Alternative lenders are generally considered a low interest rate phenomenon: when interest rates are low, money is cheap, so alternative lenders can compete with banks because their cost of capital is comparable to the cost of capital of banks.
Then, when the interest rates regime changes, things get much tougher: cost of capital for alternative lenders rises and it becomes increasingly difficult for them to compete with any bank, where such cost stays near-zero.
In my opinion, the real opportunity for alternative lenders to build a solid business is to find a niche in which they might have a real competitive advantage over banks. This is what Revenue Based Financing (from now on RBF) businesses have done.
The goal of this post is to dig deeper into the RBF space, its model and its potential evolution.
The RBF model
Revenue Based Financing is a form of credit extended to companies in a high growth phase. Investors decide to provide capital to these companies, accepting as collateral the future revenues that the company is projected to generate. Investors don’t get an upfront ownership stake in the business, they would just get a fixed % of ongoing gross revenues in return for injected capital.
The model is appealing for scale-ups because they don’t have to sell their equity to get the capital necessary to grow, as this is a form of fundraising less dilutive than the more traditional VC funding. But, on the other hand, this form of credit is much easier and quicker to obtain for these companies than classic bank loans.
The mechanics of this hybrid form of financing are fairly simple: the company receives money upfront and pays back a fixed percentage of the future revenues. The fee is usually set around 5-15% of the future monthly revenues and it is flexible, so the amount varies based on actual (rather than projected) monthly revenues.
In most cases, the total amount to repay will be either a multiple of the original amount provided (1.5x-2.5x) or simply a fixed fee on top of the original loan.
The terms also can be flexible: so they will either be a certain number of months or a max cap of the amount repaid.
In case something goes wrong and the company has some temporary troubles, the company can also suspend the repayment of the fee, as the investors are partially sharing the business risk.
A key differentiator of RBF versus traditional credit providers like banks is the due diligence process: the tech-centricity of the due-diligence, the focus on growth rather than profitability and the speed.
The RBF lender usually requires the applicants to provide a big set of data streams like banking/platforms data, subscriptions data, accounting data, payment data.
The key metrics they evaluate are MRR (monthly recurring revenues), ARR (annual recurring revenues), Customer churn rate, Customer concentration, Net Dollar Retention. Compared to banks – that are focused on profitability and the ownership of hard assets like machines and real estate – RBF lenders want to understand how quickly the borrower can grow and if the growth is sustainable, focusing more on soft assets like customer base.
Offers usually take between 24 and 72 hours to be sent out, and the process is often completed well before 7 days.
The Market
The RBF model is designed around companies that are growing very fast and have a strong digital presence, so they can provide a wealth of data streams to assess their growth and revenue generation.
These characteristics make digital startups the perfect profile for this product. In particular, to access this financing, companies have to demonstrate that they have achieved Product Market Fit, that they are strongly generating revenues and that they have a high margin that can accommodate for repayment (they can distribute a cut to investors without compressing too much their margin).
Given the interest and the constant growth of digital businesses, over the last few years a big number of players emerged in this category: Pipe, WayFlyer, Re:cap, ClearCo, Capchase, Silvr, Viceversa, Liberis, Levenue.
| Market | Year |
| $ 3.38B | 2023 |
| $ 5.78B | 2024 |
| … | … |
| $ 41B | 2028 |
Each of them has focused on a specific vertical, but looking at the key feature of the most successful player (Pipe) suggests that a fundamental characteristic of the success of these lenders is to be a marketplace. Successful RBF lenders essentially act as a middleman between lenders and borrowers, connecting borrowers to external investors.
Conclusions
RBF lenders are a very interesting category of credit businesses. They focus on a clear niche in which traditional banks don’t really compete and they essentially invented a new investment product: credit to high growth startups.
What really intrigues me about this model is their future scalability. First of all, their present target markets are constantly expanding: businesses created today are more and more online-first businesses, and this percentage can only grow in the future. So their potential market is obviously expanding.
Second, their tech-savviness represents a serious defense against the most common alternative lenders killer: banks. Banks don’t really have the skillset to compete with RBF lenders. It is hard for them to underwrite a growing ecommerce or a Saas, and even if they could, it would be complex from a regulatory perspective. For example, how would Basel treat a loan extended to a money-losing but high-growth ecommerce?
Third, Saas and e-commerce are only the first step, but new similar verticals can easily be added, the main one being creators. Who will extend credit to OnlyFans creators or YouTubers, based on their analytics? RBF lenders have the tech understanding and the access to capital to provide this service.
In conclusion, I’m extremely bullish on RBF. I believe it represents a modern way of doing credit: very open to new types of clients, well positioned in an expanding market and protected from the biggest incumbents.
Resources
- https://sifted.eu/articles/revenue-based-financing-europe-competitors/
- https://www.researchandmarkets.com/reports/5896195/revenue-based-financing-global-market-report
- https://sifted.eu/articles/europe-record-debt-funding/
- https://www.weareuncapped.com/blog/revenue-based-finance
- https://www.re-cap.com/financing-instruments/revenue-based-financing
- https://jeffburke.substack.com/p/pipecom-the-traditional-venture-capital
