Revenue Based Financing

More numerous alternatives for financing a company exist than ever before. The cost of money varies considerably, and therefore, when considering which financial options are available to a company, it is important to compare Venture Capital to more flexible approaches better aligned to cash flow and growth dynamics.

The function of equity financing is to fill the non-bankable gaps and to lower the risk of loan defaults. A balance between Equity and Debt is a long standing measure for management, and the entrepreneur faces tough decisions on how much equity ( and control) to give away in order to access funds to create significant value.

By the time a company goes public, the founder may have given away as much as 80% of their equity, and for companies that do not achieve the magic “10x” valuation Venture Capitalists seek, this spells trouble for the founder.

A Revenue Based Finance approach potentially bypasses some of these issues, and it is an innovation that not only provides a company with cash, but in effect buys time for it to grow in sales prior to any valuation or change of ownership event.

In 1946, Ralph E. Flanders founded the American Research and Development Corporation, the first Venture Capital (VC) firm. The VC industry peaked in 2000 and began its demise in 2001, subjected to several “bubbles” which worked on the premise of 10x valuation models, and a myriad of ratchet and claw-back clauses designed to punish the founders for lower than expected performance by issuing greater ownership to the VC ( this in turn is catastrophic to the VC, after all, what is the point of owning 95% of a business, when the entrepreneurial team is chastised, and the VC does not know how to run the business!).

The VC process remains the to this day the same game of founders giving away a large chunk of equity in exchange for cash to grow their business, and there is the real need for innovation in the sector for a more sustainable and workable solution.

The Revenue Based Finance Model is the key, and whilst it has applications in start-ups as suggested above, the model works well with other stages of growth and sizes of companies. In fact, even ring-fenced project finance situations could employ the approach to replace Debt or to spread the risk even further.

Revenue Based Financing is an exciting alternative to traditional equity venture capital investing. It provides superior risk-adjusted returns, has tremendous repayment flexibility and features a built-in exit strategy.

Revenue Based Financing can serve a wide range of businesses previously ignored by more traditional funding sources. The typical Revenue Based Financing investor is looking for industry-leading businesses with an existing annual revenue stream, or a revenue stream that will be activated with a new capital infusion. These companies should have substantial gross profit margins, sufficient to pay royalties. Qualified companies will also demonstrate the potential for rapid profitable growth through the addition of new capital and ongoing management assistance.

Some of the ways in which these companies will use Revenue Based Financing include:

  • Expansion from regional to national/international marketing/sales strategy or new product roll out
  • Acquisition finance for a roll-up strategy in a fragmented market
  • Equity substitute for a management led leveraged buyout
  • Equity substitute for intra-family generation ownership transfer
  • Buyouts of stranded venture capital equity investments with conversion to Revenue Based Financing investment mode.

Variations to Revenue Based Finance may also include in-kind investment, such as coders and programmers working in a start-up project, or in a more traditional Project Finance setting.

Cooperatives also benefit from this approach to financing, but that can be discussed another time.

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