Overview

When a business needs capital, the choice between a traditional term loan and revenue-based financing (RBF) influences monthly cash flow, lender expectations, and long-term cost. Term loans give predictability; RBF gives flexibility tied to revenue. Deciding between them requires a clear view of your revenue patterns, growth runway, and whether you value stable payments or variable ones that move with sales.

Background and context

Term loans are among the oldest commercial lending tools, used by banks and community lenders to finance equipment, real estate, and structured expansions. The U.S. Small Business Administration (SBA) also backs many term loans to reduce borrower cost and lender risk (sba.gov).

Revenue-based financing emerged more recently as a non‑dilutive alternative to equity and an alternative to merchant cash advances. RBF became popular with SaaS, subscription, retail, and other recurring-revenue businesses that need runway but prefer payments that scale with sales. RBF providers typically price deals using a repayment multiple (cap) and a revenue share percentage rather than a conventional interest rate.

In my practice advising growth-stage businesses, I see predictable, asset-heavy firms do best with term loans, while recurring-revenue companies and seasonal sellers often benefit from RBF’s cash‑flow alignment.

How each product works

Term loans

  • Lender gives a lump sum; borrower repays principal plus interest over a fixed term (commonly 1–10 years for small-business term loans). Repayments are usually monthly and may be interest-only for an initial period.
  • Pricing can be a fixed or variable interest rate. Credit score, cash flow, collateral, and business history determine rate and approval. SBA-backed term loans can lower cost and lengthen terms for qualifying small businesses (sba.gov).
  • Use cases: equipment purchases, commercial real estate, franchise financing, and strategic acquisitions.

Revenue-Based Financing

  • Lender advances capital and is repaid by taking a fixed percentage of the borrower’s recurring revenue (typically 5%–20% per month) until a repayment cap is met (for example, 1.2x–2.0x the advance).
  • There is no fixed monthly payment; payments move with sales volume—low in slow months, higher in peak months.
  • Pricing is expressed as a repayment multiple or factor rate rather than APR; this makes direct cost comparisons to loans less intuitive.
  • Use cases: marketing-driven growth, bridging product launch cycles, inventory buildup for seasonal sellers, and companies with high gross margins but limited collateral.

Key differences that matter to business owners

  • Payment predictability: Term loans provide predictable monthly obligations. RBF payments vary with revenue, easing strain in slow months.
  • Cost structure: Term loans show interest rates (APR); RBF shows a repayment multiple (e.g., repay $1.5 for every $1 funded). Over time RBF can be more expensive if revenues grow quickly, but cheaper if growth stalls.
  • Qualification and speed: RBF underwriting emphasizes recent revenue and gross margins and often closes faster with fewer covenants. Banks require stronger financial statements, collateral, and time to close.
  • Dilution and ownership: Neither product dilutes equity (unlike venture capital). RBF is non‑dilutive but often carries higher effective cost.
  • Covenants and collateral: Term loans may demand collateral and financial covenants; RBF typically avoids fixed collateral but may require personal guarantees or a lien on receivables.

Practical examples

  • Term loan case: A restaurant borrows $200,000 at 6% over five years to renovate and buy kitchen equipment. Monthly principal+interest payments are predictable, enabling the owner to budget payroll and food costs without revenue-dependent swings.

  • RBF case: A subscription software company raises $300,000 using RBF with a 1.4x cap and a 10% revenue share. When monthly recurring revenue rises, payments increase and the deal repays faster; when MRR dips, payments shrink and cash flow stress eases.

How to compare true cost (APRs vs repayment multiples)

  • For term loans: calculate APR including fees, origination charges, and prepayment penalties. Understand amortization: front-loaded interest makes early years costlier per dollar of principal.
  • For RBF: compute the effective annualized cost by modeling expected revenue growth scenarios. If your revenue grows quickly, you’ll repay the cap sooner, increasing the effective APR. If revenue is flat, the effective cost spreads out over more months and can look lower.

I recommend building three revenue scenarios—pessimistic, base, and optimistic—and calculating monthly payments under each to compare cash flow impact and total cost.

Eligibility and when to prefer each

Choose a term loan when:

  • You have stable, predictable cash flow and strong financial statements.
  • You need a large, one-time capital expenditure (equipment, property, franchise fee).
  • You can pledge collateral or qualify for an SBA guarantee to lower rates.

Choose revenue-based financing when:

  • Your revenue is recurring but you lack collateral or a long credit history.
  • You want payments that naturally scale with sales (seasonal businesses, subscription models).
  • You prefer faster access to capital and can accept a potentially higher total cost in exchange for flexibility.

Common mistakes and red flags

  • Ignoring total repayment cost: RBF’s factor rates hide the effective APR. Don’t compare a 1.4x cap to a 10% interest rate without modeling.
  • Over-borrowing: With RBF, easy access to capital can lead to accepting higher repayment multiples; borrow only what you can justify with clear ROI assumptions.
  • Not reading covenants: Term loans can include cash-sweep clauses, minimum liquidity covenants, or balloon payments—know these before signing.
  • Confusing merchant cash advances with RBF: They are similar but merchant cash advances often have higher costs and harsher terms; compare carefully (see our guide comparing merchant cash advances and RBF).

Actionable selection checklist

  1. Build a 12–24 month cash‑flow projection (best, base, worst).
  2. Identify use of funds: capex (term loan) vs growth/marketing (either; model ROI).
  3. Request full cost schedules: amortization table for loans, repayment schedule examples under multiple revenue paths for RBF.
  4. Ask about fees, prepayment penalties, personal guarantees, and security interests.
  5. Run sensitivity tests: how do payments change if sales fall 20% or rise 30%?
  6. Consult a CPA or financial advisor to evaluate tax impacts (interest on business loans is generally deductible; see IRS guidance on business expenses) (irs.gov).

Interlinks and further reading on FinHelp

FAQs (short answers)

  • Can I refinance a term loan with RBF later? Usually not directly; you can repay a term loan and then take an RBF deal, but simultaneous swaps are uncommon. Refinancing depends on improved metrics and lender appetite.
  • Does RBF hurt credit? RBF payments are tied to revenue and typically reported differently; it can affect banking relationships but does not always show up like a traditional loan on personal/business credit in the same way. Ask the provider how they report.
  • Are RBF deals negotiable? Yes. Negotiate the revenue share, cap, and covenants. Ask for pro forma repayment scenarios and a cap table of potential outcomes.

Sources and authoritative references

  • U.S. Small Business Administration — loan programs and SBA 7(a) details: https://www.sba.gov
  • IRS — guidance on business expenses and deductibility: https://www.irs.gov
  • Investopedia — primer on revenue-based financing structures and factor rates: https://www.investopedia.com
  • FinHelp — practical guides and comparisons (linked above)

Professional disclaimer

This article is educational and not individualized financial advice. Terms, rates, and availability vary—consult a certified financial professional or CPA before committing to financing.