Revenue-Based vs Traditional Debt Financing
In this article we’ll define and review the 5 key differences between revenue-based financing versus the traditional debt financing methods. The four types of debt financing options and our recommendation based on the individual’s needs.
Defining Revenue Based Financing
There are several factors that set revenue-based financing apart from traditional debt financing. Those being that there are not any fixed payments nor is there interest applied on an outstanding debt. That being said, the company acquiring capital through a revenue-based financing plan does have to make consistent payments to cover the investor’s principle.
Revenue based financing and capital are directly related to the progress and success of the company. Therefore, if investors see that there is a great amount of potential in the growth of the enterprise, the higher the likelihood a company is to land a large investment agreement, resulting in rapid success rates during the initial development stages of a company. Another thing to consider when looking for revenue-based financing would be the ownership terms. This being the key factor that sets a revenue-based agreement apart from an equity loan; the ownership of the company remains with the entity and is not transferred to the investor or stockholder.
Royalty Financing
With an increase in popularity among start ups and other junior companies, royalty financing programs offer an increased chance to obtain investment capital for companies with a slight uncertainty when regarding their returns and profits. With there being no fixed payments, the enterprise tends to have less risk and more financial flexibility when getting up and running.
However, that being said, there is more risk involved on the investors side as they are unsure what kind of success the enterprise will receive. This usually leads to more expensive payment plans to account for the inherent uncertainty and risk associated with a royalty or revenue-based financing plan.
Defining Traditional Debt Financing
Regarded as the more stable and concrete financing option, the individuals and institutions agree upon the rate of return as well as establish a promise to return the borrowed assets in full. An alternative to debt financing would be considered equity financing where ownership stakes in a company are up for grabs. This type of loan consists of share-based loans and capital. For instance, stocks would be considered a form of equity financing. Stockholders receive a percentage of future income and it does not have to be paid back, however the success of a stockholder is directly related to the growth of the company. While equity financing focuses on managing stocks to increase funds, debt financing entails making income by selling debt instruments to their investors.
Several Types of Debt Financing Options:
While being the most traditional form of financing and borrowing funds as an investment into the growth of a company or one’s self, there are still multiple different forms and avenues of acquiring additional capital.
Those being:
- Bank loan. A common form of debt financing is a bank loan
- Borrowing money from a bank to facilitate and expedite growth
- Funds and capital must be paid back, often time with a fixed percentage of interest
- Bond issues. Another form of debt financing is bond issues
- Stable and fixed income is highly recommended
- Also must be paid back
- Interest rates issuing bonds to investors is typically less than banks
- Exceptional choice for companies aiming to increase capital through investors instead of a bank
- Other means of debt financing include taking loans from family and friends and borrowing through a credit card.
- Considered one of the most primitive forms of debt financing, borrowing money from someone is as traditional as it gets.
- These agreements are usually more flexible as the terms of the loan are decided amongst the investor and recipient
- Credit card loans tend to follow a similar trajectory, the main difference being the money is borrowed directly from the user’s bank instead of a friend or family member
Our Recommendation
Revenue-Based Financing Recommendation
When it comes down to it, getting a traditional loan from a bank may oftentimes be tricky and cumbersome. With less hoops to jump through, a plethora of opportunity for growth, and a less risky environment, revenue or royalty-based financing options shine through. This being the case, especially for start-ups and junior companies looking to get their foot in the door. Revenue-based bonds also tend to be more accessible for companies when traditional loans may be significantly more difficult to attain.
Traditional Debt Financing Recommendation
On the flip side, for those looking for stability and fixed payment plans, the traditional route is the way to go. For those looking to turn a smaller sum into an opportunity for much larger potential earnings while still retaining full ownership in the company. Additionally, debt payments tend to be tax-deductible. Only choose a traditional debt financing loan if revenue growth and income are practically certain as payments and interest will continuously increase regardless of the company’s success.
For the least costly and most straightforward option, it’s often best to stick with traditional debt financing options such as bank loans, bonds, or simply credit cards. However, for a more risk-free experience and ease of access when acquiring additional investment capital, a revenue-based finance option may be the optimal choice. For something of a hybrid between the two, consider an equity financial plan as an asset, and its value may be allocated to investors, all while the ownership remains in the companies’ hands.
Sources:
Royalty Financing: A New Source of Capital in Mining, Tech and Beyond
