Since the start of 2020, startups in India have been experimenting with a new way of raising funds called revenue-based financing (RBF). Here, the investor gets a regular share of the business’ income until a certain amount, decided in advance, has been paid. This amount is typically several times the investment. The revenue-based financing model is a hybrid model between debt financing and equity financing that consists of medium risk and better than debt returns. Here, the investors give debt to the startups, but not as a structured loan. The revenue-based financing model enables the investors to receive a fixed percentage share of the business’ revenues each month.
The early-stage startups, D2C brands, e-commerce startups, and SME businesses will find it difficult to raise funds through traditional venture debt since venture debt is available to only those startups or businesses that have already raised a single round of venture capital. Venture capital is a medium-term loan with fixed interest rates and monthly repayments. With RBF ( revenue-based financing model) the entrepreneurs have the freedom of raising funds from anywhere between Rs 5 lakh to Rs 15 crores and repay the amount to investors with a percentage of their revenue generated between 1% and 10%. Thus, instead of paying fixed monthly instalments or equity dilution, the startups can issue new shares followed by a decrease in stockholders’ shares of the company. Besides raising funds the RBF model makes the startups available to data points such as GST ( Goods and Services Tax) that gives companies the power to underwrite in case of losses incurred.
Bharat Sethi, the founder of the direct-to-consumer firm Rage Coffee, sees RBF as a way to grow revenue. “Taking the RBF route leads to a higher valuation,” said Sethi, who has raised funds from GetVantage twice using RBF. “If we are able to meet those targets and grow topline revenue, without equity dilution, we’re able to raise our valuations.”
The new model of funding has given a new lease of life to the startup ecosystem, since the 12-month repayment cycle gives startups adequate time to grow the topline revenue, offering flexibility and increasing company valuation without the dilution of equity. The funding raised from the RBF model can accommodate the working capital requirement.
Beginning from 2020, India has about half a dozen investment firms, who are following the RBF suit including N+1 Capital and Klub. The investors are responsible right from its aggregation and risk assessment to the collection of capital. Contrary to equity investments, the investors can expect returns through the RBF model in a span of 2-4 years that otherwise takes 8-10 years. However, there is one downside to it that is the absence of hard collaterals or guarantees supporting the finance of startups, which puts investors at risk as compared to secured loans.
As India’s startup ecosystem grows, the funding side will evolve too, and more companies will come up with other creative ways of raising money, said Srinath Sridharan, member of the governing council of the Fintech Association for Consumer Empowerment.