Revenue-based loans for early-stage companies burst into the mainstream in 2022. Whether you are a subscription commerce business or a SaaS company, this could be a powerful new way to fund your expansion.
In this guide I’ll explain what I’ve learnt as a founder from many weeks of conversations about the different flavours of debt funding, and when they’re appropriate for your business.
What is a revenue-based loan (RBL)?
An RBL is a business loan secured against a company’s future recurring revenue stream rather than the company’s assets. Most growth-phase companies can’t borrow from traditional banks because they are not profitable, are asset-light, and don’t have big enough revenue streams. Alternative debt providers, including RBLs, have stepped in to fill that need.
This is different to invoice factoring. Factoring companies take over the billing relationship with your customers to repay the debt, which doesn’t work for companies like Littledata where most of the revenue is from Stripe card processing or payouts from an app store.
How do RBLs compare with traditional loans?
RBLs are typically covenant-lite and without personal guarantees. This means if your revenue drops and you are unable to repay the loans the lender has no right to take control of the business or pursue you personally for the debt.
That said, all debt needs to be repaid in full — even if your revenue drops unexpectedly.
How do RBLs compare with selling equity (VC funding)?
Firstly, they are much less dilutive – sometimes non dilutive. This means the current shareholders keep their same hard-earned share of the business. Some lenders may ask for warrants (share options) to share in the upside if your growth takes off, but these are still a lot less dilutive than VC funds.
Secondly, RBL providers won’t interfere or distract you. They don’t want a say in how you run your business; they only want visibility on how your revenue is progressing.
On the flip side, debt providers won’t be able to advise you on growth strategy — most are very transactional. Yet, in my experience, VC investors exaggerate the benefit of their advice, which can be just as distracting as helpful.
Since the outcome for most VC-based companies is very binary, VC funds inevitably focus their attention on the biggest winners in their portfolio — meaning you won’t get their attention in times of need anyway.
In many cases RBLs are not a complete alternative to equity funding — they just reduce your dilution by match funding other equity investments.
Are RBLs the same as venture debt?
The terms are often used interchangeably, but traditionally venture debt was taken on alongside a big injection of cash for equity (e.g. alongside a Series A investment). This boosts the size of an already large funding round but doesn’t help companies trying to grow up to this level. RBLs can be used independent of any equity funding round.
Littledata started exploring revenue based loans back in 2020, and took out our first 3 month loan from Forward Advances. However, with our marketing mix and 30 day free trial it’s impossible to get a return on investment within 3 months. So in 2021 we took on a 12 month loan from ClearCo, and then in 2022 another 12 month facility from Capchase. Then later in 2022 we started working with Element Finance, who have been extremely helpful in working around our existing lending and can lend over 4 years to postpone a larger equity raise.
Will taking on a loan reduce my funding options in the future?
As this kind of debt funding becomes more mainstream it is becoming a useful bridge to ever-larger Series A rounds. In my experience, having a loan on your books will not block an equity investment – as long as it is not convertible into equity, and the warrants for the lenders are minimal.
In fact, since debt funders are agnostic about the exit route or valuation, they keep open exit options that a VC might block. So for example, If your growth stalls and you want to switch to run your company for profit, once you’ve repaid the debt, the income is all yours.
If you can use debt funding to achieve a certain scale ($5M+ ARR), you’ll be able to access much cheaper term loans from lenders like Silicon Valley Bank.
Is my business suitable for an RBL?
If you haven’t yet generated $100k annual recurring revenue (ARR), or you are investing in a new and unproven market, then equity funding is a better option.
To get confident in the stability of your future revenue streams the debt provider will want to see:
1. Majority recurring revenue
2. High net year-on-year revenue growth (at least 50%+)
3. Low customer value churn (less than 50% per year)
4. Low customer concentration (any one customer churning has low impact)
My company Littledata qualifies on all fronts with 100% recurring revenue, high year-over-year growth, less than 40% gross value churn, and our largest customer is less than 2% of our revenue.
How much can I borrow?
Loan values are usually expressed as a multiple of run rate ARR, and the maximum will be between 20% (2 months revenue) and 50% (6 months revenue) of your ARR. This maximum depends on revenue stability, term length, and other factors.
I think I can raise a VC. Are RBLs still relevant?
I think so, yes. It helps boost your valuation and gives you time to wait for the right investor.
Investors value subscription-based companies as a multiple of their ARR, depending on growth and churn. If you’re growing at a predictable rate month-over-month, why would you sell out a bigger share now when you could hold off for a higher valuation in the future.
Short-term RBLs won’t increase your runway unless you can increase your revenue faster than the loan duration – otherwise the extra revenue you gain from bringing forward hiring or marketing spending will likely be offset by the debt repayments.
But VC funding can also reduce your runway (by encouraging higher burn rates) AND limit your exit options. It’s a necessary evil in some cases, but don’t believe it’s the only way. (Image credit: Founder Collective)
What are the options for funding a sub-$2M ARR business?
At this level, you are limited to borrowing over a maximum 12-month term. This means you’ll need to repay the loan monthly over a year, so if you borrow $200k you’ll repay around $18k per month including a fee.
This fee is typically expressed as a discount rate — equivalent to the discount you might offer a customer for paying annually rather than monthly. Discount rates on 12-month loans currently range from 5% to 11% depending on the underwriting risk. This translates to an APR of 10% to 18% since half of the money is repaid within half the loan term.
Some lenders will structure the repayments as a percent of your monthly revenue (i.e. you repay over a minimum of 12 months), which limits the cash out if your revenue sinks. But, in practice for a growing company, the repayments will be fixed.
You could also borrow for 6 months for half the cost. This doesn’t work for us, but it could work for you if you can quickly translate marketing dollars into more recurring revenue.
Since the process is usually fully automated — with data feeds from common accounting and banking platforms — these lenders are very quick, with offers in 24 hours and loans within 10 days.
Some of the lenders in this space are:
- Clearco (previously Clearbanc)
Forward Advances(stopped lending)
- Velocity Capital
Full disclosure: we’ve taken loans from Forward Advances, Clearco, Capchase, and Element Finance.
What are the options for funding a $2M+ ARR business?
The lenders above will welcome you with open arms; at this scale, their risk is lower and the fees are higher. But there are now more options for lower interest rates and longer-term loans.
Element Finance offers 4-year loans of $500k+, with no warrants.
Element Finance recently provided funding to Littledata for the next stage of growth.
Saas Capital, based in Seattle, also offers 4 to 5 year loans with lower interest and warrants. They can lend between 4x and 12x trailing MRR, depending on growth and churn, but focus more on SaaS.
Riverside Acceleration Capital offers a 3 to 5-year loan, with an interest-only period at the start to reduce cash out.
Prefcap offers a 2-year, rolled-up loan (no monthly payments, but repaid or refinanced in full at the end of 2 years). This reduces your cash out, but they want warrants with the right to invest equity in the next round.
Flow Capital, based in Canada, offers a 3 to 5-year loan with lower interest but with warrants.
Lending over longer periods is much less predictable, so the process will be more like interacting with a VC: a week or two to get to a term sheet, and then 6 to 8 weeks to complete due diligence and access the funds.
If you’re a growing subscription business, check out the possibilities for RBL financing. Even if you don’t need the money now, it can be a useful option for bridging to the next equity round — or allowing you to say no to egregious term sheets.
I’ve spent many weeks pitching VCs and as flattering as it is to have experienced investors quiz you about strategy, I’d far rather be putting the capital to work in growing the product and customer base. RBL funding gives me that option.