Last Updated March 6, 2023
A retail business concept known as dropshipping allows the retailer to sell goods without maintaining inventory of the products. Sometimes dropshipping businesses can get revenue based dropshipping financing to support their dropshipping business growth.
Dropshipping has its benefits, such as lower startup costs and increased speed of order fulfillment, but it can also create some unique issues for your business. Cash flow problems are one of the more common issues dropshipping businesses experience, and revenue-based financing is one way to combat that.
Revenue-based financing is a loan that uses your future sales as collateral. It can be used to pay for business purchases and is also popular with online sellers who need working capital.
In this post, we’ll go into more detail on revenue-based financing, how it works and how you can use it to grow your dropshipping business.
What is dropshipping?
Before we dig into revenue-based financing, let's review what dropshipping is. Dropshipping is a business model where the merchant does not keep inventory. Instead, they purchase products from a supplier and resell them to consumers.
The supplier ships the products directly to the consumer (instead of having them ship them themselves). The merchant’s profit comes from the difference between wholesale and retail prices.
The fact that revenue-based financing isn't solely for drop shippers should be recognized. Revenue based financing works well for any company that wants to grow its business without taking on more risk or capital upfront by using pre-purchased goods as collateral against their loan.
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What is revenue based financing?
Revenue-based financing, also identified as royalty-based financing, is a technique for obtaining capital for a business from investors in exchange for a percentage of the enterprise's ongoing gross revenues.
Investors in a revenue based financing investment are given a regular share of the business's income until a predetermined amount is paid. This predetermined amount is typically a multiple of the principal investment and ranges between three and five times the original amount invested.
How does RBF work?
Although a business that raises capital through revenue based financing will be required to make periodic principal payments to investors, revenue-based financing is distinct from debt financing for several reasons. No set payments are made, and no interest is paid on any unpaid debt.
Payments to investors are directly proportional to the firm's financial performance.
This is because payouts fluctuate depending on the company's income level. If sales decline in a given month, an investor's royalty payment will be reduced.
Similarly, if the following month's sales increase, so will the investor's monthly payments.
Additionally, revenue-based financing differs from equity financing in that the investor does not directly own the business. Revenue-based financing is typically considered a debt and equity financing hybrid.
In some respects, revenue based financing is comparable to accounts receivables-based financing, a type of asset-financing arrangement in which a company uses its receivables, outstanding invoices, or money owed by customers to obtain financing.
The company receives an amount equal to the diminished value of the pledged receivables. The age of the company's receivables significantly impacts the amount of financing it receives.
Options for Revenue Based Financing
- SaaS companies, D2C subscription companies, and service businesses
- Companies that have at least $100K ARR.
- A history of solid financial performance along with predictable cash flow and customer metrics (e.g., churn, revenue retention).
- Best suited for technology and SaaS startups with steady recurring revenue streams, whether through long-term contracts with customers or monthly subscriptions.
- A minimum of $200k in annual recurring revenue (ARR) from a diverse customer base.
- 6+ Months in business, with a proven track record of growth
- $100k+ Monthly revenue, selling at least $100,000
- E-commerce, subscription-based, and Consumer SaaS (software as a service) companies.
- 6+ months of revenue greater than $10k/month from connected sales platform(s) corporations or limited liability companies.
- Must generate annual revenues greater than $4M; or ARR greater than $2.5M.
- Must be headquartered in the United States, Canada, or the United Kingdom.
- We focus on tech and SaaS companies but are open to companies in high-growth industries.
- +€10k revenue/month
- Positive unit economics
- Based in Germany
- SaaS and technology
- EUR 3 million annually
- High cash conversion with > 50% profit margin
- An online model such as SaaS, Subscription, eCommerce, Mobile App, B2B
- 6+ months in business
- £10k+ monthly revenue
- Growth-oriented loans for B2B SaaS companies with $1.5M+ ARR.
- You have a growing climate business doing more than $25K in monthly revenue, and you'd like founder-friendly capital to take it to the next level.
- Our RBF has no dilution, collateral, personal guarantees, or complexity.
- 10 mins to apply, a week to get a term sheet, and funding in your account in <30 days
- Eligibility is $120K of annualized revenue.
- Startups with at least six months of runway based on today's cash and burn rate.
- U.S. bank account and headquarters, as well as be incorporated in the U.S.
Pros of revenue based financing
Revenue-based financing allows businesses to get funding without giving up any control or ownership. It's also a way to get money without making large monthly payments, which can help your business grow more quickly.
Here are some benefits that revenue-based financing offers your business.
1. Less expensive than equity
Revenue based financing is less expensive than equity because you are paying for the money you use, not the amount you have.
If a company uses $100 million to buy another company and has that debt on its balance sheet, this will be counted as its total value. If they only borrow $50 million and pay back $10 million in interest over five years, then it's still counted as their total value even though they only borrowed half of what they needed (and paid back some interest).
In other words, it costs more than half as much to buy another company when you're paying back both principal and interest than when you're just paying back principal.
Imagine that a bank gives your startup funding in exchange for 20% of its equity but also wants to collect a 5% annual dividend from your company. That wouldn't float, and you'd be foolhardy to take any deal proposed in this manner.
2. Maintain greater ownership and control
Maintaining greater ownership and control over your business is one of the main advantages of a revenue based financing structure.
The more control you have, the more flexibility you'll also have with your cash flow.
As a result, modifying your business model by switching suppliers or offering new goods or services is much easier because you don't have to ask anyone else for approval or approval documents.
There's no need for a lengthy process where other people get involved in all aspects of decision-making.
You also don't have someone looking over your shoulder at every turn. Revenue based financing only requires one meeting per year with investors, their sole focus being on how many customers are using their product or service, and then everyone can go their own way until next year’s meeting takes place.
3. No covenants or personal guarantees
Many lenders require a personal guarantee from the owner or business partner to secure their loan. A revenue-based financing agreement does not require this. You don't have to agree to give up your assets in case of default, as you would with most other types of financing.
This is crucial for small firms because they could not have many valuable assets and hence have little worth outside of their contractual connection with the lender.
4. No large payments
Your monthly payments are proportional to your monthly income. If you have a terrible month, your monthly payment will reflect it, rather than you being saddled with a huge unaffordable payment.
5. Shared alignment toward development
As part of their “growth-at-all-costs” strategy, venture capitalists overinvest in companies until they self-destruct.
Due to the flexible repayment structure of RBF, investors' returns rise when a company's development rate accelerates.
Consequently, both the entrepreneur and the investor share a common objective for the company's revenue growth.
6. Faster funding timeline
A successful pitch to venture capitalists can take anywhere from months to years. Since RBF investors do not require hypergrowth or large equity exits, lenders can provide financing in as little as four weeks.
7. Financial flexibility
Revenue based financing enables founders to expand and become more established, making conventional financing more accessible.
Financing options include:
Delaying Venture Capital – RBF aids in extending a company's cash runway, which not only helps delay venture capital but can also assist in establishing higher valuations as a company reaches development milestones.
Long-Term Business Administration – Because VCs take on equity, they want the company to “exit” or sell the business. Founders can keep their firms for as long as they choose because RBF investors do not force an exit because the investment is repaid over time.
Option to Sell the Company – Alternatively, founders may choose to sell the company. Under VC financing, VC investors have veto power over company sale decisions. RBF permits the sale of the business if the entrepreneur so chooses, provided the loan has been repaid.
8. Quick approvals
One of the most significant advantages of revenue-based financing is its efficiency.
The fast and streamlined process can get you funding in days instead of weeks or months. This is because there's no need for collateral from the business owner.
All you need to do is prove that you have a good credit score and show that your business has a stable cash flow.
In addition to being efficient and easy on businesses, this type of financing also helps investors by allowing them to diversify their portfolios into an asset class they may not have been able to before because they lack collateral.
9. No fixed monthly payments
One of the most important aspects of revenue based financing is that you won't have to worry about having fixed monthly payments.
As a lender, you no longer have to rely on someone's credit score or income level to determine whether they can buy goods or services from your company. Instead, the amount they will pay depends directly on their performance and how much they currently earn through their business.
This makes it easier for people who cannot get financing through traditional means because of an unstable job situation or other factors outside their control (like a medical emergency) to receive funding without worrying about paying back huge sums every month.
Cons of revenue-based financing
1. Not available for pre-revenue companies
To utilize revenue based financing, your company must generate revenue initially. In other words, pre-revenue businesses are not eligible for RBF funding.
Most revenue based financing companies have minimum MRR and operating history requirements.
2. Funding size is constrained by revenue
While angel investors and venture capital firms may invest millions in pre-revenue enterprises, RBF funding is restricted by your company's revenue.
In general, you will be able to receive three to four times the MRR of your company in a single RBF funding tranche.
However, numerous RBF platforms are willing to provide recurring funding for your business. You can always communicate with your funding partner to find out what they can provide.
3. Required monetary repayment
Funding from the RBF is repaid through revenue-sharing. You will share a small portion of your earnings with the RBF platform until the agreed-upon sum is repaid.
It indicates that RBF funding must be repaid in cash. Unlike angel investments and venture capital, investors do not receive equity in your company.
This is seen as both positive and negative, depending on your view.
Is revenue-based financing right for you?
Here are some pointers to consider when deciding whether revenue-based financing is good for you.
1. Your company generates consistent recurring revenue
Given that you must repay RBF money through revenue-sharing, it is critical that your company produces consistent recurring revenue (even better if you have high gross margins).
Revenue predictability is also essential for the RBF platform to accurately evaluate and forecast your company's financial performance.
This works in your favor since it allows your finance partner to offer repayment terms that are compatible with your company's revenue cycle.
2. You require working capital to expand your business
Frequently, you must spend money to earn money. Inventory, advertising expenditures, and personnel are three cost items that could generate additional revenue for your business.
If growth capital is what you require, revenue-based financing is an excellent option for accelerating the growth trajectory of your business.
Here are the justifications.
RBF money can be repaid in various ways (including a tiny percentage of your company's sales). You will not be required to set aside a fixed amount for repayment, thereby avoiding the budgetary strain that loans can cause.
It is significantly less expensive than equity. The only expense associated with capital is a small flat fee. You need not be concerned about potential 10-fold repayment.
Available funding is recurrent.
3. Your business is either pre- or post-VC
This is one of the largest myths surrounding revenue-based financing. Is it appropriate for equity financing?
The brief answer is “yes.” Deeper into the subject, I would say that revenue-based financing is appropriate for both pre-VC and post-VC companies.
For companies that have not yet raised venture capital funds, revenue-based financing could assist with business expansion and valuation. You can do so while maintaining equity for future fundraising rounds.
Revenue-based financing is also suitable for post-VC firms. It could be utilized to, for example, lengthen your cash runway before the next investment round.
Revenue-based Dropshipping Funding Wrap-up
Revenue-based financing is an alternative to traditional bank loans, SBA financing, and other loan products that require collateral.
You receive a lump sum of money based on your dropshipping business's revenue and then make monthly payments until you pay back the total amount (including interest).
There are no restrictions on spending the money as long as you use it to grow your dropshipping business. It may cover payroll, sales incentives, and overhead expenses like advertising or website building costs.
If you're thinking of starting a dropshipping business and want to scale your online store quickly, there are several ways to do so, but RBF is as good as any and better than most. You want the flexibility to grow a successful dropshipping business your way, and RBF can help create a profitable business model.