Amid a sliding economy and chaos created by the pandemic, where investors were highly resistant to invest in new startups, they were surprisingly not afraid to experiment with alternate ways of funding other than conventional forms such as crowdfunding, equity funding, and venture capital funding, etc. The revenue-based financing model whose waters are now being tested by the Indian investors is a popular investing model in the US.
What is the Revenue-Based Financing Model?
The revenue-based financing model is a hybrid model between debt financing and equity financing that consists of medium risk and better than debt returns. Here, the investors give debt to the startups, but not as a structured loan.
The revenue-based financing model enables the investors to receive a fixed percentage share of the business’ revenues each month. So, if a company registers high revenue in a month, the investors receive a greater share. The value of repayment is decided in advance at the time of investment that consists of principal and returns. Based on business performance, a startup can repay the investors.
Why is the revenue-based financing model gaining steam?
The early-stage startups, D2C brands, e-commerce startups, and SME businesses will find it difficult to raise funds through traditional venture debt since venture debt is available to only those startups or businesses that have already raised a single round of venture capital. Venture capital is a medium-term loan with fixed interest rates and monthly repayments.
With RBF ( revenue-based financing model) the entrepreneurs have the freedom of raising funds from anywhere between Rs 5 lakh to Rs 15 crores and repay the amount to investors with a percentage of their revenue generated between 1% and 10%. Thus, instead of paying fixed monthly installments or equity dilution, the startups can issue new shares followed by a decrease in stockholders’ share of the company.
Besides raising funds the RBF model makes the startups available to data points such as GST ( Goods and Services Tax) that gives companies the power to underwrite in case of losses incurred.
Its effect on startups
The new model of funding has given a new lease of life to the startup ecosystem, since the 12-month repayment cycle gives startups adequate time to grow the topline revenue, offering flexibility and increasing company valuation without the dilution of equity. Since the equity is undiluted, there is no collateral involved, which leaves the repayment of debt unstrained as returns are directly connected with the revenue generated. The funding raised from the RBF model can accommodate the working capital requirement. Few revenue-based finance investors such as N+1 Capital have their criteria to fund those who can generate monthly revenue of Rs 50 lakhs and GetVantage wants the startups to have a positive operating margin.
What is in store for the investors?
Beginning from 2020, India has about half a dozen investment firms, who are following the RBF suit including N+1 Capital and Klub. The investors are responsible right from its aggregation and risk assessment to the collection of capital. The startups that can anticipate their revenue flow, the RBF model is highly lucrative for investors. Contrary to equity investments, the investors can expect returns through the RBF model in a span of 2-4 years that otherwise takes 8-10 years.
However, there is one downside to it that is the absence of hard collaterals or guarantees supporting the finance of startups, which puts investors at risk as compared to secured loans.