Revenue-Based Financing

Intro

Revenue-based financing (RBF) is a form of business financing where you borrow against your revenue and pay back a percentage of your monthly sales. It sounds perfect on paper—flexible payments that scale with your business. But there's a reason experienced operators call it a potential "sickness" on the industry.

How RBF Works

You're a growing business with unpredictable but growing sales. You need to finance inventory, marketing, and operations. You either don't have personal assets to stake or don't want to. And you either don't have inventory to stake or don't want to. But you have solid revenue.

So you reach out to (or often, they reach out to you) a revenue-based financier. They verify your revenue and offer you a loan, typically within days or weeks, with a flexible repayment plan where you simply deduct a percentage of your monthly revenue (say, about 20%).

Using only your success in revenue so far, you can get access to capital to grow your business with no credit, no assets, and you pay back proportionate to what you make.

Sounds perfect, right?

The Mechanics

RBF typically involves:

• Advance amount: Usually based on a multiple of your monthly revenue (e.g., 3–6x monthly revenue)
• Factor rate: A multiplier (e.g., 1.2x) that determines total repayment. A $500K advance at 1.2x means you repay $600K
• Revenue percentage: 5–20% of monthly revenue goes to repayment
• No fixed term: You pay faster when sales are high, slower when sales dip

Important: The amount you pay back is fixed. So if you pay it back faster, your effective interest rate (APR) is higher. This is counterintuitive but critical to understand.

The Over-Leverage Trap: A Detailed Example

Let me walk through how RBF can spiral into a debt trap.

Phase 1: Initial Draw

Imagine a DTC e-commerce brand in the CPG space with steady monthly revenue of $100,000. The company needs capital for inventory and marketing to scale. They opt for RBF because it's easier to qualify for early-stage businesses without strong assets.

They receive a $500,000 advance from an RBF lender (e.g., similar to Shopify Capital). They agree to repay 10% of monthly revenue until total repaid reaches $600,000 (a 1.2x factor rate, implying ~20–50% effective APR depending on repayment speed).

At $100K monthly revenue, they pay $10K/month. Seems manageable—leaves $90K for operations. At this pace, full repayment would take about 60 months (5 years), but if revenue grows, it speeds up.

Phase 2: Revenue Spikes, Lender Offers More

A few months in, marketing pays off. Revenue spikes to $150,000/month. Now repayments jump to $15,000/month. This accelerates payback, which sounds good.

If the story ended here with steady growth and payback, it would be a success (albeit with high APR). But here's what actually happens:

Seeing the spike, the lender offers an additional "top-up" draw (common in RBF, as eligibility is based on recent revenue). The company takes another $300,000 advance (new terms: repay 8% of revenue until $360,000 total repaid, 1.2x factor).

Now total pledged is 18% of revenue ($600K + $360K = $960K to repay).

RBF lenders often allow stacking based on trailing revenue, encouraging borrowing during highs. The company feels confident—payments are "flexible" and tied to sales.

At $150K revenue, payments are now $27,000/month (18%), leaving $123K for operations. Still okay.

Phase 3: Revenue Dips

Suddenly, revenue dips to $80,000/month. Maybe it's supply chain issues, iOS 14 marketing changes, or seasonal slowdown.

Payments drop to $14,400/month (18% of $80K). This "flexibility" helps short-term, but the total debt ($960K to repay) doesn't shrink fast.

With only $65,600 left after payments, the company struggles to cover fixed costs (e.g., $50K in payroll, rent, inventory). They cut marketing, which worsens the dip.

Phase 4: The Debt Spiral

To survive, they seek more RBF—another $200,000 advance at 7% of revenue (repay until $240,000).

Now total pledged is 25% of revenue ($960K + $240K = $1.2M to repay).

This provides immediate cash but increases the revenue share extracted long-term.

Phase 5: Trapped

Revenue partially recovers to $120,000/month, but now 25% ($30,000) goes to repayments—leaving just $90,000 for operations. That's less than before any debt.

The high revenue share crowds out reinvestment (no budget for new inventory or ads), stunting growth. If revenue dips again, payments drop but the business is even more fragile.

This creates a loop: Need cash → More RBF → Higher % pledged → Less cash for growth → Slower revenue → Need more cash.

Potential Outcomes

Debt Trap: Effective cost skyrockets (if repayment drags due to dips, APR equivalent could hit 50–100%). The company might default, triggering covenants (lender takes equity or forces sale).

Insolvency Risk: Like over-leveraged firms in 2008, they could face bankruptcy if unable to service growing obligations.

Recovery Difficulty: Even if revenue rebounds to $200K, $50K (25%) goes to lenders, limiting agility. Restructuring is expensive, and bootstrapping back is slow.

Why RBF Creates These Risks

Variable but proportional repayments: Unlike fixed loans, RBF takes a % of revenue. This seems flexible but can lead to over-borrowing during highs and strain during lows.

No collateral, but high effective cost: Eligibility based on revenue encourages stacking, but dips expose the risk without asset backing.

Lender incentives: RBF lenders make money by deploying capital. They're incentivized to offer top-ups when your revenue looks good, not to protect you from over-leverage.

The Moral of the Story

Temptation is a killer. RBF isn't necessarily bad, but the risks of over-borrowing are high. It can seem somewhat predatory, with lenders dangling large relief checks in front of you during times of desperation.

The smarter thing to do when you're mid-repayment and revenue dips: bite the bullet and finish the payment without accepting more capital. Cut costs, extend runway, but don't stack more debt.

When RBF Can Work

• Short-term bridge capital for a specific, time-bound opportunity
• Single draw with conservative revenue projections
• Businesses with predictable, non-seasonal revenue
• When you have the discipline to say no to top-up offers

When to Avoid RBF

• Seasonal businesses with significant revenue swings
• Businesses already carrying other debt
• When you're relying on RBF to cover ongoing operational costs
• Any time a lender is offering more than you specifically need