When Is Revenue Based Funding Better Than a Term Loan?

Small and medium-sized businesses (SMBs) face a crucial decision when it comes to financing growth: which funding option best suits their needs? Choosing the right funding method can affect cash flow, flexibility, and long-term success. Two popular options are revenue based funding and term loans. Understanding the differences and knowing when to use each can help business owners make informed financial decisions.

Revenue based funding provides capital in exchange for a percentage of future revenue, while term loans offer a fixed amount repaid over a predetermined period with interest. This guide compares the two methods, outlines scenarios in which each works best, and provides a framework for SMBs to make the right choice.

What Is Revenue Based Funding?

Definition and Explanation

Revenue based funding (RBF) is a type of financing in which businesses receive capital in exchange for a percentage of their ongoing revenue. Unlike traditional loans, repayment fluctuates with your business performance. This means that during slower months, payments are smaller, and when revenue is high, payments increase.

How It Works

In a typical revenue based funding arrangement, a business receives a lump sum upfront. The lender then receives a fixed percentage of the business’s revenue each month until the total repayment, often referred to as a “cap,” is met. There is no fixed term, making RBF flexible for businesses with fluctuating income.

Pros and Cons

Pros:

• Flexible repayments tied to revenue

• No collateral required

• Fast access to capital

• Useful for businesses with growing or seasonal revenue

  
  

Cons:

• Higher overall cost compared to traditional loans

• Repayment percentage reduces cash flow during peak months

• Not ideal for businesses with unpredictable revenue declines

What Is a Term Loan?

Definition and Explanation

A term loan is a traditional financing option where a business borrows a fixed sum of money and repays it over a set period, usually with interest. Term loans can be secured or unsecured, with secured loans backed by collateral such as equipment or real estate.

How It Works

When a business takes a term loan, it agrees to repay the principal plus interest according to a fixed schedule. The repayment amount does not change with revenue fluctuations, making it predictable for financial planning.

Pros and Cons

Pros:

• Predictable repayment schedule

• Lower overall cost compared to RBF in many cases

• Suitable for long-term growth projects

• Builds credit history

Cons:

• Fixed monthly repayments can strain cash flow

• Often requires collateral or personal guarantees

• Less flexible if revenue drops unexpectedly

Revenue Based Funding vs Term Loan: Key Differences

Repayment Structure

Revenue based funding adapts to your business revenue. Term loans require fixed payments regardless of performance. Businesses with seasonal sales often find RBF easier to manage because payments adjust to cash flow.

Cost of Capital

Term loans generally have lower interest rates than RBF. However, RBF’s variable repayment structure can make it less burdensome during low-revenue periods, even if the total repayment ends up higher.

Flexibility

RBF is flexible and does not require collateral, whereas term loans offer less flexibility but provide certainty in planning. Choosing between them depends on whether your business prioritizes predictability or adaptability.

Eligibility and Requirements

Revenue based funding often has more lenient eligibility criteria, focusing on revenue trends rather than credit scores or collateral. Term loans, especially from banks, may require strong credit and collateral.

With guidance from MyAlphaLoans, SMBs can compare these options and choose the solution that aligns with their growth goals.

When Revenue Based Funding Is the Better Choice

Revenue based funding is ideal for businesses that anticipate revenue growth but face short-term cash flow challenges. Consider RBF if your business fits any of these scenarios:

• High growth or seasonal revenue: Startups or seasonal businesses benefit from payments tied to actual revenue.

• Minimal collateral: Businesses without assets to secure a traditional loan.

• Flexible repayment needs: Companies that cannot commit to fixed monthly payments.

• Short-term projects: Funding marketing campaigns, inventory purchases, or other initiatives that generate immediate revenue.

Businesses with online sales, subscription models, or recurring revenue streams often find RBF advantageous because lenders can rely on predictable revenue percentages for repayment.

Risk and Repayment Considerations: While RBF reduces the risk of default, the total repayment may exceed a term loan’s cost. SMBs should carefully evaluate whether the flexibility outweighs the potential higher cost.

When a Term Loan Might Be Preferable

Term loans are better suited for businesses with predictable revenue and long-term growth plans. Here are the scenarios where term loans shine:

• Stable revenue businesses: Companies with steady sales can handle fixed monthly payments without cash flow strain.

• Long-term growth funding: Investments in equipment, real estate, or expansion projects often require term loans for better financing rates.

• Predictable repayment advantages: Term loans provide certainty in budgeting and financial planning.

• Lower overall cost: For businesses confident in revenue stability, term loans usually cost less than RBF.

  
  

If your business can commit to fixed payments and has collateral to support the loan, a term loan often provides the most cost-effective option.

Hybrid Models and Alternative Approaches

Some SMBs combine revenue based funding with term loans to balance flexibility and cost. Hybrid strategies can work as follows:

• Use RBF for short-term cash flow needs while taking a term loan for long-term investments.

• Apply RBF as a bridge until term loan funding is secured.

• Mix smaller RBF rounds with a primary term loan to reduce reliance on either option.

  
  

Pros of Hybrid Strategies:

• Balances flexibility with predictable cost

• Reduces reliance on a single funding source

• Supports different phases of business growth

Cons of Hybrid Strategies:

• More complex repayment structure

• Requires careful planning to avoid overleveraging

Decision-Making Guide for SMBs

Before choosing between revenue based funding and a term loan, consider the following:

Step 1: Evaluate Your Revenue Stability

• Is your revenue predictable or seasonal?

• Do you have recurring income streams?

Step 2: Assess Your Growth Needs

• Are you funding short-term projects or long-term expansion?

• Do you need flexibility or cost efficiency?

Step 3: Review Eligibility Requirements

• Can you provide collateral or personal guarantees for a term loan?

• Does your business meet the lender’s revenue-based criteria?

Step 4: Compare Cost and Repayment Impact

• Calculate total repayment for both options.

• Consider the impact on cash flow during low-revenue periods.

Step 5: Consider Hybrid Options

• Would combining RBF with a term loan give you the best of both worlds?

• Identify which portion of your funding should come from each source.

By answering these questions, SMBs can create a framework for deciding which funding method best fits their business model and growth goals.

Conclusion

Choosing between revenue based funding and a term loan is a critical decision for SMBs. Revenue based funding offers flexibility and aligns repayments with revenue, making it ideal for businesses with fluctuating income. Term loans offer predictability, lower overall cost, and are suited for stable businesses with long-term growth plans. Hybrid approaches can combine the benefits of both, but require careful planning.

By assessing your revenue patterns, funding needs, and repayment capacity, you can select the financing option that aligns with your business goals. Remember, the best choice is one that supports growth while maintaining financial stability. Explore funding options today and find the solution that matches your business growth. Contact us to get started with a personalized assessment.

FAQs

1. Can I switch from revenue based funding to a term loan later?

   Yes, some businesses start with RBF for flexibility and later transition to a term loan once revenue stabilizes.
   

2. Which is cheaper, revenue based funding or a term loan?

   Term loans are generally cheaper in terms of total repayment, but RBF can be easier to manage if your revenue fluctuates.
   

3. Is collateral required for revenue based funding?

   No, RBF usually does not require collateral, making it accessible for businesses without assets.
   

4. Can I use both RBF and term loans together?

   Yes, hybrid funding strategies allow SMBs to leverage the advantages of both methods.

   
   

5. How do lenders calculate repayment for RBF?

   Repayment is usually a fixed percentage of monthly revenue until the agreed-upon cap is reached.