Debt or Revenue Share, Which is Right for My Business?
When it comes to running your business, you have a lot on your plate, and figuring out what funding option makes the most sense to grow your business is not usually at the top of the list for most business owners. But, when your business needs capital it’s critical to choose a source that fits your budget and puts your business on a path to success.
Two common types of funding for small businesses are traditional loans and the increasingly popular revenue share agreements (also referred to as revenue share notes). If you aren’t familiar with the revenue sharing model, you can learn more about the basics in this article.
Within these two categories, there are many terms and details to look out for such as collateral requirements, personal guarantee requirements, prepayment penalties, term lengths, and of course, the price. But at a high level when it comes to determining whether a term loan or a revenue share note is right for your business, it boils down to the consistency of your business’s revenue.
For most businesses, the overall expense of borrowing capital on a traditional loan is much lower than on a revenue share agreement. Below is an illustrative example of a $100,000 loan with a 10% interest rate compared to a $100,000 revenue share:
However, for some businesses and some certain circumstances, the total repayment amount isn’t the only thing to consider. Below are a few examples when a business might want to consider a revenue share note over a traditional loan:
Seasonal businesses that have strong months and quieter months may want to consider borrowing on a revenue share to help smooth out their cash flow. The variable payment can help preserve cash in the slower months by offsetting it with higher payments when business is strong.
As an example, let’s say you run a bicycle shop and in the busy spring and summer months you generate $70,000 per month but in fall and winter, you only generate $30,000 per month.
Let’s say you decide to borrow $100,000 to upgrade your bike workshop on the following revenue share note terms:
5% revenue percentage (the percent of your monthly revenue paid to your lender)
Then, your monthly payment could vary from $3,500 during your busy seasons down to $1,500 during your slower months. As shown in the table above, a comparable loan with a 10% interest rate would have a monthly payment of $2,124.70 throughout the year.
If your business is seasonal be sure to spend some time looking at your margins and cash flow at different points in the year to better understand what monthly payment you can afford and whether a revenue share note or more traditional loan may be better for your business.
2) Growth Trajectory
If your business is growing rapidly over the term of the loan, a revenue share product may be more attractive despite the higher cost. With the promise of higher revenue in the future, a revenue share agreement can keep your monthly payments lower in the short term and only increase them as you grow and generate more revenue.
As an example, let’s say have a brewery that is just opening up. Your monthly revenue in Year 1 will be limited, in Year 2 you will have full operations in your taproom, and by Year 3 you have plans to distribute your beer widely, beyond your own taproom. To help fund this project, you take out a $500,000 revenue share note with a 1.6x multiple and a 6% revenue percentage.
As you can see, the monthly payments grow exponentially, corresponding to the rapid revenue growth forecast. This could allow your business to preserve cash in those early months and years to help you scale your business.
Two important things to remember as you make this decision:
A comparable 5-year term loan with an 8% interest rate would have a monthly payment of $10,138.20, far lower than the amount you would be set to pay each month in the later years of your revenue share agreement. The overall interest payment over the 5 years would also be a whopping $190,000 less than a revenue share note.
Most revenue share notes require a large, lump-sum payment (often called a balloon payment) at the end of the term if the full multiple has not been paid back, so it is imperative to have a high degree of confidence in your revenue forecast before taking on a revenue share note.
If your business is growing rapidly and you have a high level of confidence in your growth trajectory and forecasts, then revenue share notes can be a powerful tool to help get the funding you need to scale your business.
With the proliferation of revenue share notes, it is no wonder that more business owners are considering this as a new way to fund their businesses. But remember, a revenue share is not for everyone.
If you can consistently make the monthly payment that comes with a traditional term loan, then in most cases it will be a more affordable source of capital for your business. However, if your business is highly seasonal, or if you are running a very high growth company, then you may want to take a serious look at revenue share opportunities.
Trying to figure out if debt or revenue share is better for your business?
Meet with our team of small business experts to discuss whether debt or revenue share is a better fit for your business by filling out the form at honeycombcredit.com/grow.