When you need liquid funds to meet the needs of a large customer purchase, purchase order financing can be an incredibly valuable tool. With purchase order financing, a lender will pay your suppliers to complete an order, and the supplier will then in turn pay you for the transaction minus a factoring fee and other costs. In short, this type of financing can ensure that your customers get the merchandise they are purchasing and that you get the profits from that purchase.

While purchase order financing can be a valuable method of making sure your transactions go smoothly, obtaining this type of financing does come with requirements. So if you’ve decided that purchase order financing is right for you, it’s important to go over a checklist of requirements before applying. 

Purchase Order Financing Requirments

Before you apply for purchase order financing ensure you meet the below requirements are able to provide the documentation associated with them.

Requirement #1 – You Must be a B2B or BTG Entity

In order to qualify for purchase order financing, you must be a business-to-business or a business-to-government agency. This simply means that you must be doing business with either another business, such as a supplier, or with a local, state or government agency through a government or municipal contract. 

Requirement #2 – You Must Sell a Tangible Product

The first requirement is that you must sell a product that can be touched and seen. This sounds obvious, of course, but what this really means is that purchase order financing cannot be applied to the sales of services, such as accounting services or medical treatments, it can only be applied to physical goods. 

Requirement #3 – You Must Meet a Minimum Purchase Order Amount

Lenders offering purchase order financing charge a factoring fee based on the amount of the transaction, so they all require a minimum purchase order amount to make the transaction worth their while. The minimum amount of the transaction varies from provider to provider, with some financing companies requiring a minimum of $50,000 while others requiring a minimum amount of up to $200,000. Therefore, you should make sure the amount you need to fulfill your order is at least $50,000 just to be able to find a purchase order financing provider. 

Requirement #4 – Your Suppliers & Customers Must Meet Minimum Credit Scores

In a purchase order financing agreement, financing companies are paying your suppliers directly then depending on them to deliver the goods or products. From there, your customers actually pay the purchase order financing company. Therefore, they will be checking the creditworthiness and reputation of your suppliers and customers before approving the transaction. The best way to meet this requirement on your end is to make sure you are doing business with reputable suppliers and accepting purchase orders from customers with good credit ratings. 

This should be simple enough if the transaction involves a single supplier and one customer, but if it involves multiple suppliers, you should check with them early. You can request a credit check from them or check their business credit through Dun & Bradstreet.

Requirement #5 – You Must Meet Minimum Profit Margin Requirements

In order to approve you for purchase order financing, the lender will want to know if you can afford the fees. The best way for them to do this is to set a minimum profit margin for the transaction. Typically, the minimum profit margin ranges between 10% to 20% depending on the lender. 

Requirement #6 – You Must Have a Minimum Time in Business

With most small business financing, you’ll need to have some time in business in order to qualify for purchase order financing. More specifically, however, is that you need to have engaged in the specified transaction with your suppliers before in order to qualify. 

Requirement #7 – Your Financial Statements

You will also need to provide your company’s financial statements such as bank statements and other balance sheet information. More importantly, however, you will also need to provide information on any contracts you have with your suppliers and clients/customers. 

Start Your Application Early

If you decide purchase order financing is right for you, you should start the application process early, as funding can take longer than with other types of financing such as a online working capital loans or revenue-based financing because more parties are involved in the transaction. 

It’s common knowledge that individuals and families should have at least six month’s worth of their expenses in a savings account to deal with emergencies.   But did you know that having an emergency fund is a good business practice as well?  The unexpected could come at any moment, and as the past four years have taught us the residual impacts of the unexpected can just keep coming and coming.   

How and where do you start building out an emergency fund without negatively impacting your business right now?  Let’s run through a few ways that you can use business financing to get you on the road to securing your business in the event of an emergency. 

What is a Business Emergency Fund?

To start, let’s cover the basics:  a business emergency fund is a savings account set aside to quickly cover unexpected expenses for your business. It is a fund that should be contributed to regularly and should not be accessed for anything other than a real emergency that could risk closing your business’s doors. To put it simply, this fund is your first line of defense when something risks interrupting your daily operations.

How Much Money Should an Emergency Fund Have?

The amount of money needed in an emergency fund will depend wholly on your business and its annual operating expenses along with other factors such as your inventory, receivables, and whether or not your business runs seasonally. All these factors, as well as your personal preferences as the business owner, will determine how much money you will need to handle what your business would consider an emergency. A good rule of thumb, though, is that your emergency fund should cover – at minimum three months worth of your business expenses.

Using a Business Loan to Boost Your Emergency Fund

If you are looking to quickly build or add to an emergency fund without impacting your existing cash flow and putting other business goals on the back burner, creatively using funds from a business loan could make that possible. Here are a few strategic ways you can use business loans (or other types of business financing) to build an emergency fund without sacrificing other areas of your business – some can lead to a quick build of an emergency fund and some require a long-game mentality.  

Cover an Expansion or Improvement That Will Lower Overall Expenses

Using a business loan to expedite expansion or a business improvement is a classic way to boost your overall capacity and, eventually, your revenue. If investing back into your business means that you’ll make more profit down the line, you could allocate a percentage of all new revenue to invest in your emergency fund at a level that may not have been possible before making the improvements.

Let’s say, for example, an auto repair business has a plan to increase its capacity and efficiency by adding a new hydraulic lift to its garage. Using a business loan (or equipment financing) to buy the lift more quickly could increase the business’s rate of repair and eventually free up more working capital as a result. As long as the business eventually puts a percentage of that working capital back into an emergency fund, financing could help get that fund off the ground faster.

Cover Payroll to Expand Staff

Business loans are also a solid means for a business owner to cover payroll. Instead of using the loan to cover payroll when cash flow is low, consider, instead, using that loan to hire more employees or temporary workers which, in turn, could increase your profits over time. If high-achieving or strategically placed employees have the potential to make you more money more quickly, it can be more than reasonable to use a loan to expedite those workforce additions. It’s then, of course, essential that the business owner uses that capital boost to reinforce their emergency fund.

Refinance or Consolidate Current Debt

If your existing debt is spread across several lenders or is steeped in high interest, refinancing that debt could change up your monthly payments and give you more working capital. Especially if your business has a serious amount of credit card debt, it’s more than possible that refinancing or consolidating your business debt could help reduce your overall monthly payments. By bringing your monthly payments down and your working capital up, it’s possible your business could have more capital on hand each month to boost your emergency fund.

Buy Up More Inventory

Managing inventory is the basis of good daily operations. If you can find a way to pay less per piece for your inventory stock you’re confident will be sold, it may make sense to use a business loan to take advantage of bulk discounts to the fullest. If your business can turn that inventory win into a cash flow win, you can then reinvest that cash flow back into your emergency fund.

Using an SBA Disaster Loan

SBA Disaster Loans aren’t going to help establish an emergency fund unless your business has already been hit by a disaster. So, if your business is hit with a disaster and your emergency fund is either now depleted or never existed in the first place, applying for an SBA Disaster Loan could be a great way to quickly build back up your emergency fund and help get your business back on its feet.

Eligibility for SBA Disaster Loans is based on how the federal government and FEMA determine disaster zones. Keep a close eye on the SBA website to find out when or how your business could be eligible for a disaster loan.

Putting Loan Funds Directly into Your Emergency Account

The easiest way to use a business loan to build out an emergency fund is to simply directly deposit those funds into your emergency account.   Of course, this would mean you already have the revenue coming in to cover the payments for that loan so this strategy should only be used when you want to and afford to quickly bolster that fund. 

Other Financing Options Relevant to Emergency Funds

Business loans aren’t the only way to keep your emergency fund in good form.  Here are a few additional financing options you could use to strategically build or add to your fund. 

Line of Credit

While a line of credit won’t necessarily help build an emergency fund, having a well-maintained line of credit could free up some of your working capital and allow you to invest back into the fund more fully. A great example of how a line of credit can help free up cash flow is invoice management. Imagine that a business deals with many invoices that can take several weeks or months to pay out. Using a line of credit to cover expenses and then eventually paying them back through those paid-out invoices is a great way to boost your working capital.

Business Credit Cards

A business credit card could be seen as another line of defense between an emergency and your cash reserves. While business credit cards generally have quite high monthly interest rates, using that card instead of dipping into your savings or operating expenses is a great way to ensure your cash flow (and your ability to invest back into your emergency fund) stays consistent.

Every Business Needs an Emergency Fund

No business is insulated from unexpected expenses. Building an emergency fund that can get your business through essential repairs or major changes can be the difference between whether or not your business exists tomorrow at all.  Especially if your business is behind on its emergency fund targets, using a business loan to quickly free up your working capital could be just what is needed to get you on the road to building the emergency fund you need.

Business expansion is one of the primary reasons that small businesses seek out financing. But if your business is taking on its first big expansion or you are relatively new to the modern world of financing, finding the best financing solution for your expansion may seem daunting. After all, both expansion and financing are not one-size-fits all, especially when considering that different type of business growth call for certain types of business financing.   How do you determine which type of business financing is best for your expansion plans?   

Types of Business Financing that Fund Expansion

Let’s go product by product and lay out some use cases where one type of financing may fit better than another.

The Versatile Nature of Business Loans

It is very common to pair a business loan with expansion because business loans are so versatile. Business loans allow an owner to take out a lump sum of capital after making an agreement to pay that sum back over time with predetermined interest. So, any kind of expansion that calls for a lump sum of money, (that would mean most) could likely be expedited with a business loan.

Any kind of expansion – from mergers to real estate has the potential to increase profits, especially with an owner who knows their industry well. Using a business loan to strategically expand your operation is so common, then, because it fits so many practical use cases. Further, business loans tend to have much longer repayment terms compared to other types of financing. This means that business loans may be the preferred choice for expansions that take longer to break even or require a significant amount of capital upfront.

Expansion Through Equipment

If your expansion is going to require new equipment, then equipment financing is an excellent option to consider.  Equipment financing, as the name implies, is a financing product specifically for acquiring equipment. This means that the total value of the loan should not exceed the price of that equipment, plus interest. Further, in many equipment financing cases, the equipment itself can be used as collateral for the loan. The terms of the loan, also, are often based on the life expectancy of the machinery itself.

Expediting your ability to acquire new equipment is a great way to increase your profits faster. For example, a trucking company could use equipment financing to expand its fleet. This trucking company could then increase its capacity to take on orders thereby meeting expectations for that return on investment. 

Leverage Outstanding Invoices to Fund Expansion

By leveraging invoice factoring, small businesses can access immediate cash flow by selling their outstanding invoices to a factoring company at a discounted rate. This infusion of funds can then go toward growth-related needs such as expanding operations, hiring staff, investing in marketing, or purchasing inventory. Unlike traditional financing options, invoice factoring often doesn’t require traditional collateral (the invoice, itself, can typically be used as the collateral) and it doesn’t have a lengthy approval process, making it an attractive option for small businesses looking to expand quickly.

By staying proactive in managing finances and working closely with your factoring partner, small business owners can leverage invoice factoring as a strategic tool to fuel growth and achieve their expansion objectives.

Expansion Opportunites Funded by Future Revenue

Revenue-based Financing offers an alternative funding solution for small businesses looking to fuel growth. This financial tool allows businesses to receive a lump sum upfront in exchange for a percentage of future credit card sales. Unlike traditional loans, RBF  are based on a business’s projected revenue rather than credit history, making them accessible to businesses with limited credit or those in need of quick funding. The flexibility and speed of RBF makes it an appealing option for businesses looking to seize growth opportunities without the constraints of traditional lending processes.

To effectively leverage RBF for small business growth, it’s essential to understand the terms and repayment structure. While RBF offers quick access to capital, they typically come with higher fees and shorter repayment periods compared to traditional loans. Small businesses should carefully evaluate the terms of their specific RBF deal and make sure they have a clear plan for repayment that won’t strain cash flow. 

Make sure to explore multiple RBF providers to find the best fit for your needs, considering factors such as fees, repayment terms, and customer service reputation. By using RBF strategically and responsibly, small businesses can accelerate their growth trajectory and achieve their expansion goals.

Expand with Government-Backed Funds

Small Business Administration (SBA) loans offer a valuable avenue for small businesses to secure financing and foster growth. These loans, backed by the federal government, provide businesses with access to capital for various growth initiatives, including expansion, equipment purchases, working capital, and more. SBA loans often feature longer repayment terms and lower interest rates compared to conventional loans, making them an attractive option for businesses seeking affordable financing options. Moreover, the SBA’s guarantee mitigates risk for lenders, making it easier for small businesses to qualify, even if they lack extensive credit history or collateral. By leveraging SBA loans, small businesses can unlock the financial resources needed to scale operations, enter new markets, hire additional staff, and ultimately realize their growth potential.

Expanding Your Business and Your Receivables

Smart financing can be a strategic move for small businesses aiming to expand their operations and reach new heights of success. Whether through traditional bank loans, SBA loans, revenue-based financing, or invoice factoring, businesses have a range of financing options available to expedite expansion. However, it’s crucial for business owners to carefully evaluate their needs, assess the terms and conditions of each loan product, and develop a comprehensive repayment plan to ensure financial stability and success in the long term. By leveraging loans responsibly and strategically, small businesses can overcome financial barriers, seize growth opportunities, and achieve their goals, ultimately paving the way for expansion and growth that lasts.

Debt can be a burden for any small business owner, especially when you have multiple forms of high-interest debt that you have to keep track of and that could slow down your cash flow. One of the ways to simplify this problem is to take out financing to consolidate your debt and, hopefully, save you money by lowering the interest and fees you are paying on your existing debt.

Why Consolidate Debt?

There are two general reasons you would want to consolidate your business debt. The first one is to save money on interest rates and fees. If you are paying high interest rates on a business credit card and a working capital loan, for example, you should consider consolidating those debts into a lower interest-charging business line of credit or loan. This will save you a significant amount of money on the cost of capital and fees.

The second reason is to simplify. If your business is on the hook for multiple sources of debt such as business credit cards, equipment financing, and working capital loans, your life as a business owner could be made much simpler (and more affordable) if you consolidate those into one financing option and one debt payment.

What are the Best Financing Options for Debt Consolidation?

Before you dive into the question of whether you should consolidate your debt, it’s important to know which financing options generally offer the lowest interest rates and the terms that go along with them Those options are:

 SBA 7a Loan

An SBA 7(a) loans are offered by authorized lenders that include traditional banks and alternative lenders. These loans are backed by the US Small Business Administration and typically offer the lowest interest rates. Much like a bank loan, these loans provide a lump sum of cash upfront in exchange for a pre-agreed upon monthly payment. 

7(a )loans generally require excellent credit scores and a lot of paperwork as part of the application process. If you have an existing bank loan and believe you may qualify for a 7a loan, this could save you money on interest payments, 

Traditional Loans

A traditional loan – or term loan – is offered by both alternative lenders and traditional banks. These loans are much like SBA 7(a) loans but typically charge slightly higher interest rates. A traditional loan is a good option if you are seeking to consolidate debts such as an outstanding balance on a business line of credit and a business credit card or equipment loan. 

Business Line of Credit

A business line of credit gives you access to a predetermined credit line and only charges interest on what you borrow. The interest rates for business lines of credit are generally higher than traditional loans and SBA 7(a) loans, but this could be a good option if you’re seeking to consolidate outstanding balances on high-interest business credit cards and working capital loans. 

What Factors Should You Consider Before Consolidating?

There are multiple financing options to choose from if you have multiple forms of high-interest debt, which may include business credit cards, business lines of credit, or equipment financing. If you are thinking of consolidating your debt, however, there are several factors to consider:  

Have interest rates gone down? 

Interest rates on your loans and business lines of credit are strongly dependent on the federal funds overnight rate, which can be changed 8 times a year by the US Federal Reserve Bank. If the rate has gone down since you took out your traditional loan or business line of credit, you may want to consolidate to save money on the cost of capital.

Which business financing options have the most favorable interest rate? 

There’s little point in consolidating your debt if it’s not going to save money. If you’re paying high interest rates on debt products such as business credit cards or working capital loans, you should consider consolidating that debt into lower interest rate products such as traditional business loans, SBA 7(a) loans or business lines of credit.

What type of financing products offer you the most flexibility?

If you’re looking to consolidate your debt, carefully consider what type of flexibility you are looking for in terms of repayment options. For example, a business line of credit is a highly flexible tool in terms of when you can borrow, but it may have a stricter repayment requirement than a traditional loan or SBA 7(a) loan. Consider the type of flexibility that best serves your needs.

Have your credit scores improved enough to notch a lower interest rate?

As a small business owner who requires debt to operate your business, you should always keep a close eye on both your FICO and business credit scores. If you have an outstanding bank loan or business line of credit and your credit score has improved since you took them out, you may want to consider debt consolidation as you may be able to notch a lower interest rate. 

How will you adjust your business spending once you’ve consolidated your debt? 

If you’re looking to consolidate your debt, it’s important to plan on how you’re going to manage that debt afterwards. For example, in your personal life, if you consolidate the debt on your high-interest credit cards into a lower-interest-rate personal loan, but afterward you keep spending on those credit cards, your debt is going to once again become unmanageable. The same thing applies when you consolidate your business debt. If you consolidate your debt on a business line of credit or business credit card into a traditional loan, for example, it’s important to make sure your debt stays manageable afterwards by limiting your spending on your card or business line of credit.   

What are the Pros and Cons of Consolidating Debt?

If you’re seeking to consolidate your business debts, you should carefully weigh the pros and potential cons of doing s0.

Pros of business debt consolidation

• Saving money. If done correctly, consolidating your business debts can substantially lower the interest rate you’re paying on your debt. Lower interest payments can improve your cash flow and free up money to use on other parts of your business.
• Improving Your Credit Score. By consolidating your debts, you’re effectively zeroing out the balances on any outstanding debts you may be carrying into one debt, which will improve your credit score, and credit bureaus generally don’t look favorably on too many outstanding debts. 
• Simplifying Your Payments. As previously stated, having to manage multiple debts can become a burden. Simplifying your debts into one payment can save you time and headaches. 

Cons of business debt consolidation

• The payment period could be longer. If you’re seeking to consolidate your debt intoa loan,  the time it takes to pay off your debt could become longer, depending on the terms of the bank or 7(a) loan.
• The payment amounts could increase. Consolidating your debts into one financing option could increase the amount you owe every week or month, even though you’d be paying a lower interest rate. For example, while high-interest credit card debt isn’t pleasant, credit cards typically allow you to make a minimum monthly payment, whereas the monthly payment on a loan is a fixed amount. 

Carefully Consider Your Options

Consolidating debt could save your business a significant amount of money if you are stuck with multiple, high-interest debts. However, it’s important to carefully consider what your options are when consolidating your debt, and which financing options offer you most flexible payment options and interest rates. 

For small business owners, getting the capital you need through a bank loan to maintain and grow your business can be a lengthy and difficult process, especially over the past two years as interest rates continue to rise and traditional banks have tightened their lending requirements as a result. Small business loan applicants must have excellent credit and a strong cash flow to even be considered for a loan. 

There are, however, certain financing products that have risen to prominence that allow small business owners access to working capital without having to face difficult requirements, give up equity in their business, or fill out lengthy paperwork. One of those products is revenue-based financing, an alternative way to get funds based on your business’s future revenue.

What is Revenue-Based Financing?

Revenue-based financing – sometimes referred to as sales-based or royalty-based financing – is a unique funding method in which a financing “fronts” a lump sum of cash to a small business in exchange for a predetermined percentage, or “factor” of that business’ future sales. In essence, the financing company is purchasing a business’s future sales at a discounted rate.

Let’s say that a financial institution, typically an alternative lender, fronts $100,000 in a revenue-based financing deal to a small business with a factor rate of 1.2. That means that, over time, the business owner will pay 20% of their sales on a daily, weekly or monthly basis back to the financing company until $120,000 has been paid off. There is no set date for when the payments end, they only end until the owed amount has been paid. 

Unlike a traditional small business loan which requires fixed payments, there are no fixed monthly payments in a revenue-based financing arrangement. If sales go down, the factor rate won’t change, but the amount being paid back will go down since you’re paying a percentage of your sales to pay back the “fronted” amount.

Why and When Revenue-Based Financing is Needed

Since revenue-based financing is more expensive than a loan or line of credit, it is not for everyone. If you’re seeking to invest in the long-term growth of your business by adding more space, increasing inventory, or hiring additional staff, then a bank loan is a very good financing tool if you qualify. 

Revenue-based financing, however, is a great form of financing when you need cash quickly for immediate expenses, short-term growth targets and emergencies. While it is more expensive than a bank loan, it is also easier to qualify for if your business has a strong sales history or can otherwise demonstrate the ability to produce future sales. Generally, you want to make sure your small business is making enough in sales to remain profitable under the terms of a revenue-based financing agreement. Also, since the approval for revenue-based financing is largely dependent on sales history, the financing company will typically place less weight on your personal credit during the underwriting process. 

Here are just a few examples of when businesses could use revenue-based financing:

• A small construction company is awarded a large contract but needs cash quickly to purchase inventory and hire additional workers. That small business can receive $700,000 through revenue-based financing to fulfill the obligations set in the contract. If the contract is worth $2 million and the company has a factor rate of 1.2 and must pay back $840,000, the revenue-based financing deal would be well worth it, especially if the construction company does not qualify for a bank loan or line of credit.
• A small, two-year-old retail store borrowed money from investors when it launched and has produced $250,000 in annual sales. That business needs cash to expand but doesn’t want to dilute its earnings with additional investors. Since most lenders would reject an application for a bank loan from a company that’s only two years old, that small business owner can borrow $50,000 through a revenue-based financing deal and use those funds for immediate expansion, while slowly paying back the money through increased sales due to expansion.
• A small software firm is seeking to quickly develop and launch a new product that is expected to increase sales by 20%. However, the owner does not want to pull capital away from other units to pay for the $250,000 in marketing, research, and development that it will take to launch the new product. With a revenue-based financing deal, the firm can get those funds quickly, and the sales of the new product will exceed the cost of capital in the revenue-based financing deal.

Essentially, the rule of thumb for revenue-based financing use is that the cost of the funds you receive in the agreement should be covered by the growth opportunity you are funding while still giving you profit.  The idea being that, without the funding, you would not have been able to move forward with your project and would have lost all of that potential revenue. 

How is Revenue-Based Financing Different from a Loan?

While revenue-based financing does front your business money, it differs significantly from a traditional business loan. The most significant differences are:

Easier to obtain.

The biggest difference between a loan and a revenue-based financing deal is accessibility. Obtaining revenue-based financing is substantially easier than obtaining a loan. A bank loan usually requires:

1. A good to excellent credit score;
2. Several years in business;
3. A strong cash flow; 
4. In some cases, a business plan presentation, and
5. A compelling plan on how you will use the proceeds of the loan.

The qualifications for revenue-based financing, however, are considerably less since this form of financing relies heavily on the strength of your sales. When you apply for revenue-based financing, you will often only need:

1. A fair credit score in the mid-600s, depending on the lender;
2. Typically two years in business, and
3. A strong sales history. 

No default risk.

With a traditional loan, you must pay back the borrowed amount with interest over a predetermined period. If you fail to make your payments in that confined time frame, you will default on your loan. With revenue-based financing, you don’t have this same risk of defaulting. Instead, you will keep paying the pre-agreed-upon percentage of your future sales until the money that’s been fronted to you is paid back. If sales are low, your payment amount is smaller.  If sales are great, your payment amount is larger.

Quicker funding.

Loans from traditional lenders often take time to obtain – sometimes weeks – especially if you’re trying to get a SBA 7(a) loan. Revenue-based financing is typically offered by alternative lenders and non-bank financing companies and requires less paperwork than traditional lenders. In the case of revenue-based financing, the application is far simpler than for a loan, and funding can come in as little as 24 hours. 

Revenue-based financing is more expensive.

While revenue-based financing has some unique advantages over traditional loans, small businesses must keep in mind that generally, factor rates are more expensive than an interest rate on a loan, so it’s important to carefully weigh the pros and cons of each before deciding on the type of financing to apply for. 

Revenue-Based Financing is Changing the Lending Landscape

Data indicates that with the advent of alternative lenders (the predominant financial institutions that offer revenue-based financing), this type of funding has changed the landscape of the small business lending market over the past 15 years. While revenue-based financing has been available to small business owners for the past two decades, it has gained massive popularity as an alternative financing source for small business owners who need funding quickly and may not have all of the qualifications for a loan or do not have the time required to wait on approval for a small business loan.

During periods over the past 15 years when loan requirements from traditional banks tighten and bank loans become harder to obtain, revenue-based has soared in popularity. According to the Federal Reserve of St. Louis, in 2010, two years after the Great Recession, the volume of revenue-based financing grew to $524 million – nearly double the amount from three years prior.  According to a study conducted by Benziga Research, the global revenue-based financing market size was valued at $2.8 billion in 2022 and is forecasted to grow to $4.9 billion by 2028. 

Economic Woes Bolster Revenue Based Financing

Rising interest rates since March 2022 coupled with rising inflation since the end of the COVID-19 pandemic, caused the cost of capital on bank loans to skyrocket and traditional banks to demand higher borrowing standards such as excellent credit scores and higher cash flows than in the past. 

According to the Federal Reserve, applications by small businesses for bank loans and lines of credit decreased from 89% in 2020 to 72% in 2022. Approvals for loans and lines of credit dropped to 68% in 2023 from 76% in 2020. In the Federal Reserve’s latest study, 10% of small businesses that applied for financing in 2022 sought revenue-based financing. That figure was up from 8% in 2020 – when interest rates were very low – and 9% from 2019.

Additionally, approval rates on small business loans and lines of credit have decreased dramatically, making an alternative lending option such as revenue-based financing all the more attractive. Approval rates by traditional banks were 83% in 2019, the year before the COVID-19 pandemic, and fell to 68% at the end of 2022. 

Pros and Cons of Revenue-Based Financing

As much as revenue-based financing can be an extremely valuable financing tool, it must be emphasized that this type of funding isn’t for everyone nor for every situation, as it’s more expensive than a traditional bank loan and line of credit. However, while bank loans and lines of credit are excellent financing tools, they often carry high borrowing requirements and, therefore, may be difficult to obtain for some small businesses. 

Revenue-based financing is a great funding tool under the right circumstances, but it does have potential downsides. It’s extremely important for any small business owner to closely examine the pros and cons of revenue-based financing before choosing this as a financing option. 

Pros of Revenue-Based Financing

• Revenue-based financing is easier to obtain than a loan or line of credit. Since the main requirement is a strong sales history, you don’t need an excellent credit score or three years in business to obtain revenue-based financing.
• There is no default risk since payments are based on a factor of future sales.
• Business owners don’t have to give up equity to obtain revenue-based financing like they would with private equity.
• revenue-based financing is a good way to boost your short-term cash flow without having to meet the often stringent requirements of bank loans or lines of credit. 

Cons of Revenue-Based Financing

• revenue-based financing is more expensive than a loan. Depending upon the strength of your sales and your credit rating, the cost of capital can be significantly higher than a loan or line of credit. 
• In a typical revenue-based financing arrangement, the payments you make are variable and based upon how strong your sales are. Therefore, if sales are slow, the payment arrangement can last for an extended period of time. 
• You may get rejected for revenue-based financing funding if you don’t have a strong sales history. 
• You need a strong cash flow to obtain revenue-based financing funding. For bank loans, most lenders will closely examine your cash flow to see if you qualify. Revenue-based financing providers mostly focus on your sales history. Therefore, if you have high monthly expenses and don’t adjust them to make a revenue-based financing arrangement, your business could lose money since you are giving up a percentage of your sales in a revenue-based financing deal.  

How to Obtain Revenue-Based Financing

Alternative lenders that operate mostly online offer revenue-based financing funding, so a quick online search can give you an expansive list of providers. Reputable revenue-based financing providers do have requirements for obtaining this form of funding, including

1. A credit score in the mid-600s
2. 2 years in business, and
3. At least $250,000 in annual revenue.

Watch out for Bad Actors

Some states are tightening regulations surrounding revenue-based financing, but it remains a loosely regulated industry. Therefore, when searching for a revenue-based financing provider, you may come across some predatory financing companies that are claiming to be legitimate. When researching alternative financial institutions that do offer revenue-based financing, here are some of the signs you should look for that may indicate a “bad actor”:

• It will offer you funding despite a very low FICO score (under 600).
• It does not have bonafide customer reviews.
• It does not offer strong customer service or is difficult to reach.
• It will try to rush a deal before carefully going over specific terms with you.
• It will try to downplay or gloss over abusive terms of funding, such as exorbitantly high factor rates and transaction fees.
• The lender’s history in business is obscure or difficult to research.

Consult a Small Business Financing Specialist

Many reputable financing companies offer small business financing specialists who can assist you in deciding whether revenue-based financing is a good option for your business, and you should work closely with them. The main thing to do is to examine whether you will be using the funding to increase your profits to the point that you can pay the factor rate and still be profitable. 

You should also go over the timeliness of receiving funding – are you in need of cash right away and have a strong sales history, or are you seeking to borrow funds for long-term growth? Does your sales history justify a revenue-based financing arrangement? Finally, like with any financing product, you need to go over the specific terms of repayment to make sure you can comfortably afford them.