tl;dr – Understand different loan options – traditional vs. revenue sharing loans – and choose what works best for your business. Below are some key differences and terms to learn. Generally, revenue sharing loans will cost you more than a traditional but also provide the comfort of not having a mandatory amount of payment for any given month.
In the previous blog, we went over the basics of funding your startup with loans and outlined some commonalities between both traditional and revenue sharing loans.
It’s time for more #MoneyTalks
Before we dive in here are some reasons a company may want to look into a revenue sharing loan instead of a traditional loan:
- Your company may not be able to qualify for a traditional loan
- More flexible payment schedules. Under a traditional loan, you can owe a set payment each month regardless of your company’s performance which can lead to default if your cash flow falters. Under a revenue sharing structure, you pay what you bring in revenue-wise.
- Time to pay back the loan amount may not be fixed but rather is a multiple of the principal (i.e. you may not have a maturity date lingering over your head).
A founder may prefer a traditional loan instead, however, if their company’s repayment amount under a revenue sharing loan may exceed the loan + interest amount under a traditional one. The major reason a founder would not want to enter into a revenue sharing loan is the likelihood that their company’s repayment amount under a revenue sharing loan will exceed the loan + interest amount it would owe under a traditional loan.
As promised, let’s dive into and outline more key terms specific to revenue sharing loans.
Revenue Sharing Loan Key Terms
Key Terms shared with Traditional Loans — Principal, Personal Guarantee, Restrictive Covenants, Secured or Unsecured, and Event of Default. Sometimes you will see a maturity date as well.
Gross or Net Revenues — Net revenues are generally gross revenues minus returns and shipping cost. So, when you negotiate this term understand that gross will always be larger than net revenues. Gross tends to be more commonly used.
Revenue Percentage — This is the percentage of revenue that is shared. The standard range is 2-10%, whether it is calculated out of gross or net revenue. Expected a higher percentage if calculated off of net revenue.
Repayment Amount — Typically 1.5-2.0X of the loan amount although it may go as high as 3x. This is the maximum amount the company pays back the lender. So if you receive a loan for $100K with a 2x repayment amount then you will have to pay back $200K.
Quarterly or Annual Disbursement — Companies normally choose to make annual or quarterly payments to their lenders. This is seen better than monthly as it provides less work and pressure on the company’s operations in delivering the payments.
Defer Payments — A clause that allows a company to miss one payment without being in default.
Target payback period — The projected length of time, based on financial projections, it would take the business to pay back investors up to their Repayment Amount. The standard here is 3 to 5 years.
The business of borrowing money — especially when you’re in the early phases of a startup — can seem overwhelming at first. Generally speaking, revenue sharing loans can get small businesses and startups the funding they’re seeking in a shorter amount of time although the trade-off may be paying a bit more than you would with a traditional loan. It is all a matter of what’s most important to you and your business when choosing between traditional or revenue sharing routes. Successfully growing your business takes time and dedication as well as the right funding sources!
According to Fortune Magazine, roughly 30% of businesses dry up due to a lack of funding. Let’s ensure your business doesn’t fall into that category — reach out (firstname.lastname@example.org) if you want to learn more.