Revenue Based Funding (RBF) is becoming an important tool in a startup’s corporate finance strategy these days, as a way to extend runway, either to defer a capital raise (with valuations currently lower) or to conclude a capital raise (with transaction times currently longer). Indeed, RBF’s unique characteristics have translated well into the mainstream of SME funding, originally starting with retailer merchants but now extending into many new verticals.

RBF, in its essence, is a loan facility which is paid back as a % of monthly revenue – with no fixed term (payback period), no security and without the administrative burden of historical annual statements. And of course, no dilution! The risk of default for the borrower is much lower than a typical fixed payment bank loan, as they automatically end up paying less in a lean month.

Sounds pretty good! RBF is usually more expensive (circa. 5-15% in finance charges), but that is often very acceptable to the borrower, who in many cases would not have had the security or assets to qualify for a bank loan. Although no fixed term, the % revenue payment is usually calculated on a 12 month repayment assumption, but this assumption can sometimes flex up to 24 months. In practise, the monthly payments are variable and the term extends until the loan is paid back.

In the startup space, RBF is usually applicable to eCommerce startups that have demonstrable, consistent and growing sales volumes, and subscription-based/SaaS startups that have contracted and growing monthly revenues. Loan facilities can be as high as 50% of ARR (Annual Recurring Revenue, calculated monthly as 12 x Monthly Recurring Revenue), but would usually start at a lower %. There can be further draw-downs as the ARR increases over time and/or as the lender becomes more comfortable with the underwriting risk of the borrower.

RBF lenders share the revenue and growth risk with the borrower – not the comfort zone for traditional banks, and has ironically become the domain of Fintech startups. Sifted reported in March 2022 that 18 RBF startups have been founded in Europe since 2019, attracting $671m in VC funding in 2021, with more recent raises by Wayflyer, Karmen and Silvr. The more established players such as Liberis, ClearCo, Pipe and Capchase  originated in the US and have expanded into Europe. Linea Capital is pioneering RBF for startups in South Africa.

Lending decisions are relatively quick and easy, some promising a decision within 24 hours but usually not longer than 7 days, with applications (and reporting ) done directly on an online portal. Decisions are made based on monthly revenue and transactional data over the past, up to 12 months, and forward projections, which need to show consistency and growth, with not too much revenue concentration risk, and gross margins that can support the monthly payments.

The mPOS-based (mobile Point of Sale) Payment Service Providers (PSP) such as Block (formerly Square), Zettle (now owned by PayPal), SumUp, and South African-based Yoco have been providing finance to their merchant customers for years, as part of a strategy to provide complete financial services to merchant SMEs, such as acquiring, accounting, financing, stock control etc. (given that this is little margin in transaction acquiring).

The logic is that PSPs already have the revenue and transactional data from the card transactions. SumUp announced a new $100 million credit facility last week to provide merchant financing to their 4 million SME base in 35+ markets.

The same logic  has been extended by other RBF providers into the startup eCommerce sector through accessing their historical and real-time transaction/payment systems. Technology is the enabler to provide RBF at scale.

Innovative startups are taking RBF finance to SMEs in many other verticals. A great case study is South African Fintech Merchant Capital, that started out providing RBF to retail merchants but has expanded into restaurants/hospitality and even medical professionals, wholesalers and manufacturers, sometimes in partnership with traditional banks for distribution – funding 25,000 businesses with R7 billion ($371 million) since 2012.

RBF is truly coming of age for SMEs of all types (including tech startups) that have strong transactional revenues even if they do not have a long trading history or collateral. It is more accessible and less risky than traditional bank loans, and provides leverage and/or runway to enable companies to grow without equity dilution.