Revenue Based Financing — New Way of Financing Online Businesses
In the past decade, e-commerce sales have skyrocketed and the pandemic further accelerated its growth as many consumers discovered the convenience of online activities. Just in 2020, over two billion people purchased goods or services online with online retail sales surpassing $4.2T. There is a movement to disintermediate parts of the supply chain in emerging markets as multiple brands are connecting directly to the end consumers. An example of the increasing relevance of the direct-to-consumer (D2C) segment can be found in India, according to a report by Inc42, the addressable D2C market in the country stood at $45B in FY21 and is expected to reach $100B by FY25, growing at a CAGR of 25% during the period.
These direct-to-consumer and e-commerce businesses, which in its majority are SMBs, oftentimes face challenges when scaling, and how they are able to cope with this acceleration often defines success from failure. The faster they grow, the more they will need the inventory and marketing capital, which will convert into revenue over time. This especially gets acute during demand peaks like Black Friday or Christmas, forcing brands to lose out on growth because they were not able to timely finance their inventory. Until recently, these companies either relied on regular lenders — which do not know how to assess their credit profile — or venture firms for financing, but the nature of their business has made both such options widely inefficient.
FINANCING PROBLEM
Many digital businesses run into obstacles when seeking early-stage growth financing :
- Every business is not a right fit for venture capital financing (and not everyone wants to sell a stake of their company as well). According to a recent estimate, less than 0.5% of over 75,000 independent e-commerce stores on platforms such as WooCommerce and Shopify in India were equity funded.
- Further, traditional sources of financing like banks take a really long time to process and many ultimately struggle to underwrite loans to online businesses.
- This leads to many e-commerce entrepreneurs often having to get personal loans with significant collaterals and taking on personal guarantee requirements to finance their companies — and this is also true for even online retailers with sizable revenue, who are also routinely declined by banks.
Given this sub-optimal situation, where should e-commerce companies get money to run their business? We believe revenue based financing is the solution!
BENEFITS OF RBF
It is a source of funding that is non-dilutive, doesn’t require collateral or personal guarantees, and that does not take months to obtain. Revenue based financing fits between venture capital and a traditional small business loan. It doesn’t require personal guarantees, warrants, equity, nor even the entrepreneur’s credit scores. Instead, by connecting different data sources via API — Stripe, Shopify, FB, Adwords etc — the company’s financial health is measured, and capital is provided — in a matter of hours — in exchange for a small percentage of future revenue. We believe this is an extraordinarily compelling value proposition: no interest, no dilution, no warrants, no covenants and no long-term commitment.
ClearCo and Pipe along with Uncapped, Wayflyer, Jenfi to name a few are some of the companies doing this. Of these ClearCo and Pipe are the leaders in the space with unicorn valuations.
Since its inception in 2015, Clearco’s biggest challenge was scaling the capital market side of its business and making sure it consistently had funds available. The product allowed e-commerce companies to raise non-dilutive marketing growth capital between $10,000 to $10M based on its revenue and ad spend. Clearco claims to have invested over $2B in over 4,500 businesses and is the world’s largest e-commerce investor.
Pipe was founded in September 2019 with the mission of giving SaaS companies a way to get their revenue upfront, by pairing them with investors on a marketplace that pays a discounted rate for the annual value of those contracts. It charges both parties on each side of the transaction a fixed trading fee of up to 1%, depending on the volume. Over time, Pipe’s platform has evolved to offer non-dilutive capital to non-SaaS companies as well, with as much as 25% of its customers currently non-SaaS.
Growth capital accessed by SME / D2C brands through the revenue based financing route could be onwards of $10,000. It is usually through a revenue-share agreement which includes up to 20% monthly revenue sharing by startups. A one-time financing fee, 6–14%, is also charged on the principal amount. Here is a typical RBF financial model, courtesy Bigfoot Capital, and their anonymized term sheet.
EXCITING ASPECTS OF THIS MODEL
Flexibility: An RBF company offers its customers a far more flexible approach to financing than traditional banks or lending institutions because it ties the repayment schedule to the performance of the business, charging a percentage of that business’ future sales. When businesses do well, they pay back the money faster. Different RBF platforms provide financing ranging from as little as $10,000 to $3M over a period of six months to three years. This makes it ideal for teams with a strong idea, product and market fit, but that don’t necessarily need to raise hundreds of millions to scale.
Speed: This unique repayment model doesn’t just provide flexibility to businesses, it also benefits the RBF company. When businesses use the growth-capital effectively to increase their revenue, they also pay back the RBF company faster than they would a traditional fixed-rate loan. This accelerates the loan-cycle, giving RBF companies the opportunity to redeploy their capital into profitable ventures faster than their traditional lending competitors. Additionally, having first access to money is key to not being disintermediated.
Data: Using the data provided by customers, RBF companies can offer an analytics platform that provides actionable business recommendations, for example, to spend more money on Facebook advertisements. Successful companies in this space use a product-led-growth strategy of offering free analytic tools for its customers and becoming entrenched in their workflow. This helps the company create stickiness, and later upsell ads-financing or inventory buying.
HOW MODELS AROUND THE WORLD ARE EVOLVING
RBF companies around the world currently have two different main sources of funding: Marketplace models like Klub and Pipe and raising debt funds like Clearco, Divibank (in LatAm), and Wayflyer. Also, though the D2C/SaaS ecosystem in emerging markets is experiencing growth with other consumer tailwinds, it has yet to reach a stage of maturity comparable to western markets. Therefore this solution is relatively new for emerging markets so companies trying to build this need to have in mind the importance of educating its customers.
Marketplace model: Companies adopting the marketplace model operate by pairing customers with investors. This allows both institutions and individuals to provide capital to their loved brands with users of marketplace RBF can now participate in the brand story and invest in it. The marketplace model may be better suited to D2C brands because customers can relate to the brands and want to invest in them. Also, expanding to other countries with this model is more difficult as the company needs to establish liquidity in both sides of the marketplace, or deal with complex regulatory issues.
Debt fund model: Companies operating this model adopt a balance sheet lending approach and therefore raise debt to finance the loans they provide to the customers. If the platform is unable to raise cheap capital, it’ll only be able to serve high-risk customers, which may lead to high NPL and a smaller TAM. The debt fund model suits both D2C companies and SaaS businesses. The platform doesn’t need to establish trust between customers and investors because all sources of capital are “proprietary”. This model is also easier to expand to other countries as the company doesn’t need to raise capital in each country it targets. Also, unlike a marketplace model, there’s no need to match companies and investors — so the deployment of capital is faster. Privacy is also a positive factor for companies.
CONCLUSION
With the tremendous potential of e-tail markets in emerging market regions, revenue based financing is a strongly positioned solution for the pain points of the digital-first brands. Companies pursuing this business model excite us and we would love to hear from those interested in or invested in its evolution. As we develop our thinking in the space, please feel free to reach out to us at siddharth@alter.global and yash@alter.global. Thank you!
