By Isabella Edwards May 26, 2025
Every business, whether new or established, eventually reaches a point where outside capital is needed. That could mean launching a new product, expanding operations, filling a short-term cash gap or investing in new technology. The big question is: what kind of funding is best suited for your business?
Two common approaches are traditional loans and revenue-based financing (RBF). Both serve the purpose of providing capital, but they operate under very different models. Traditional loans are usually secured, fixed-term debt instruments issued by banks or credit unions. Revenue-based financing, on the other hand, offers a more flexible approach where repayments are tied to the business’s future revenue.
What Is a Traditional Business Loan
Traditional business loans are financial products offered by banks and other institutional lenders. These loans typically provide a fixed amount of money that the business repays over time with interest. Repayments are made in fixed monthly installments and usually span several years.
Lenders assess a business’s creditworthiness before issuing a loan. Factors such as credit score, time in business, annual revenue and available collateral are used to determine whether a loan will be approved and under what terms.
Common types of traditional business loans include:
Term loans which provide a lump sum with fixed interest and monthly payments
Lines of credit which offer revolving access to capital up to a set limit
SBA loans which are partially guaranteed by the government and available through approved lenders
Equipment financing which is used to purchase machinery, vehicles or tools for the business
What Is Revenue-Based Financing
Revenue-based financing is a flexible funding model where a business receives capital in exchange for a fixed percentage of its future revenues. Instead of paying a set amount each month, the business repays the funder through a share of its ongoing sales, often until a predetermined total amount is repaid.
RBF is especially useful for businesses with strong monthly revenue but limited credit history or collateral. Since repayments are tied directly to income, they rise and fall with the business’s performance. This makes RBF a more dynamic and less rigid option than traditional debt financing.
Typically, funders charge a factor rate to determine the total repayment amount. For instance, if a business receives $50,000 at a factor rate of 1.3, it agrees to repay $65,000. The percentage of revenue deducted may range from 5 to 20 percent, and repayment continues until the total amount is paid in full.
Application Process and Approval Criteria
Traditional Loans
Applying for a traditional loan often involves a detailed and time-consuming process. Business owners must submit extensive documentation, including:
Business plan and financial statements
Tax returns and bank statements
Credit reports and personal financial history
Collateral details, if applicable
The underwriting process can take several weeks. Banks typically favor businesses with established histories, strong credit scores and consistent profitability. Startups or those with irregular cash flow may find approval more difficult.
Revenue-Based Financing
Revenue-based financing has a faster and more streamlined application process. Instead of focusing on credit scores and assets, funders assess daily or monthly revenue trends. To apply, businesses generally need to provide:
Bank statements from the past few months
Merchant processing or accounting software data
Basic business verification documents
Approval often takes just a few days. Since revenue history is the main qualification, businesses with steady sales but low credit scores may still be eligible.
Repayment Structure
Traditional Loans
With traditional loans, repayment terms are fixed. Borrowers repay a set amount each month, which includes principal and interest. This structure is predictable and helps with long-term financial planning.
However, fixed payments can be burdensome during months when revenue is low. Missing payments can result in late fees, penalties or damage to the business’s credit profile.
Some loans allow early repayment, but this can sometimes include prepayment penalties.
Revenue-Based Financing
In RBF, repayments are variable and based on a percentage of the business’s sales. If sales are high, the repayment for that period increases. If sales drop, so does the payment amount. This can offer important flexibility for businesses with seasonal or fluctuating revenue.
There are no fixed due dates or monthly obligations. Repayment continues until the agreed-upon total is reached. There is no compounding interest, and the total repayment is known from the start, though the time it takes to repay may vary.
Cost of Capital
Traditional Loans
The cost of capital in traditional loans is typically calculated as an interest rate. These rates vary based on creditworthiness, loan size and term length. Secured loans often come with lower rates, while unsecured loans are priced higher to reflect risk.
Bank loans may have lower overall costs than revenue-based financing, especially if the borrower qualifies for favorable terms. SBA loans, for example, offer competitive interest rates and long repayment periods.
However, banks may also charge origination fees, late payment penalties and annual fees, which should be factored into the total cost.
Revenue-Based Financing
RBF uses a factor rate, not an interest rate, to determine the cost of borrowing. Factor rates typically range from 1.1 to 1.5. This means if a business borrows $100,000 with a 1.4 factor rate, it repays $140,000 in total.
While this model provides clear cost visibility upfront, it often results in a higher effective annual percentage rate, particularly if the business repays quickly. There is no discount for early repayment, and the total amount remains fixed.
Despite the higher cost, many businesses accept this trade-off for the benefit of flexible and sales-based repayments.
Use of Funds
Traditional Loans
Traditional loans may come with restrictions on how funds are used. Some loans are purpose-specific, such as equipment loans or real estate loans. Term loans and lines of credit offer more general flexibility but may require the borrower to disclose plans for fund usage.
Banks often prefer that funds be used for growth-related activities or working capital rather than speculative ventures. Misuse of funds can violate the loan agreement and trigger default terms.
Revenue-Based Financing
RBF generally comes with fewer restrictions on how funds are used. Once approved, the business can allocate funds toward marketing, inventory, payroll, expansion or any other operating expense.
The flexibility makes it attractive for entrepreneurs who want to act quickly on opportunities or invest in short-term growth strategies without strict lender oversight.
Impact on Ownership and Equity
One key consideration when raising capital is whether the funding involves giving up equity in the business.
Traditional Loans
Traditional loans do not require giving up ownership. Borrowers retain full control of their business, and the lender’s involvement ends once the loan is repaid. This allows founders to grow their business without diluting shares or bringing in new decision-makers.
The trade-off is that the business must repay the debt regardless of performance. Defaulting can lead to asset seizure or legal action if the loan is secured.
Revenue-Based Financing
Revenue-based financing also allows businesses to maintain full ownership. It is not equity financing, and the funder does not take shares or voting rights in the company.
This is a significant advantage for entrepreneurs who want to avoid investor involvement or preserve their ownership stake. Like a loan, the funder exits once the repayment obligation is fulfilled.
When to Choose a Traditional Loan
A traditional loan may be the right choice if your business:
Has strong credit and financial history
Can provide collateral or personal guarantees
Is seeking long-term financing with low interest
Has steady and predictable revenue
Is comfortable with fixed monthly payments
Traditional loans work well for buying assets, real estate or long-term investments where the cost of capital must remain low. They are also suitable for businesses that need larger funding amounts and have the financial stability to manage structured repayments.
When to Choose Revenue-Based Financing
Revenue-based financing may be the better option if your business:
Has consistent monthly sales but a limited credit history
Operates in a seasonal or variable revenue environment
Needs funding quickly without extensive paperwork
Is looking to preserve equity and ownership
Wants flexible repayments based on performance
RBF is ideal for consumer-facing businesses like retailers, restaurants, gyms or e-commerce brands. It works particularly well for short-term capital needs, such as launching a campaign, buying inventory or covering a temporary cash flow gap.
Risks and Considerations
Traditional Loans
While they often offer lower costs, traditional loans come with more rigid terms and consequences. If the business experiences a downturn, fixed repayments may strain cash flow. Secured loans put business assets at risk in case of default.
The lengthy application process and high rejection rates can also delay important investments, making this path less feasible for newer or cash-strapped businesses.
Revenue-Based Financing
The primary risk with RBF is cost. Even though repayments are tied to sales, the overall repayment amount may be significantly higher than a loan. Businesses that repay quickly may face a higher effective cost compared to borrowing from a bank.
It is also important to avoid over-reliance on this model. Taking multiple advances or not properly managing cash flow during repayments can lead to financial strain.
Conclusion: Making the Right Choice for Your Business
Choosing between traditional loans and revenue-based financing is not about which is universally better. It is about which option aligns with your business’s current needs, goals and financial position. Traditional loans offer lower costs and structured repayments but require a strong credit profile and may take longer to access. They are ideal for long-term investments and stable revenue models.
Revenue-based financing offers speed, flexibility and access for businesses that may not qualify for traditional credit. It is best for short-term needs and businesses with consistent card sales that can accommodate variable repayments. By understanding the mechanics, costs and implications of each model, business owners can make informed decisions that support both growth and sustainability. Whether you choose traditional financing or a modern, performance-based approach, the key is to use capital as a tool for progress, not just survival.