As an entrepreneur or a start-up founder, one of your top priorities is to raise funds for your business. There are multiple options in front of you for raising funds. You may opt to sell the equity to a venture capitalist or any other investor. Revenue-based financing is another option for raising money. Otherwise, you may look at taking business loans from any lending institution like a bank or a non-banking financial company.
It is challenging for an entrepreneur to choose between revenue-based financing and a term loan as the best option for raising money. It is advisable to have a clear understanding of both options so that you are in a position to act in the best interests of your business.
What is revenue-based financing?
Revenue-based financing or royalty-based financing is a method of raising funds where the amount one can borrow depends on the company's revenue. Under revenue-based funding, the current revenue of the business, which is also an asset, is used to raise funds. A certain percentage of the revenue is provided as collateral to the loan. In other words, in revenue-based financing, you use your business's projected revenue to borrow additional funds.
The quantum of future revenue is arrived at based on your existing market and your business's current revenue generation. Companies in high-growth industries may be able to raise a higher amount as revenue-based financing as the projected revenue growth is on a larger scale.
How much does it cost to take a revenue-based loan?
You need to understand what revenue is required to be generated to repay the loan. One may use the online revenue-based finance calculator for the purpose.
While using the calculator, one needs to enter the following:
- Desired loan amount
- Current monthly revenue
- The proposed rate of revenue share
- Loan term
- Monthly growth rate projection
Revenue-based financing has started becoming a popular choice among entrepreneurs for raising capital. Many revenue-based financing firms have come up that help high-growth start-ups raise funds for their business.
What is a term loan?
The term loan is the traditional form of a loan. Under this option, financial institutions offer a credit line. The loan needs to be repaid within a prefixed tenor along with a pre-determined rate of interest. The duration of repayment of a term loan may be mutually decided between the borrower and the lending institution.
The rate of interest on a term loan may be either fixed or floating. Most of the borrowing companies prefer a fixed rate as that helps them in their financial planning as the monthly liability is fixed.
Comparison Between Revenue-Based Financing And Term Loans:
As an entrepreneur, you need to consider three essential comparative features in revenue-based financing and term loans before opting for either.
1. Risk Factor:
While comparing revenue-based financing vs term loans, you need to consider the risk factors associated with each option. In the case of revenue-based financing, the loan is sought based on the revenue projection of a business unit. As you continue to grow profitably, revenue-based financing will not pose any challenge in front of you.
If due to some unforeseen circumstances, your business runs into rough weather, you may have to resort to the refinancing of your debts at a much higher rate of interest.
For term loans, the loan amount, rate of interest and the loan repayment term is prefixed at the time of commencement of the loan term. Hence you will be better positioned to plan your finances and make provisions for servicing the monthly installments.
2. Cash Flow:
The impact on the cash flow is in revenue-based financing versus term loans. In the case of revenue-based financing, the monthly repayment goes up with an incremental income over some time. Since the amount of repayment is directly proportional to the revenue generation of the business, it does not impact the cash flow.
In the case of a term loan, the monthly commitment to repay the loan remains constant. Any business has a gestation period before earning at its optimum. In a term loan, you end up paying a higher percentage of your revenue at the beginning of the tenor.
3. The Rate of Interest on Repayment:
There is a fundamental difference between revenue-based financing and a term loan in the repayment tenor. There is no fixed repayment term for revenue-based financing. The cost of borrowing goes up with the duration of the tenor. In case revenue-based financing goes on for a longer duration, you end up paying more in terms of interest.
In a term loan, the repayment tenor is fixed in the beginning. Hence the uncertainty factor is not there. The monthly commitment and the duration of repayment are all known to you, which helps in financial planning.
In many cases, the cost of borrowing for revenue-based financing is higher than for term loans. At the same time, revenue-based financing gives you more flexibility in operating the loan.
Conclusion:
Both revenue-based financing and term loans have their share of pros and cons. As an entrepreneur, you need to apply due diligence and choose what is most beneficial to you. In case you are short of funds, apply for Tata Capital Business Loans and ensure you are always adequately funded to meet your business needs!
03 November 2022
5 mins read
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