What’s REVENUE-BASED FINANCING?
Revenue-based financing (RBF), also referred to as royalty-based financing, is a distinctive type of financing supplied by RBF investors to small- to mid-sized companies in exchange for an agreed-upon percentage of a business’ gross revenues.
The capital provider receives monthly payments until his invested capital is repaid, along with numerous of that invested capital.
Investment funds that offer this distinctive form of financing are known as RBF funds.
- The monthly payments are known as royalty payments.
- The percentage of revenue paid by the business for the capital provider is known as the royalty price.
- The several of invested capital that’s paid by the business to the capital provider is known as a cap.
Most RBF capital providers seek a 20% to 25% return on their investment.
Let’s use a very easy instance: If a business receives $1M from an RBF capital provider, the business is anticipated to repay $200,000 to $250,000 per year towards the capital provider. That amounts to about $17,000 to $21,000 paid per month by the business for the investor.
As such, the capital provider expects to acquire the invested capital back within 4 to 5 years.
What is THE ROYALTY Price?
Every single capital provider determines its expected royalty price. In our basic example above, we can perform backward to identify the rate.
Let’s assume that the business produces $5M in gross revenues per year. As indicated above, they received $1M from the capital provider. They may be paying $200,000 back towards the investor every single year.
The royalty rate in this example is $200,000/$5M = 4%
VARIABLE ROYALTY Price
The royalty payments are proportional to the top line of the business. All the things else becoming equal, the greater the revenues that the business generates, the greater the monthly royalty payments the business tends to make towards the capital provider.
Classic debt consists of fixed payments. Consequently, the RBF scenario seems unfair. In a way, the business owners are being punished for their tough function and achievement in growing the business.
To be able to remedy this dilemma, most royalty financing agreements incorporate a variable royalty price schedule. Within this way, the higher the revenues, the reduced the royalty rate applied.
The exact sliding scale schedule is negotiated between the parties involved and clearly outlined inside the term sheet and contract.
HOW DOES A BUSINESS EXIT THE REVENUE-BASED FINANCING ARRANGEMENT?
Every business, in particular technology businesses, that grow very promptly will sooner or later outgrow there will need for this kind of financing.
As the business balance sheet and income statement turn stronger, the business will move up the financing ladder and attract the attention of extra classic financing option providers. The business may come to be eligible for the conventional debt at more affordable rates of interest.
As such, every revenue-based financing agreement outlines how a business can buy-down or buy-out the capital provider.
The business owner often has a solution to buy down a portion in the royalty agreement. The certain terms for any buy-down choice vary for each transaction.
Commonly, the capital provider expects to obtain a specific distinct percentage (or numerous) of its invested capital before the buy-down option could be exercised by the business owner.
The business owner can physical exercise the selection by producing a single payment or some lump-sum payments to the capital provider. The payment buys down a specific percentage on the royalty agreement. The invested capital and month-to-month royalty payments will then be decreased by a proportional percentage.
In some instances, the business could make a decision it wants to purchase out and extinguish the complete royalty financing agreement.
This frequently happens when the business is becoming sold along with the acquirer chooses not to continue the financing arrangement. Or when the business has grown to be sturdy sufficient to access less expensive sources of financing and desires to restructure itself financially.
Within this situation, the business has the option to get out the whole royalty agreement to get a predetermined various with the aggregate invested capital. This multiple is generally known as a cap. The distinct terms for a buy-out solution differ for every transaction.
USE OF FUNDS
There are generally no restrictions on how RBF capital is usually applied by a business. Unlike inside a traditional debt arrangement, there are small to no restrictive debt covenants on how the business can use the funds.
The capital provider permits the business managers to use the funds as they see fit to grow the business.
Quite a few technology organizations use RBF funds to acquire other businesses so that you can ramp up their development. RBF capital providers encourage this kind of growth since it increases the revenues that their royalty rate may be applied to.
As the business grows by acquisition, the RBF fund receives higher royalty payments and consequently rewards in the development. As such, RBF funding can be a terrific supply of acquisition financing for any technology firm.