Legal 101 for Revenue Based Financing
By: Sam Kawtharani
If you have read our recent posts about revenue based financing, you might be wondering, from a legal perspective, how is it different from a traditional loan?
Revenue Based Financing is increasingly becoming a compelling and suitable funding options for entrepreneurs and business owners.
What is Revenue Based Financing?
A blend between bank debt and venture capital, revenue based financing (RBF) is a funding model whereby investors inject capital into a business in return for a percentage of its revenue. The business pays back the lender or investor a multiple of the original amount (at Seedlify, this varies between 1.5–2.2x).
Similar to traditional loans, revenue based financing requires an agreement that includes several legal terms, such as:
- Financing or Loan Amount (a.k.a the principal) — the amount borrowed or the amount still owed on a loan, separate from interest. If you take out a $50,000 loan, for example, the principal is $50,000.
- Repayment Terms — usually takes the form of periodic payments that normally include part principal plus interest in each payment.
- Maturity Date — the date on which the principal amount of a loan becomes due and is repaid to the investor and interest payments stop.
- Event of Default — an action or circumstance that causes a lender to demand full repayment of an outstanding balance sooner than it was originally due.
- Default Remedies — the actions a lender may take in case of default or breach of the loan agreement.
- Representations and Warranties — usually cover whether a borrower is legally capable of entering into finance agreements and the nature of the borrower’s business.
So what is special about revenue based financing agreements?
In revenue based financing, the monthly payment amount is based on the previous month’s top-line revenue .
Top-Line Revenue refers to a company’s gross sales or revenues.
That is why, it is crucial that a revenue based financing agreement clearly states the definition of a top-line revenue and the rate applied to calculate the monthly payment.
- Due to the fluctuating monthly payment, accounting for the principal and interest portions of the monthly payment is not as straightforward as in a traditional loan.
- Because the monthly payments of revenue based financing are dependent on the underlying top-line revenues, lenders will usually require access to a company’s financials to confirm they are being paid the right amount. At Seedlify, we make this process transparent. By connecting to your bank account and payment processors, we relieve you from the burden of monthly audits.
- A revenue based financing agreement might sometimes include a success fee — usually charged if the company is sold or acquired during the term of the loan, or within a certain timeframe after repayment.
What information do you need to provide when applying for revenue based financing?
Each lender has different criteria. However, a borrower will usually be expected to provide the following information to a lender:
- Historical financial information (such as profit and loss statement, balance sheet and cash flow statement)
- Growth projection
- Top customers’ information and standard contract used
- Product or service overview
- The amount of funds needed and their intended use
Revenue Based Financing is considered an alternative financing solution that is not suitable for all businesses.
Revenue Based Financing is attractive for early growth and revenue businesses, and will probably become a lot more common in the years to come.
This is not meant to be legal advice, but rather tips from a fellow entrepreneur.
About the Author: Sam Kawtharani is an experienced FinTech product manager and co-founder of Seedlify, the first Canadian Capital-as-a-Service provider of marketplace revenue based financing for early-stage growth businesses.
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