Revenue-Based Financing: What’s at Risk

It’s safe to say that many small businesses have, at some point, worried about being unable to pay the bills. Whether it’s a slow month, a job or two fell through, or foot traffic just wasn’t at its height.

But what if you paid your bills depending on how much cash your business actually brought in? For a big risk, of course.

Revenue-based financing allows borrowers to do just that—pay off their loans based on a monthly allocation of the revenue their business brings in. While interest rates are typically higher, some say they like the ‘riskier’ lending format better because it allows them to maintain ownership of their companies while not forcing them to borrow against their homes and possessions.

Mike Glanz, 28, sought out a revenue-based loan from LighterCapital in November 2011 for $200,000. Within two weeks of applying, Glanz said the money was wired into his bank account.

He says he has “as long as it takes” to pay it off at a rate of 2.5% revenue interest each month. The loan should take his company, Hire a Helper, 10 years to pay off, at most, he said. This model wasn’t their first choice for a loan, however, Glanz said they went to Wells Fargo and were turned down.

“They won’t loan more than a certain percentage of the majority partner’s yearly take home,” he said. “We also talked to angel investors but it was the same thing—it’s really expensive, you give up one-third of your company forever.”

San Diego- based Hire a Helper is cash-flow positive, Glanz said, and has been growing at a rate of 85% annually since 2007. The company is similar to Travelocity.com, he said, although instead of hotels, it connects consumers with movers across the country for relocation at the best rates.

According to Glanz, right now every dollar the company earns goes back into growing the business.  He said they are six months into paying off their loan and are completely satisfied. They’ve hired six new programmers, for a total of 14 employees.

“I am so happy we did it,” he said. “They didn’t have to have any equity in the company, previous investors didn’t have to cosign and they didn’t look at our personal interest.”

LighterCapital started up in 2010 and has since lent out $2 million to 14 clients, some of which have received multiple rounds of financing, according to vice president Rob Belcher. The average loan is between $150,000 and $250,000. Most loans are paid back within three years, with between 15% and 30% annual interest, Belcher said.

“There is no personal liability with this model, so they are personal guarantee-free,” he said. “The risk is on the company, and on us.”

The major risk here is that if the borrower becomes delinquent on the loan after a set time period they stand to lose everything--their business, patents, domain names and trademarks-- to LighterCapital.

“Any kind of loan is risky,” he said. “This is just a different kind of risk. They have your business as collateral, so you have to be responsible. If the company goes out of business in two years, they go down with it. But, they’re not taking my house, so it’s really assuring.”

Belcher said the company does conduct background checks on applicants, however, their personal history doesn’t necessarily dictate the outcome of the loan. FICO scores are rarely taken into consideration, as LighterCapital focuses more on business situations, revenue models, and business cycles throughout the year, he said.

A seasonal business is the ideal client for this type of financing, Belcher said, because they have steady income flows during certain time periods throughout the year. However, a consulting group that sees customers on a one-off basis is riskier for LighterCapital, because it does not have a clear forecast of its revenue stream.

“A two-year deal will get a two-or-three-times return, including principle, repaid to us,” he said. “In the equity world, that is small, but [for borrowers] it is pretty bad. But, in two to three weeks after they get the money, we all start getting money. That is the upside to how much risk we are seeing.”

Laloo’s Goat Milk Ice Cream Company in Petaluma, Calif., also received funding from LighterCapital in 2011 for $200,000, according to owner Laura Howard. The business has four full-time employees, and up to 60 part-time employees and sales people across the country.

Howard said she turned to revenue-based financing when she, too, found herself ineligible for a loan from a bank.

“We couldn’t get loans from a bank, and I didn’t want to give out the amount of equity needed to bring in venture capitalists,” she said. “Banks required I used my farm as collateral. We were bringing in lots of new business, and I didn’t want it to be such a personal thing.”

While Howard declined to discuss the repayment period and interest rate on her loan, she did admit there is more at stake with this model than in traditional lending.

“It’s riskier, and definitely more expensive,” she said. “It’s a new thing we are exploring.”

National Federation of Independent Business’ Senior Research Fellow William Dennis said that the model is not necessarily more or less risky than a traditional loan from a bank. Having more flexibility with payment can be a definite bonus if you are a seasonal business that has money coming in steadily throughout some parts of the year, and more slowly during others, he said.

“It’s matched to how well you are doing, where more traditional models are not necessarily tied that way,” Dennis said.

The small business lending environment is working in response to two dynamics, Dennis said, one being cash flow and the other being real estate. Small business cash flow is increasing, as is their demand for financing, however real estate is still holding many businesses back because so many are tied to the suffering market.

“Banks look for two things—one, they want to get paid on time, and two, they want something back they can take,” he said. “A lot of small businesses own real estate and that will be with us for awhile, causing problems. This is where the positives of revenue-based financing come in.”