Businesses who have limited start-up capital or tangible assets often look for creative ways to secure loans. When deciding which form of funding is best for your company, you should consider whether you want to gain more debt or give away equity. Both have their pros and cons. When you take on debt your business may struggle when interest rates fluctuate. Equity also has its drawback by forcing you share ownership and profits of your business.
One creative option that can overcome the general limitations mentioned above is a revenue loan.
A revenue loan or revenue-based financing are types of loans.
Unlike normal loans however, the business promises to provide a fixed percentage of their net or gross profit. The loan continues to exist until the initial amount including a multiple or cap is repaid. The multiple or cap is similar to the interest charge on a loan, and is based upon the fixed percentage of profit to be repaid. These types of loans can usually be repaid within 4 to 5 years.
Revenue loans are usually sought out by small or growing businesses that are either:
- having difficulties securing a bank loan due to lack of history; or
- struggling to convince investors to inject large amounts of capital.
Revenue loans are considered as a hybrid form of debt-equity between bank debt and venture capital.
For every loan type, there are benefits and there are downsides. The main downside of revenue loans is that, due to the high risk of the loan, the effective interest rate is usually set at a range of approximately 20 to 30 percent of the profit of the business until the loan is repaid. This incentivises companies to grow to repay the loan within a short period of time.
Are revenue loans the right option for your business?
Revenue loans are great alternatives for those who cannot receive traditional loans from banks. They are also useful to businesses that do not wish to give away large stakes of equity in their company for relatively small amounts of capital from angel investors or venture capitalists. Businesses whose sales fluctuate in different months will benefit from the fact that interest or the cost of the loan is based upon their profits.
However like all forms of fundraising, revenue loans are not the right option for all businesses. Due to the high interest rates, these loans will not suit slow growing businesses or those with low profit margins.
Such loans may also not suit start-ups who wish to reinject all profits into the growth of their business.
Is your business considering raising funds for growth? Do you need a loan but have limited working capital and assets? Why not discuss your many options today with one of LegalVision’s business lawyers. Just call 1300 544 755.