Are you in need of financing to start or grow your business, but don’t have the credit score or collateral needed to secure a bank loan? One of the latest loan products to hit the market for small-business owners is revenue-based financing. Let’s take a look at what it is, why you might consider it, and what you need to quality for it.
What Is Revenue-Based Financing?
This type of alternative financing is designed for business owners who generate revenue, but, despite positive cash flow, still can’t get a bank loan because of a less-than-perfect credit rating and/or lack of collateral. Also known as royalty-based lending, the loan product has been around since the 1900s, but until recently, was mostly used only in the oil and gas industries. With it, business owners can acquire growth capital by selling a percentage of their future revenues to investors. (It has been called a cross between a bank loan and venture capital funding.) In addition to the principal, there is a negotiable cap that equals 1.5 to 2.5 times the principal loan amount.
What Are the Benefits?
There are a number benefits to this type of funding that set it apart from other financing options.
- There are no fixed payments. Instead, investors are paid back as a fixed percentage of your business’s monthly revenue, and payments fluctuate with sales. For instance, when you have a great month, your payment will be higher, but if your sales fall the next month, your payment will be reduced. This makes your loan payments a variable rather than fixed expense. The percentages charged are negotiable, but are always below 10 percent of your gross revenues.
- Although investors like to be repaid within five years, the loan will be repaid when you have earned enough in gross revenue to repay it.
- When you use a revenue-based loan for a startup, you won’t experience any dilution of your company. And because you won’t lose equity, there is no need for a formal valuation of the company.
- When you accept capital from an angel investor or venture capitalist, there typically has to be an exit strategy in place, but revenue-based investors don’t require one.
- You will not have to back the loan with your personal assets.
- You don’t have to borrow everything at once, but can take out loans as you need them.
- The application process is quick and easy, and funding typically occurs within a month.
How to Qualify
While this is easily one of the most advantageous loan products to emerge in years, it’s not for every business owner. Here are some of the requirements you will have to meet to qualify for this type of financing.
- While you don’t need perfect credit, you do need a minimum FICO score of 550.
- You must be able to show with solid documentation that your business generates revenue.
- Since the loan payments will be deducted from your gross revenue, you’ll need gross margins of 50 percent to accommodate the loan.
- You can typically borrow up to one-third of your company’s annualized revenue run rate.
- You typically need $15,000 per month in revenue, but you don’t need to be profitable.
- You must specify how you’ll use the money to grow your business.
- Loan payments are typically made via monthly electronic payments withdrawn directly from your business checking account.
There are a few lenders that specialize in these types of loans, and you should contact each one for specifics. If your business is located in Texas, you can approach Next Step Capital Partners. Lighter Capital works with businesses across the nation.
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