Revenue-Based Financing for Technology Companies
WHAT IS REVENUE-BASED FINANCING?
Revenue-primarily based financing (RBF), additionally referred to as royalty-based totally financing, is a completely unique shape of financing furnished via RBF buyers to small- to mid-sized organizations in trade for an agreed-upon percent of an enterprise’ gross sales.
The capital company receives month-to-month payments till his invested capital is repaid, alongside a multiple of that invested capital.
Investment funds that provide this precise shape of financing are known as RBF finances.
– The month-to-month bills are referred to as royalty bills.
– The percent of revenue paid by means of the commercial enterprise to the capital company is referred to as the royalty rate.
– The couple of-of invested capital this is paid through the business to the capital provider is known as a cap.
Most RBF capital carriers are searching for a 20% to 25% return on their funding.
Let’s use a completely easy instance: If an enterprise gets $1M from an RBF capital provider, the commercial enterprise is expected to pay off $two hundred,000 to $250,000 in line with year to the capital issuer. That amounts to approximately $17,000 to $21,000 paid in step with month with the aid of the enterprise to the investor.
As such, the capital issuer expects to receive the invested capital lower back within 4 to 5 years.
WHAT IS THE ROYALTY RATE?
Each capital company determines its own predicted royalty rate. In our easy instance above, we will work backward to decide the charge.
Let’s count on that the commercial enterprise produces $5M in gross revenues in step with a year. As indicated above, they received $1M from the capital provider. They are paying $2 hundred,000 again to the investor every 12 months.
The royalty price, in this case, is $two hundred,000/$5M = 4%
VARIABLE ROYALTY RATE
The royalty bills are proportional to the top line of the enterprise. Everything else is identical, the better the revenues that the commercial enterprise generates, the higher the month-to-month royalty bills the business makes to the capital issuer.
Traditional debt includes fixed bills. Therefore, the RBF state of affairs appears unfair. In a manner, the business proprietors are being punished for his or her hard paintings and achievement in developing the commercial enterprise.
In order to remedy this hassle, maximum royalty financing agreements incorporate a variable royalty fee schedule. In this manner, the better the revenues, the decrease the royalty price carried out.
The precise sliding scale schedule is negotiated between the parties involved and definitely outlined in the term sheet and agreement.