D2C brands frequently produce, promote, sell, and transport their items directly to consumers, keeping the D2C model lean and lucrative. Their development has been phenomenal, with the entire addressable D2C market in India predicted to reach a staggering USD 100 billion by 2025.
In addition, most ecommerce and direct-to-consumer (D2C) businesses in the early stages of development require capital to increase operational efficiency and establish efficient marketing tactics. However, these expansion costs will almost certainly have an influence on revenue growth, which is frequently required by investors. There are, however, other options, one of which is revenue-based financing.
The more quickly you expand, the more inventories you’ll require. You’ll have to spend more money on marketing, which will eventually pay off in income. According to him, the working capital gap continues to increase, and this is one of the main reasons why ecommerce businesses do not develop as quickly as they could.
What is Revenue-Based Financing?
RBF is a financing mechanism that combines the finest aspects of debt and equity financing. It’s a type of growth finance in which repayments are based on a percentage of revenue. In exchange for cash, a firm might share a defined proportion of future sales with an investor through revenue based financing. Because the amount is based on your income rather than your balance sheet, it differs from bank loans in that there are no personal guarantees and you may acquire cash without having to cope with limited EMI payments. It differs from equity financing [angel investment or venture capital] in that the company does not have to give up any of its stock in order to get funds.
How does Revenue-Based Financing work?
Let’s pretend you own a company that generates monthly sales of Rs. 50 lakhs on average, and you plan to make Rs. 3 crores in the following six months.
You decide to raise Rs. 50 lakhs for marketing, inventory, or capital expenditures. Let’s suppose this comes with a ten percent revenue share [the revenue share is normally between two and fifteen percent] and a ten percent fixed yield.
In this situation, you reimburse the investor at a revenue sharing rate of 10% – that is, 10% of your revenues are owing to the investor – until you have repaid the investor Rs. 55 lakhs. The investment is complete after you have repaid Rs. 55 lakhs.
RBF may be increased at any stage of a company’s development as long as sales are steady, if not rising. RBF may be used to accelerate growth in any size company, whether it’s a giant corporation with several investors or a tiny startup. RBF is commonly used in the following ways by businesses:
- Expenditures on marketing and promotion.
- Expanding the inventory
- Expansion into a new market, area (nationally or globally), or product line.
- Capital Expenditure is a term used to describe how much money is spent on something.
How is Revenue-Based financing better?
RBF is suitable for D2C eCommerce companies for a variety of reasons, including the following:
- No Dilution of Equity
Unlike venture funding, where founders would lose considerable stock and hence control of the firm, RBF does not entail selling any equity position, and as a result, does not need abandoning business controls.
RBF does not need any type of collateral from the founders, unlike banks, who require assets and personal guarantees for funding.
- Ease of Access
In contrast to the complicated legal documents required by banks and venture capitalists, the application form takes minimum data and the procedure is entirely electronic, needing no offline document submissions or visits.
- Quick Underwriting
The underwriting is automated and based on information from the company’s marketing and revenue. This allows for speedy processing and preparation of term sheets, as well as quick distribution, which takes about 7 to 15 days. VCs may take 4–6 months to handle funding, whereas banks may take 1–2 months.
- Flexible Payments
Payments adapt automatically to shifting revenues since they are based on a proportion of revenue sharing. When opposed to set repayments on bank loans in terms of EMI, firms would pay a proportion of revenue earned during lean months, alleviating revenue stress.
What is RBF and how does it work?
Let’s imagine you own a company that generates monthly sales of Rs. 50 lakhs on average and expects to generate Rs. 3 crores in the following six months. You decide to raise Rs. 50 lakhs for marketing, inventory, or capital purposes. Let’s imagine this comes with a 10% revenue share [the revenue share ranges from 2% to 15%] and a 10% fixed yield.
In this situation, you reimburse the investor at a revenue sharing rate of 10% – that is, 10% of your revenues are owing to the investor – until you have paid the investor Rs. 55 lakhs. The investment is over once you’ve paid back Rs. 55 lakhs.
Why do Direct-to-Consumer businesses favour Revenue-Based Financing?
1. Investors put their Money where their mouth is
Because the financier is paid based on the borrower’s future earnings, a reduction in the latter’s profits means a reduction in the financier’s fees. As a result, they are engaged in the success of the D2C brand, and the partnership is mutually beneficial.
2. The Flow of Capital is Quicker
Before a deal is made, you must pitch to venture investors for months or even years. However, because RBF is based on machine underwriting and does not require equity exits or extensive documentation, funding can be approved and given in as little as four weeks.
3. Serves as a Platform to other Financing Options
After receiving RBF, the D2C brand can utilise the funds to run its day-to-day operations and expand its activities. The brand will be in a better position to seek greater sums of money from banks and venture capitalists once it has found its footing.
4. The equity of a D2C brand does not have to be diluted
This is likely the most important factor for RBF’s rising popularity. It’s difficult for companies to secure equity investment since venture capitalists are unlikely to consider proposals for tiny sums of money. When it comes to higher sums, money is frequently exchanged for significant stock. RBF investors, on the other hand, are not looking for ownership or board seats, which allow the D2C brand to maintain complete control over its operations.
Why RBF could be your new BFF?
For D2C firms, RBF is ideal. RBF fits in ideally with its revenue-share feature because sales quantities in a D2c company model might be unexpected. You pay more in good months and less in bad months, avoiding the risk of locking yourself into a predetermined repayment schedule.
Let’s figure out when your firm should raise growth capital using RBF now that you know how RBF can help you:
• You have high gross margins because of strong unit economics.
• You have a stable, if not expanding, income profile.
• You’ll need capital for regular expenses like marketing, inventory, and capital expenditures, and you’ll need it in a way that the capital input and output are related.
RBF Fund Utilization Categories
1. CapEx
As a D2C eCommerce business expands, it will need to invest in capital expenditures such as property, machinery, and digital infrastructure updates, as well as tools and technology to enable a better customer experience and journey.
2. Expansion into New Market
Analyzing D2C eCommerce brand traffic and sales might reveal new regions where the product line can be expanded. Without the risk of a loan, RBF can assist these businesses in establishing themselves in new markets.
3. Staffing and Talent Acquisition
In order to expand the brand according to the business demands in terms of customer service, marketing, and so on, it is necessary to make significant expenditures in hiring.
Gap in Current Lending Practices
Access to growth financing can help with many of the concerns mentioned above. Traditional finance options, such as bank loans and venture capital, are more difficult to come by for ecommerce businesses for the following reasons:
Collateral documentation, personal guarantees, and several years of profitability statements are required by banks. These financial statements may not be available to early-stage D2C ecommerce companies.
This is when venture money enters the picture. VCs, on the other hand, generally hedge their risks by investing in low-risk, high-return company concepts. They expect 10-20x returns on their investments in general. Only 8.9% of money obtained through angel investors and venture capitalists go to the D2C category.
Conclusion
Businesses in a rising country like India require a variety of financial sources in order to grow fast and sustainably. Revenue-based finance has evolved as a more flexible and straightforward alternative to traditional forms of financing, one that takes into account changing company models and dynamic financial needs.
Cash-flow based financing and collateral-free working capital loans for firms are close cousins of this type of finance. Whatever the product structure, the concept remains the same: businesses in need of expansion capital are better served by new-age credit solutions underwritten by more agile algorithms and backed by contemporary lenders than by waiting in a bank teller’s line.