Revenue-Based Financing: The New Kid On the Block
The US already has unicorns in the space such as ClearCo and Indian startups are now joining the bandwagon
India's startup ecosystem is evolving as we speak, with newer business models coming to fore every day. To match up to the pace of innovation, the business of venture funding is also going through newer additions and changes. One such model that is creating ripples today is revenue-based financing (RBF), a unique financial solution that allows businesses to access necessary capital without the need to transfer any ownership stake to investors.
The global RBF market is projected to reach more than $42 billion by 2027. The US already has unicorns in the space such as ClearCo and more than $2 billion was financed in 2020 through this route. This global uptick is pushing many Indian entrepreneurs also to join the bandwagon. Startups including GetVantage, KredX, Velocity, Klub and N+1 Capital are cashing in on the opportunity by offering this innovative form of financing wherein the amount raised by a borrower is repaid as a percentage of future revenues.
"The financier has skin in the game to support revenue growth and takes the risk of a drop in revenue also. Therefore, the financier ends up being a partner in the growth of the borrower," said Abhiroop Medhekar, founder and CEO, Velocity, a startup in the space that has given capital to several D2C brands such as Greensoul, Bombay Trooper, Athlos, Nobero, Bella Vita, Imagimake and Water Science through this route.
What's The Noise Around RBF?
Since the RBF involves zero collateral, many small and digitally-run businesses that are not on the radar of VCs or private equity firms for funding seem to opt for this. During times like pandemic, RBF can help businesses stay afloat, claim these startups, adding that they offer a hassle-free paperless digital onboarding process and quick disbursal of capital within 48 hours.
"If you look at the overall Indian market, companies spread across the bottom-most level of the pyramid are mostly the offline MSMEs, and on the top we have bigger corporates who have access to capital. So, RBF caters to this specific lower part of the pyramid where you see companies like D2C brands and SaaS models," said Anurag Jain, co-founder and executive director, KredX, a fintech startup that has been offering RBF for more than two years now.
"It is difficult for startups or any new business to get equity funding and debt funding, and that is what necessitates the need for a clarity on the revenue side for their business to leverage the potential of RBF. D2C, SaaS and edtech companies with visibility in terms of their revenue line, can take advantage of RBF and pay it off in the next couple of quarters based on a certain percentage of their revenue going in as repayment to their lenders," added Jain.
Additionally, traditional financial institutions in India have been built to support asset-heavy, offline businesses and online businesses have no physical assets. "Therefore, they are considered to be risky by financial institutions. However, these businesses are data-rich. This data can be utilized in the RBF model for effective underwriting decisions. Further, the specific sub-segment of D2C or e-commerce businesses that we work with is also experiencing phenomenal growth. We strongly believe that RBF will be a massive $50 billion opportunity in India," said Velocity's Medhekar.
"RBF creates an opportunity to lend money to the people who have solid cash flows. It is a superior way of assessing credits for a lot of people and enhancing the overall ecosystem. That is why there is a lot of excitement around RBF-based products," added Ashish Goyal, a fintech expert and co-founder and CFO, EarlySalary.
While debt creates fixed repayment obligations and equity leads to founder dilution, RBF plugs both these shortcomings, claim startups in the space. "Repayments in RBF are directly linked to a company's performance and the fee paid to the financier is minimal. Traditional financing models are broken. Equity leads to dilution for founders while debt creates fixed EMI obligations that a company might be unable to service in case of a downturn. RBF is gaining traction given it effectively plugs equity and debt shortcomings," explained Medhekar.
Opportunities In the Space
India's D2C boom and proliferation of SaaS players have created a huge opportunity for RBF. "While VC interest in the D2C sector has been rising, it remains inaccessible to a vast majority of brands. Out of 75,000-plus independent e-commerce stores hosted on platforms like WooCommerce and Shopify, less than 0.5 per cent are equity funded," said Velocity's Medhekar.
RBF is expected to become a mainstream way of getting the financing done for anybody in organized retail or SME business. "There is a lot of product innovation possible once we move away from asset-backed financing. So, there is a vast amount of opportunity created by Revenue-based finance, and that's why I think that RBF time has come," said EarlySalary's Goyal.
However, Jain also cautions that a company that offers only RBF may suffer from an existential threat, in case RBF does not work for some reasons; hence it is always advisable to offer an array of products and services than rely on one single product. "Money has no color; irrespective of what form of financing you get it, businesses will always choose the path of low-cost capital. Things will evolve over a period of time, and not everything that works in the US will work in India. The Indian market is very different from that of the US. We are keeping our fingers crossed. Multi-product companies are always a better strategy than single-product companies in the market," said Jain.
Long Way To Go
Some believe that largely it is still financing, just that out of the very big pie, you have taken a small pie to create a different vertical or pipeline. "For any business loan, companies will need to provide business projections; and any new company who does not have a lot of years that have passed by, the only measurable metrics is to look at business projections. And metrics such as business projections are all about potential revenue, margins, expected profit, etc – all that has been there for long, but has just been given a different shape and packaging and targeted at a specific audience, which is why it has picked up in the US and other markets," said Jain.
Another challenge that the startups face is educating borrowers about RBF. "Even without these standard rails, global companies and their Indian equivalents are disrupting the RBF space well enough with competitive pricing for raising working capital, especially in the D2C space. The challenges now primarily faced are adoption on both lender and borrower side for these new Open Digital Ecosystems," added Nikhil Kurhe, a fintech expert and CEO of Finarkein Analytics.
Additionally, RBF startups carry the underwriting risk that comes with lending in startups. "RBF usually is predicated on high revenue growth in their borrowers. A faster turn around leads to better outcomes for the company. The borrowers growth plans not materialising can thus lead to significant risk to the RBF startups," said Anurag Ramdasan, partner, 3one4 Capital.
Further, unless a startup has reached certain growth numbers, RBF won't make sense for them. "One needs to be aware that RBF isn't like typical venture capital, wherein one can go and raise successive rounds of capital. RBF in that way can turn out to be an 'expensive' way of financing your venture. Also, revenue growth gets linked to your repayments and that makes your startup unattractive for venture capitalists for that period," said Ajay Ramasubramaniam, co-founder CEO, Startup Reseau, a Mumbai-based early-stage focused startup accelerator.
Ramasubramaniam added that at the same time, RBF isn't a perpetual capital. One can always argue about alternative or hybrid structures but, that comes into play only when the company is at a Series-B stage of funding.
Overall, it is still unclear how the uptick for RBF will look like in the next couple of years. "It caters to a very specific segment. In India, there will be not more than 15000 SaaS companies, 200 D2C brands and equivalent for the digital education companies too. If you look at the overall customer numbers, it is not huge. From that perspective, it is a very specific segment of financing. So that is one concern," said KredX' Jain.
To sum up, there is a lot left to be discovered in the RBF space. As Ramasubramaniam rightly pointed out, "We can maybe call this the first wave of RBF in India."