Latest / Franchise Conversations with Fexingo: Buying, Running, and Scaling Franchise Businesses / How Franchisees Are Using Revenue-Based Financing for Growth
Transcript
- Lucas: Luna, I want to talk about a funding structure that's quietly becoming a go-to for franchisees who want to grow without giving up equity or getting crushed by fixed loan payments: revenue-based financing. Luna: You mean where an investor gives you a lump sum, and you pay them back as a percentage of your top-line revenue each month until you hit a cap? Lucas: Exactly. It's also called royalty-based financing, and it's been around in tech for a while — companies like Clearbanc, now Pipe, popularized it for SaaS businesses. But in the last two years, it's really taken off in franchising. Luna: What's driving that shift? I thought most franchisees still default to SBA loans or bank debt. Lucas: They do, but here's the thing: traditional debt comes with fixed monthly payments. If you hit a slow month — maybe a construction project blocks your store for a week — you still owe the same amount. Revenue-based financing floats with your sales. Good month? You pay more. Bad month? You pay less. Luna: So it's less stressful on cash flow. But I imagine the total cost is higher if you have a great run. Lucas: Right, and that's the trade-off. Let me give you a concrete example. I spoke with a multi-unit Subway operator in Texas — he wanted to open three new units in 2025. He had decent credit, but his existing debt service ratio was already tight. A traditional bank would have required more collateral or a higher down payment. Luna: What did he do instead? Lucas: He found a revenue-based financing firm — there are a handful now focused specifically on franchises, like Kapitus and Lendio's franchise division. They offered him $450,000 in exchange for 8% of his monthly gross revenue from those three new stores until he repaid a total of $585,000. That's a 1.3x cap. Luna: So the effective interest rate depends entirely on how fast his revenue grows. If the stores do well, he might hit the cap in 18 months, and the annualized cost is maybe 15 to 20 percent. If they struggle, it could stretch to 36 months, and the cost is lower but he's paying for longer. Lucas: Exactly. And that flexibility is the whole pitch. But there's a tension here that a lot of franchisees don't see coming. Luna: The franchisor. Lucas: Bingo. Most franchise agreements give the franchisor a first-priority claim on revenue — their royalty comes off the top. If you then pledge a percentage of revenue to a third-party financier, you're effectively creating a second lien on your top line. Some franchisors explicitly prohibit this in their operating manual. Luna: I've heard of franchisees getting into trouble because the financing agreement triggered a default clause. The franchisor said they couldn't assign revenue streams without approval. Lucas: Right, and that's why the smart operators — like the Subway franchisee I mentioned — get a side letter from the franchisor acknowledging the arrangement. Subway was okay with it because the financing was for new units, not existing ones. But some franchisors, especially in the fast-casual space, are more restrictive. Luna: Is there a particular type of franchise where this works best? Lucas: Yes, two characteristics. First, high gross margins — think 60% or better. Because the payment comes off the top, you need enough margin to cover both the royalty and the financing payment. Second, predictable revenue. Seasonal businesses like lawn care or holiday-themed concepts are riskier because the payment percentage stays fixed even when revenue drops. Luna: So quick-service restaurants, auto repair shops, maybe certain service-based franchises like MaidPro or Mosquito Joe? Lucas: Exactly. Those have consistent demand and decent margins. I've also seen it used in fitness franchises — Anytime Fitness, for example — where membership revenue is highly predictable. But the key is unit-level economics. You need to model out the worst-case scenario: what happens if revenue drops 20%? Can you still cover the financing payment plus your royalty plus operating costs? Luna: And that's where some franchisees get burned. They assume revenue will grow, and they don't stress-test the downside. Lucas: Right. I saw a case in 2024 where a franchisee of a frozen yogurt brand took a revenue-based loan on a single unit that was already underperforming. The financing payment ate into cash flow so badly that they couldn't restock inventory. It was a death spiral. Luna: That's a cautionary tale. But for the right operator, in the right brand, with the right unit economics — it's a powerful tool. Lucas: It really is. And honestly, Luna, conversations like this — getting into the real mechanics of how franchisees fund growth — are exactly why we do this show. If you find value in digging into these details, you can support the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. It helps keep the podcast ad-free and independent. Luna: Yeah, and we really appreciate it. Every little bit goes toward research and making sure we bring you specific, actionable examples. Lucas: So back to the mechanics. One thing I want to highlight is the cap structure. The 1.3x cap I mentioned — that's actually lower than what many revenue-based lenders charge. I've seen caps as high as 2.0x, which effectively means the franchisee pays back double the advance. Luna: That's expensive. But if the alternative is not opening the unit at all, maybe it's worth it. Lucas: Right, and that's the calculus. But I think franchisees should also compare revenue-based financing to other non-dilutive options like equipment leasing or SBA 7 loans. The SBA loan might have a lower effective cost, but it takes longer to close and requires a personal guarantee. Luna: Revenue-based financing can close in two to three weeks, right? Lucas: Yeah, some providers claim as fast as 10 days. Speed is a huge advantage, especially when you're competing for a prime site. But you pay for that speed in cost. Luna: So what's the one piece of advice you'd give a franchisee considering this? Lucas: Model three scenarios: base case, best case, and worst case. And make sure the worst case still leaves you with a positive cash flow after the financing payment and the royalty. If it doesn't, you're better off waiting until you can qualify for cheaper capital. Luna: Good rule of thumb. And check your franchise agreement before you approach any lender. Lucas: Absolutely. Get that side letter. One other thing: some franchisees use revenue-based financing not just for new units, but for equipment upgrades or leasehold improvements. The same principles apply. Luna: Have you seen any data on how many franchisees are using this now versus, say, three years ago? Lucas: I pulled some numbers from a 2025 franchise funding survey. About 12% of franchisees who opened a new unit in 2025 used some form of revenue-based financing. That's up from roughly 4% in 2022. So it's still a minority, but it's growing fast. Luna: That makes sense. As awareness spreads and more lenders enter the space, it'll probably become a standard option. Lucas: I think so, especially for smaller franchisees who can't access institutional capital. The key is to use it as a growth tool, not a lifeline. Luna: Well said. Next episode, I want to talk about something I've seen pop up: franchisees using revenue-based financing to buy out underperforming partners. Lucas: That's a great angle. Let's dive into that next time.