What is Revenue-based Finance and How does it Work?

What is Revenue-based Finance and How does it Work?

What is revenue-based finance and how does it work?

In its simplest definition, Revenue-based finance (RBF) refers to access to capital that is linked to sales or revenues. It is a widely used and common form of financing that tightens the repayment of the loan to the top-line (i.e, sales) of the debtor.  In recent years, with the online economy booming, technology is allowing a mass adoption of revenue-based finance within digital businesses. And this will be our purpose here: to discuss how RBF works in the digital economy in general, and for the ecommerce industry in particular.

One of the commonalities of digital businesses is they digitally track their operations (and their revenues) through digital platforms, ERPs or accounting softwares. As such, these accounts contain very valuable information about operations, revenue trends, products offering, payment cycles etc. Given how valuable this information can be when analyzing a business, RBF capital providers have developed the technology to easily connect to all of these accounts in order to access all of this data in a seamless way. This data is then used to produce a sales forecast against which money will be lent.

Revenue-based finance can be thought of as a cash advance. The capital provider (like Ritmo) will advance today a portion of the sales the digital business (client) is expected to make over the coming months. In exchange, the client will share a fixed % of future sales with the capital provider until the full advanced amount plus a commission has been repaid. The commission typically ranges between 6% and 12%. Repayments usually happen on a daily, weekly, or monthly basis through a direct debit agreement that allows the capital provider to charge the client the agreed % of the observed sales over each concrete time period. As such, there is no specified repayment period but rather an estimated one. The ultimate repayment schedule will depend on how the business evolves: the higher the growth in sales, the shorter the repayment period.

From a legal point of view, RBF is classified as unsecured lending and has (typically) no claim on the company's assets or equity.

Based on all of the above, you can anticipate why RBF is becoming so popular among digital businesses.

Quite simple. In short, as a client you simply connect your main shopping/sales platforms and a few hours later you are approved a financing offer that you will repay gradually depending on how well your business does, without any personal guarantees or collateral requirements and no specific repayment schedule.

Major RBF trends and capital uses

Within revenue-based finance for digital businesses, two major trends have emerged based on the type of client: subscription or recurring revenue models (SaaS) and ecommerce.

Subscription model RBF annualizes the MRR and brings it forward allowing the company to use today the income current clients would be paying in future months. Funds are typically used to acquire new customers as these businesses usually have very specific (and known) costs of acquiring new clients as well as client conversion cycles. The RBF provider will then keep most of the previous MRR with the company keeping most of the newly generated business of newly acquired clients. This is possible because of the low marginal cost of servicing new clients.

The solution for ecommerce works a bit differently. The main drivers of growth for ecommerce are digital marketing and inventory. And both are variable and recurring costs not only related to sales, but also to the sales cycle. In addition, ecommerce face higher seasonality swings than subscription models. This creates additional issues for the business because larger investments in marketing and inventory are required ahead of the strong sales period. Or stated differently, large investments need to be made during periods of weak sales preparing for coming higher demand. Revenue-based finance for ecommerce tends to come with a lower revenue-share agreement than SaaS. The main reason is online sellers have lower operating margins and the marginal cost of new clients is as high as for previous ones.

Therefore, RBF allows ecommerce businesses to not only solve the question of how to fund growth, but also how to fund operations and seasonality peaks. Let's have a quick look at each.

  • RBF to invest in growth allows ecommerce to double or triple up investments in growth levers (like marketing and inventory) aiming to accelerate sales, expand to new markets or launch new products. The seller can unlock value from future sales, accept a reduced margin for a few months (as the revenue-share will partially eat from margin), and have available funds to invest in growth. The revenue-share in these instances will typically range between 5% and 15%. This gives the seller the ability to embark himself in a growth project without having the funds to do so, and pay for the expansion as higher sales come through.
  • RBF to improve operations aims to create a more business-friendly inventory, cash-flow, and sales cycle, particularly around high seasonality peaks. It allows sellers to match the cost of the sale to the actual sale. It can be thought of as a buy now pay later for sellers: buy inventory now and pay as sales come through. This avoids having to disburse a large amount of money upfront to pay suppliers. Instead, Ritmo pays their invoices and sellers only pay it back as they get the merchandise and sell it. This can also avoid making an unaffordable investment in digital marketing with own funds. Instead, Ritmo takes care of the investment and funds are repaid as this investment translates into higher sales. If costs are closely related to sales, it makes sense to pay for them when sales occur. In this type of RBF, revenue-share is usually higher, between 20% and 40%. It is important to note that this revenue-share is not eating from margin like in the growth example above. Instead, margins stay the same, but the payment of the costs is only made once the sale occurs.

Jorge Jüttner from Ritmo

Ritmo specializes in growth and inventory financing for ecommerce businesses and digital sellers. Through an innovative technology platform, Ritmo can provide up to EUR 5M in financing in just 24 hours by simply connecting to your main Shopping/Sales platforms (Prestashop, WooCommerce, Shopify, Stripe, Amazon Seller Central etc.).

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Jorge Jüttner
April 9, 2024
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