly. It differs from equity financing in that the investor doesn’t have an ownership stake in the business.
While revenue-based financing might seem like an ideal solution, there are a few challenges that SaaS companies should be aware of before choosing this avenue. Below, we’ll compare revenue-based financing for SaaS companies with venture debt financing from River SaaS Capital.
Qualifying is Difficult
RBF: Because revenue-based financing is, as it states, revenue-based, your company must be able to demonstrate strong annual and monthly recurring revenues (ARR/MRR) in order to qualify.
Venture Debt: Venture debt still requires a minimum of $150K in MRR, though slightly lower figures won’t necessarily result in disqualification. It all depends on your company and your goals. At River SaaS Capital, profitability isn’t required to obtain venture debt funding, so while this financing type is still an expense, it won’t deprive you of a great deal of your hard-earned profit each month.
The Initial Investment Will Be Lower
RBF: Revenue-based financing investors typically only provide capital up to four times a company’s MRR. While you may have access to follow-on rounds as you grow, that will depend on your performance and the results.
Venture debt: While loan amounts are tied to your business meeting certain qualification criteria, loan amounts can be anywhere from $500K to $4 million. Tranches are available as well, enabling you to take advantage of additional capital without paying interest on the full loan amount.
Your Payment Will Fluctuate
RBF: Because your monthly payments are tied to how much gross revenue your company brings in, you won’t know for sure what it will be from month to month. As you monitor sales activity throughout the month, you’ll likely be able to get a sense for a ballpark payment, but anything can happen. Companies can change their mind, cancel their new subscription, and so on. Not knowing your revenue-based financing payment makes it difficult to plan ahead and fully understand what your liabilities are from month to month.
Venture debt: Our venture debt solution features step-up financing, which is similar to revenue-based financing in that payments increase as your company grows, but these details are locked in ahead of time and are known at the inception of the loan.
Growth Gets Tricky
RBF: Because revenue-based financing requires monthly payments, your business might find itself a bit cash-strapped every now and then — particularly if a stronger month for gross revenue results in a larger payment to the investor. The more revenue you earn, the more you have to pay out — reducing the resources you’ll have available for other expenses and profit that you’ll need to grow the business.
Venture debt: This is perhaps the most significant area where revenue-based financing and venture debt differ. While you’ll be able to use your revenue-based financing investment to grow, the results of that growth are returned to the lender in some capacity, reducing the amount of additional capital you’ll have on hand to put toward growth. With venture debt, payments do increase, but if you have a strong month, you’ll already know what your payment will be, and any extra resources can be put toward accelerating your growth strategy in whatever way works best for you.
You Might Have to Offer a Warrant
RBF: Because revenue-based financing lenders aren’t taking any equity in your company in exchange for their investment and also aren’t charging you any interest, there is the chance that they may want or require some additional incentive to invest — especially if your revenues aren’t as strong as they’d like. This would take shape in the form of a warrant — a mechanism that allows a lender to purchase stock in your company at a fixed price up to a specific expiration date.
Venture debt: Many venture debt lenders in the market will accept warrants as part of a deal with a SaaS company. And while warrants have their place, River SaaS Capital doesn’t take them. We believe in giving you full control of your company and growth strategy. Warrants are simply one way for a venture debt lender to become an equity owner.
Work with a Partner Committed to Your Success
While revenue-based financing and venture debt capital do mirror one another in many ways, there are subtle aspects that can make all the difference in how your SaaS company is able to grow, use its investment and hard-earned profit, and ultimately achieve its goals. At River SaaS Capital, we take a partnership approach in each relationship — providing insights, guidance, and support without taking an ownership position or occupying a seat on your board.
If you’d like to learn more about our venture debt financing solutions, simply fill out the form below, and a member of our investment team will be in touch as soon as possible.