Revenue-Based Financing Challenges The Bank Loan Status Quo

Traditional bank loans remain the undisputed leader in small business lending. Fueled further in the U.K. by regulatory initiatives (designed to spur competition in small business banking, open up the market to new challenger banks and support marketplace lending platforms), the bank loan is often the first place small business owners look when in search of capital.

Venture capital, too, remains a dominating source of funds for entrepreneurs, particularly in the U.K. — where a flourishing tech startup community attracts venture capitalists both at home and abroad. The latest data from PitchBook and London & Partners, for example, found 2019 to be a record year for U.S. venture capital investments in U.K. startups.

However, the status quo of bank loans and venture capital doesn’t always hit the mark with every young, growing business, as Asher Ismail, co-founder at Uncapped, recently told PYMNTS. There are drawbacks to these traditional sources of capital, and revenue-based financing could be an appropriate — albeit surprising — fit for entrepreneurs.

The Drawbacks Of Banks, Venture Capitalists

Though some analysts agree that bank lending and venture capital remain strong options for small businesses and startups in need of financing, these avenues to capital are not without their drawbacks. When it comes to bank loans, Ismail pointed to high costs and the common practice of banks requiring a personal guarantee to agree to financing.

“This could be putting up your house,” he said. “For a lot of entrepreneurs, that doesn’t feel right.”

Furthermore, availability of traditional bank loans for U.K. businesses may be on the decline. A recent Bank of England survey found that small businesses are facing the largest lending squeeze since the global financial crisis, reflecting the rising concerns over small business loan defaults.

On the other end of the spectrum, venture capital can similarly be costly, as well as time-consuming (sometimes as long as nine months, noted Ismail), while adding on the burden of selling equity. Again, this may not be the right fit for small businesses.

Searching For Alternatives

Today, the market shows signs of an increasing appetite for alternative sources of capital.

In the U.S., for example, the New York Stock Exchange (NYSE) recently filed paperwork with the Securities and Exchange Commission (SEC) to develop an alternative to the initial public offering (IPO), with Nasdaq expected to do the same. In the U.K., equity crowdfunding has also emerged as a strategy to raise capital from sources other than banks and venture capitalists.

In Uncapped’s case, revenue-based financing shows promise to find the middle ground between banks loans and venture capital funding for fast-growing small businesses not ready to divest shares or put a personal home up as collateral. The business model bases its repayment plan off of a business’ future revenues, with Ismail emphasizing flat fees, without the need for warrants or personal guarantees. (Some companies that claim to offer revenue-based financing do indeed require warrants, he warned, adding to the confusion about what a true revenue-based financing option means for small businesses.)

Data Visibility

Misconceptions about revenue-based financing add barriers to adoption, so education among the startup and small business community about this option to access capital will be critical.

“Transparency is absolutely critical to this business,” said Ismail, pointing to his own personal experience with various sources of capital. “It made me realize how overwhelming and complex it can be for entrepreneurs.”

Presenting straightforward repayment models and transparent fees isn’t the only way for the revenue-based financing industry to embrace visibility, though. For Uncapped, integrations into small businesses’ existing back-office platforms are essential to assessing a startup’s risk to the financier, without adding the burdens of identity verification and business documentation that traditional financing strategies entail.

Ismail explained that Untapped connects into existing marketing and sales platforms, as well as bank and tax software, to understand business performance. (The company doesn’t require pitch desks or business plans, he said.) Selfies and photo identification fulfill the company’s requirements to verify the identities of business owners and executives. This data integration and digitization strategy lowers the burden of having to aggregate and submit physical documentation, or visit a bank branch.

“The thing entrepreneurs need most, other than capital, is time,” he said. “So, if we can help them save a few more minutes, we think that’s a great thing to help further their cause.”

Uncapped — which recently announced $13.17 million in new funding in the form of equity funding and debt — is targeting fast-growing businesses with more than £25,000 ($33,682.25 USD) a month in sales. While revenue-based financing can be a more appropriate avenue to capital for some businesses, Ismail noted that it can also act as a stepping stone for businesses to other financing tools.

While Uncapped aims to gain repeat customers, Ismail added that revenue-based financing could support businesses as they prepare to “raise equity in the future,” or further fuel growth “so they get the higher valuation they believe their company really deserves.”

As more options to access financing emerge, providing choice and understanding over what avenues are most appropriate for one business at a given point in time is key to filling gaps in the ever-fluctuating small business finance market.