We’ve Heard About SAFEs, But What About RBFs?
Written by: Saranjit Dhindsa
Start-ups need financing – that much is clear.
There are many ways early-stage financing can take shape, but it will either take the form of debt (i.e., a bank loan) or equity (i.e., selling shares to investors to raise capital).
One of the most popular forms of early stage outside financing for start-ups comes in the form of a SAFE – a “Simple Agreement for Future Equity.” Developed in 2013 by YCombinator, SAFEs have been viewed as a quick and easy way to secure financing in seed rounds. For more information on them, check out this blog post.
However, there is a new kid on the block – and it goes by the name of Revenue-Based Financing (or RBFs; the “r” is sometimes referred to as “royalty”).
What is RBF?
Revenue-based financing, also known as royalty-based financing, is another method of raising capital from investors. Investors inject growth capital into the business, in exchange for a percentage of future monthly revenues.
The investor receives their share of the business’s income, until a predetermined amount has been paid. This amount is often a multiple of the initial investment amount.
For example, if an investor initially invests $1 million, the predetermined amount could be a multiple of 3, or 5 times that initial investment (i.e., $3 million or $5 million).
On its face, RBF sounds a bit like debt financing, but unlike debt, you do not pay interest on the outstanding investment, nor are there any fixed payments. Instead, payments have a directly proportional relationship to the business, as the payment calculations are based on the business’s income. So, if a business sees a high number of sales, the royalty payment will be higher, and if the sales slump for a month, the royalty payment will be lower.
RBF is also different from equity financing, as the investor does not have direct ownership of the business. As such, RBF occupies a weird, hybrid space between debt and equity financing.
What Kind of Start-Ups Can Benefit from RBF?
Businesses that are experiencing moderate and hyper-growth can benefit well under RBF. As such, RBF can be a good way for growth companies to secure growth capital. In addition, businesses that are approaching profitability or have become profitable can benefit from RBF. RBF can be used where a company is pre, post or anti-venture capital. It can also be used to extend cash runaway or eliminate the need for a final funding round.
Currently, RBF is most successful with Software-as-a-Service (SaaS) companies. This is because SaaS companies usually have high gross margins and subscription-based revenue models.
So, what are the pros and cons to RBF?
Blog posts are by students at the Business Venture Clinic. Student bios appear under each post.