post by:
Donna Cohen
We are always trying to find the best financing option to fit our businesses. We get inundated with different loans, terms, rates, and types of funding that we just want to scream: “What should I choose?”
Well, we are not here to tell you that revenue share agreements are the right choice. That is 100% for you to decide. We will, however, give you the good, the bad and the ugly when it comes to Revenue share financing to help make your decision a bit easier.
What is a Revenue Share Agreement?
The long and short of it is: a revenue share agreement states that revenue generated from a product or service is split (based upon agreed percentages) between two or more business partners. The revenue refers to all incoming money that a business makes including, but not limited to sales, interest, and investments and distributed according to all the parties that own rights to it.
Revenue share loans, or revenue-based financing, is a loan that you pay back based on a percentage of your revenue each month. This type of financing allows you to avoid high fixed monthly payments and never pay more than you make.
For example, if you borrow $100,000 with a 12-month repayment term, traditional banks will divide the principal and expected interest into 12 fixed minimum payments. Now if you borrow the same $100,000 with a 10% revenue share, you do not have a fixed payment. In this example, if you make $10,000 in month 1, you will pay $1000. The next month you make $30,000 so you pay $3,000. Then the third month, you hit a lull and only make $5,000, so you pay $500.
Revenue share agreements allow the flexibility to make payments until a designated dollar amount is reached. The dollar amount is agreed upon before you accept the loan and could be any multiple of the principal amount.
How To Create A Revenue Share Agreement
The process to set up a revenue share agreement is fairly simple, but you should have your accountant or attorney review the terms before you sign anything legally binding related to your finances.
Establishing a Revenue Share Agreement:
- Create a written document outlining which employees or stakeholders receive.
- In the document, clearly define what percentage of profits or revenue will be dispersed to each person.
- Create an account or trust for all revenue shares to be dispersed.
Transparency is the key to a less-complicated revenue share agreement. It is important to keep an eye on
Drawbacks of Revenue Shares
Revenue share agreements for eCommerce businesses can be great for flexible payments, but it is important to note that it is not the end-all-be-all of eCommerce financing. Revenue share agreements are not without risk and you can suffer incredible costs.
For one, you are required to produce revenue. That may sound like a give-in, but when it comes to revenue share agreements, if you do not produce revenue, not only will you be subjected to fees and minimum payments, but your investor (lender) may adjust your terms so that they still get their money resulting in lawsuits or bankruptcy.
Second, revenue share agreements tend to be smaller than other financing options. While you could receive a larger loan from a different financial source, revenue share agreements statistically offer a lower loan amount than competitors.
Now, revenue share agreements do not require you to put up personal collateral or offer equity in your company. That is a rare benefit of financing, however, it also means you are required to pay your loan back in money. If you are not generating revenue, you can’t offer repayment in another form. Online businesses can find themselves with their backs against the wall with nothing to offer their lender.
Additionally, you have to consider that you are cutting into your profits. Since revenue is the overall term for money coming in, it does not factor in expenses and profits. The revenue share lender takes their cut off the top of the revenue which decreases your working capital.
Finally, revenue share agreements are not available for startups. The whole point of this loan is that the lender earns money based on revenue. You are required to prove you can pay the loan back with the evidence that you have generated revenue in the past 3-6 months. If you are a startup eCommerce company or you are not a company that generates revenue (yet), you will want to skip revenue share agreements.
Alternatives to Revenue Share Agreements
Here a few alternative options that we think you’ll find more attractive. Take a look while you continue to research which financing options are available to you.
Merchant Cash Advance
Merchant Cash Advances, or Merchant Capital Advances, are a way for you to draw on future revenue right now. With an MCA lender, you receive a lump sum to be repaid with a percentage of your credit/debit card sales each day. The MCA lender will deduct the day’s remittance from your established business account.
Merchant cash advances are based on your marketplace revenue and sometimes do not require a high credit score to qualify. You are required to have a high volume of credit card and online payment transactions to be eligible for financing.
Crowdfunding
Crowdfunding allows you to meet your cash goal by receiving multiple small donations or investments. With crowdfunding campaigns, you are relying on your ability to sell the idea of your product to people who may not benefit from giving to you. In many campaigns you can offer a non-monetary reward or monetary stake in the company to entice would-be investors.
It could take a long time to reach your goal, but if you succeed, you can improve your cash flow considerably. Keep in mind that on many crowdfunding platforms if you do not reach your goal, you may be required to forfeit the campaign and not receive any of the donations or investments.
Business Line of Credit
Finally, a business line of credit functions similar to a traditional term loan or credit card. You receive a lump sum in credit to draw from as you need it. Your balance increases until you reach the predetermined limit. You are required to make monthly payments with interest.
The difference between a line of credit and a traditional loan is that you can pay down your balance and continue to draw from the line of credit over and over. This revolving cycle allows you to increase your cash flow without taking on multiple loans.