Two forms of non-dilutive capital, often confused

Founders looking to fund growth without selling equity usually arrive at two instruments: venture debt and revenue-based financing. They get grouped together because both avoid dilution, and the grouping causes real confusion. They are not variations of the same product. They are built on different assumptions about a company, and they behave very differently when conditions change.

We have written elsewhere about how revenue-based financing compares to venture capital and to traditional bank debt. This piece fills the gap between them. If you have recurring revenue and you are weighing your non-dilutive options, this is the comparison that matters most.

What venture debt actually is

Venture debt is a loan provided to a company that has recently raised, or is expected to raise, venture equity. The lender is not underwriting the business on its cash flows. It is underwriting the strength of the equity investors behind it and the runway that equity provides. The loan is usually sized as a share of the last equity round, typically between a quarter and a third of it.

The economics reflect that logic. Interest rates in the current environment tend to land somewhere around 10 to 13 percent all-in for growth-stage borrowers, structured as a floating base rate plus a spread. Terms usually run two to four years, often with an interest-only period at the start followed by amortisation. The lender also typically takes warrants, commonly equivalent to one or two percent of the loan amount, which give it the right to buy a small slice of equity later. There are usually upfront fees and a further fee at maturity. And there are covenants: minimum cash balances, runway requirements, sometimes revenue targets, whose breach can accelerate repayment.

Venture debt is genuinely useful in the right hands. It extends runway between equity rounds, and it can reduce the dilution of the next round by getting a company to a higher valuation before it raises again. But it carries a dependency that is easy to overlook. Because the loan is underwritten against future equity, it works best for companies that intend to keep raising equity. If the next round slips or shrinks, the covenant structure can turn a growth tool into a liability at the worst possible moment.

A common sizing confusion

It is easy to conflate three different numbers when estimating how much venture debt a company could raise: the company’s valuation, the size of its last equity round, and its revenue. They are not interchangeable, and mixing them up produces a distorted picture.

Take a company with 5 million euros in ARR, valued at 25 million euros on a 5x revenue multiple. It would be a mistake to assume venture debt is sized as a quarter to a third of that 25-million-euro valuation. Venture debt is sized against the equity round itself, which is typically much smaller than the valuation. If the company raised, say, 5 million euros in its last round, venture debt in the region of a quarter to a third of that round would be roughly 1.25 to 1.7 million euros, not 6 to 8 million.

This is worth being precise about, because it changes how the two instruments actually compare for a given company. Revenue-based financing is sized against ARR directly, so a company with 5 million euros in ARR and no unusual constraints could access a broadly similar amount without needing to have raised a large equity round in the first place. For capital-efficient companies that raise smaller, less frequent rounds, this is often where venture debt capacity turns out to be smaller than founders expect, and where revenue-based financing can fill the gap without depending on the size or timing of the next raise.

What revenue-based financing does differently

Revenue-based financing starts from a different question. Rather than asking who backs this company, it asks whether the company’s own revenue is predictable enough to lend against. For a software business with genuine recurring revenue, the answer is often yes.

The capital is provided against that recurring revenue. Repayments are made as a fixed percentage of monthly revenue, so they scale with the business. In a strong month the company repays a little more, and in a soft month it repays a little less. There is no fixed interest rate compounding against a schedule. Covenants and warrants are used selectively, shaped by the situation the company is in, rather than applied as standard terms. The total repayment is capped at an agreed multiple of the original amount, typically between 1.4 and 2 times, and once that cap is reached the arrangement ends.

The size of the facility itself is a function of more than ARR alone. As a rule of thumb, the loan can reach up to around 30 percent of ARR, but where a company sits in that range depends on whether other debt is already in place, how that debt is secured, and whether it ranks ahead of or behind this facility. A company with no existing debt, or with debt that sits behind ours, can typically support a larger facility than one where senior, secured debt already has a first claim on the same revenue.

The two consequences that matter most to a founder are these. First, the repayment structure absorbs volatility rather than fighting it, because it is tied to performance instead of the calendar. Second, and more fundamentally, revenue-based financing does not assume a company is on the venture treadmill. It does not need the next equity round to exist. That makes it a fit for the efficient, growth-stage software businesses that could keep raising equity but would rather not.

Growing with the business: follow-on capital

The comparison so far has treated the facility size as fixed at the outset, but in practice it rarely stays static for companies that keep performing. Because revenue-based financing is sized against recurring revenue, additional capital tends to become available as that revenue grows, provided the company has met its commitments to that point. This is not automatic, and each top-up is assessed on its own merits, but for a business that continues to perform, it is often the expected next step rather than a fresh negotiation.

In practice, this can look like modest, frequent increases tied to revenue growth, or a larger top-up following a strong quarter. A company that grows ARR by a million euros might see a further tranche in the region of 300,000 euros become available. A company that adds three million euros in ARR growth, often measured over the most recent quarter, might see its facility increase by around a million euros. Over time, this gives a track record of good performance real financial weight: the better a company delivers, the more capital it can typically draw on, without repeating the process of raising a new round.

This is where the comparison with venture debt gets more interesting than it first appears. Venture debt can be the cheaper instrument per euro, priced closer to a conventional interest rate. But venture debt is sized against the last equity round, so its capacity is capped until the company raises again, at whatever valuation the market gives it at that moment. Revenue-based financing capacity, by contrast, keeps growing alongside revenue on its own terms. A company that funds its growth with equity at a valuation of, for example, five times revenue is paying for every euro of additional ARR at five times its size, priced into the ownership it gives up. A company drawing further revenue-based tranches instead is paying its agreed multiple on the capital itself, not on a valuation built on top of it. The per-euro cost of revenue-based financing may sit above venture debt, but the ability to keep drawing more of it, without waiting for or depending on the next funding round, is often what makes it the cheaper path overall, because it is what lets a company avoid or delay the equity round that would otherwise price that growth at a multiple.

The comparison, side by side

On dilution, the two are closer than the rest of the picture suggests. Revenue-based financing takes no equity, and most of the time issues no warrants either, so ownership is largely untouched. Venture debt is described as non-dilutive, and it is far less dilutive than an equity round, but the warrants do transfer a small amount of ownership over time.

On repayment risk, they diverge sharply. Venture debt repays on a fixed schedule regardless of how the business performs that month, which is manageable while things go well and punishing when they do not. Revenue-based financing repayment moves with revenue, so the burden is heaviest when the company can most afford it and lightest when it cannot.

On dependency, venture debt leans on the equity ecosystem around the company, while revenue-based financing leans on the company’s own revenue. That single difference determines which instrument stays reliable when equity markets tighten.

On term length, the two also diverge. Venture debt is typically structured over two to four years, in step with the rhythm of equity rounds it depends on. Revenue-based financing typically runs longer, commonly four to six years, because it is not tied to a funding cycle and instead runs for as long as it takes the agreed multiple to be repaid out of revenue. A longer term is not automatically better or worse, but it does mean a founder is not forced back to the table on the same fixed rhythm that venture debt imposes, and it gives the follow-on capacity described earlier more time to compound alongside the business.

A worked example

Consider a software company that wants three million euros to fund growth. Under a venture debt facility priced at, for instance, twelve percent, with a fee at the front and another at maturity, plus warrants equal to a couple of percent of the loan, the company repays on a fixed schedule regardless of how any given month goes. If the business performs well and raises again on schedule, the all-in cost is modest, and the warrants dilute only slightly. If the next equity round slips, the fixed repayments continue anyway, and a covenant on minimum cash can force the issue exactly when the company is least able to absorb it.

Under revenue-based financing for the same three million, the company repays a fixed share of monthly revenue until it has returned the agreed multiple, commonly somewhere between 1.4 and 2 times. The cost is visible and bounded from the start. In a soft month the repayment shrinks with the revenue, so the financing flexes with the business rather than against it. Covenants and warrants are shaped to the situation, so in most cases nothing accelerates in a downturn and ownership stays largely untouched.

The two are not simply cheap versus expensive. Venture debt can be cheaper in a smooth scenario where equity keeps flowing. Revenue-based financing is more resilient in the scenarios where things do not go to plan, because its cost is capped and its repayments move with performance. Which trade-off is right depends on how confident a founder is in the next equity round and how much they value protection against the months that do not cooperate.

Which one fits your company

Venture debt tends to suit companies that are committed to the venture path, have strong equity investors, expect to raise again, and want to extend runway or reduce dilution between rounds. If that describes you, it can be a sensible and inexpensive tool.

Revenue-based financing tends to suit companies with real recurring revenue, healthy unit economics, and a path to funding themselves, that want growth capital without either the ownership cost of equity or the fragility of a fixed schedule and covenants. These are often companies that could raise equity easily and have simply decided that ownership is worth keeping.

At Round2 Capital, this is the profile we are built for. We provide growth capital to recurring-revenue software businesses in Europe, repaid as a share of revenue, with no equity, and with covenants and warrants used only selectively, shaped to the situation. The right instrument is the one that matches how your business actually earns and how you want to own it. If you are weighing the two, we are happy to talk it through, even where the honest answer is that another route fits you better.