Startups are now crowding for revenue-based financing

Revenue-based financing (RBF), or non-collateralised debt against a percentage of gross revenue, is gaining traction amongst statups and digital SMEs, as venture capital flow continues to be dry and traditional credit remains out of reach for many.

Platforms such as GetVantage, Velocity and Klub, all of which came up between 2019-2020, are rushing in to fill the working capital gap in the market, estimated to be over $150 billion, as per a Redseer study published in August 2023, which says only about 30% of the existing $220 billion credit demand of digital SMEs is being addressed.

“The kind of interest in our revenue-based financing product that we had seen between 2020-23, we are now seeing that kind of consolidated interest already in 2024,” said Karun Arya, chief growth officer at GetVantage, which invests Rs 40-45 lakh on an average for a tenure of about 12 months.

He added that in the next one year, the company is on track to generate more revenue than it has in the last three years combined, helping it increase its revenue run rate by 3 times over FY24. In FY22, it had a revenue run rate of $1 million, which had increased to a run rate of $3.5 million in FY24.

Revenue-based financing is an alternative financing product for digitally-enabled businesses, where they can raise capital in exchange for a percentage of their gross revenue as a monthly repayment, in addition to a fixed fee between 8-10% of the principal amount.

It is usually opted by companies with steady revenue flow that have a high requirement for short-term working capital, such as cloud kitchens, e-commerce merchants, financial services companies or software-as-a-service firms.

While some of these companies may be unwilling to dilute any equity to venture capitalists, others may not qualify for bank loans on account of being loss-making or lacking collateral.

Among the other alternate financing products for startups is venture debt, which is also largely restricted to late-stage companies that have venture capital backing. With an average tenure of 12-18 months and a percentage of gross revenue varying between 5-20%, RBF is emerging as a top option to raise short-term capital for many startups.

“Short-term debt products are absolutely going to eclipse venture debt in overall AUM soon, simply because all businesses have working capital requirements but not all of them can access venture debt” noted GetVentage’s Arya. Last year, India’s venture debt market topped $1.2 billion, as per a report by Stride Ventures, marking a 50% jump over the preceding year.

Besides the ongoing crunch in equity financing, an increasing awareness of the options available in alternative financing, and the fast and flexible nature of RBFs, are the main reasons behind this uptick, noted Anurakt Jain, co-founder and CEO of Klub, which has seen a 55% year-on-year increase in the number of investments done by the company.

“We are seeing entrepreneurs become more aware of this optionality and even investors recommending RBF, who used to earlier recommend venture debt as the only option,” he said, in an interaction with FE. The company has recently expanded to the Middle East region, planning to invest Rs 2,300 crore in revenue-based financing.

However, RBF can often be more expensive than traditional credit, and have a much higher internal rate return than bank loans, investors said. Moreover, automated monthly payments of a percentage of gross revenue can eat into the monthly cash flow of small companies.

“We’re in the business of pricing risk and we expect a product structure and a return commensurate to that risk. So if there is a higher-risk business, the returns have to be higher risk as well, as long as the return expectations are not egregious,” Jain said.