The Promising Future of revenue-based financing
By Priyank Kothari, Director, Arvog
Revenue-based finance is a way of obtaining capital for a company by paying investors a percentage of the corporation’s continuous gross revenues in exchange for their investment. Investors in an RBF investment receive a regular share of the company’s earnings until a set sum is redeemed. This predetermined sum is usually a multiple of the initial investment.
From the point of view of an investor, revenue-based financing offers a chance to make a lot of money. However, because the payback rate is directly related to revenues, an investor should be mindful of the risks involved with the financing arrangement. If the company’s revenues drop dramatically, the repayment rate will fall in proportion, immediately lowering the IRR.
Entrepreneurs and enterprises can benefit from RBF in a variety of ways. However, the nature of RBF necessitates that organizations possess two crucial characteristics.
First, the company must generate revenue, as payments for the loan will be made from that revenue.
Second, the company’s gross margins must be high enough to cover the percentage of income committed to loan payments.
The interests of RBF investors and the companies in which they invest are aligned. Both parties benefit when the company’s revenue increases and both parties lose when revenue decreases. By delivering a revenue-tracking repayment, RBF assists the firm in managing bad months.
When it comes to acquiring funds, the cost of capital is also a critical factor to consider. For various reasons, the cost of capital in an RBF venture is typically lower than that of a comparable equity transaction.
To begin with, the loan’s effective interest rate is far lower than the effective interest rate demanded by an equity investor on their invested funds if the company is sold or additional funds are raised. Second, legal fees for compliance and other regulatory checks are lower as compared to equity fundraising. Finally, because the investment is a type of debt, the interest paid on it is a tax-deductible expense for corporations.
While revenue-based finance is still in its infancy in India, the timing could not be better. Over 800 new-age brands have established themselves as successful eCommerce businesses in the country, using a direct-to-consumer method. Scores of new, interesting D2C companies and millions of small and medium-sized enterprises (SMEs) across the country have gone online in the last 18–24 months.
India boasts one of the world’s largest start-up ecosystems – the third largest, to be precise – and this does not include the millions of SMEs on the verge of embarking on their digital adventure. According to Avendus Capital, the direct-to-consumer market in India will be worth US$ 100 billion by 2025.
Due to a mix of variables, early-stage start-ups or these SMEs are most suited for RBF.
First and foremost, RBF platforms are willing to lend as little as ten lakh rupees and as high as two crore rupees for a fee of 4-8 percent, depending on specified characteristics. Second, the rapid disbursement enables small businesses to obtain funds when needed. Third, knowing exactly how much of your income is required to settle your debt in a given number of months is transparent. Finally, some platforms use a data-driven approach to provide funding that is focused on the fundamentals of the business and performance rather than on whom you know.
While the access to cash is swift, due diligence is not compromised. RBF fintech platforms leverage technology-driven procedures and unique data-driven underwriting algorithms to analyse firms and their performance. This also explains why RBF has so few NPAs.
The most significant development opportunity for RBF, however, comes from India’s booming D2C industry, which has seen huge growth throughout the pandemic. According to a recent analysis by Inc42, while D2C businesses saw an 88 percent increase in customer demand in 2020 compared to the previous year, only 25% of the $2 billion in funding in the last eight years went to D2C firms in the development stage.
RBF’s future in India is exciting and full of promise. RBF, as a revenue-first, founder-friendly alternative, could be the extra stimulus India’s start-up ecosystem requires to recover from COVID.