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Back when we were doing our MBA Monday series on Financing Options For Startups<\/a>, I got an email from my friend Andy Sack<\/a>. Andy was one of the first entrepreneurs we funded by in the mid 90s with our Flatiron Fund. He’s done something like a half dozen startups since then and he’s a veteran in the very best sense of the word.<\/p>\n Andy said “You missed an important option Fred \u2013 revenue based financing. I’ve got a new firm called Lighter Capital that does just that”. I said, “Can you write a blog post for MBA Mondays explaining how it works?” So today, we have a guest post\/advertorial on Revenue Based Financing from Andy\/Lighter Capital<\/a>. I hope you like it.<\/p>\n \u2014\u2014\u2014<\/p>\n Fred\u2019s series on alternative financing options has been awesome to follow, especially because it broadens the discussion of how companies can fund business growth when they can\u2019t (or don\u2019t want to) raise venture capital or bank debt. Fred\u2019s original list\u00a0missed one option \u2013 revenue-based finance \u2013 that’s near to my heart and I\u2019ve been encouraging entrepreneurs and angels to consider, and Fred graciously let me offer my insights here.<\/p>\n Disclaimer: I am founder of Lighter Capital and have a self interest in educating and promoting the use of this new type of financing called revenue-based finance.\u00a0 I\u2019m also a serial technology entrepreneur and believe this type of financing has real advantages to traditional debt and traditional real advantages over equity for the entrepreneur.<\/p>\n A revenue-based finance (RBF) investment provides capital to a business by \u201cselling\u201d an ongoing percentage of a company\u2019s future revenues to the investor.\u00a0 For simplicity, you can think of it as a revenue share type of arrangement. Investor gives capital to company in exchange for a small percentage of gross revenues. RBF lives as a hybrid of bank debt and venture capital. This kind of financing has been around for a while in\u00a0non-tech industries such as mining, film production and drug development,\u00a0but it\u2019s recently been gaining traction in the world of growth finance and early-stage technology funding.<\/p>\n I want to explain how an RBF structure is different than traditional funding sources, detail what situations could be better suited for an RBF structure (for entrepreneur and investors alike), and offer a\u00a0word of warning about the businesses that aren\u2019t a good fit for the structure.<\/p>\n First, let me explain how a revenue-based loan works:<\/p>\n Instead of a typical bank loan which requires a business to pay a fixed interest payment, a revenue-based loan receives a percentage of revenues over a specified amount of time, allowing “interest” payments to fluctuate when a growing company has inconsistent cash-flows or lumpy or seasonal revenues. In a world where business costs such as software and infrastructure are increasingly becoming \u201cas-a-service\u201d and adjust with the ebbs and flows of a business needs, RBF payments automatically ramp up and down along with a business. It\u2019s the inherent variability of RBF that makes the structure so appealing so appealing.\u00a0 Imagine if your business loan payment reduced to zero if your business revenue dropped to zero for an unanticipated quarter, and then automatically kicked backed on when your revenue returned. Another way of saying this is RBF turns loan repayment from a fixed expense to a variable expense.<\/p>\n So, when does it make sense to raise revenue-based funding?\u2028Revenue-based loans are, by nature, most appropriate for companies already generating revenues but without hard assets typically required to get bank loans. It\u2019s especially applicable for companies that have lumpy, seasonal, or hard to predict revenues.<\/p>\n For entrepreneurs,\u00a0revenue-based loans are attractive to founders who are allergic to dilution and loss of control.\u00a0 The structure of RBF is often non-dilutive to founders and does not require a board seat. The financing is obtained without having to agree to a valuation, which leaves management in control of the company and typically requires no personal guarantees from management.\u2028\u2028RBF means you can grow without swinging for the fences<\/p>\n For investors, funding using an RBF structure provides an opportunity to get a return on their investment without needing an exit. While this is clearly an advantage for investors, it also means company founders shouldn\u2019t get as much pressure from investors to \u201cswing for the fences\u201d and the projected return due to the investor can be lower as the entrepreneur repays the investor more quickly.<\/p>\n As\u00a0Fred has mentioned before, big exits are rare for startups. Some ideas have the potential to be home runs, but others are better suited to operate as smaller, standalone businesses. For the companies in the latter category, raising money from VCs who expect the big exits can misalign goals. A revenue-based loan has the potential to better align incentives for investors\u00a0and\u00a0founders in these cases. With that said, if you\u2019re a pre-revenue, startup still figuring out your business model or considering some kind of \u201cgo big or go home\u201d strategy, there can be realadvantages to working with the equity-based venture capital or angel investors. Similarly, certain businesses, especially brick-and-mortar and manufacturing-focused businesses may not have the margin profiles to pay monthly payments of 2-5% of revenues.<\/p>\n An RBF structure isn\u2019t limited to specific funds \u2013 angels, VCs or banks could theoretically provide capital in this manner, but the risk\/return profile of RBF doesn\u2019t always fit the investor\u2019s needs. Similarly, RBF may not be the best funding option for all businesses. In the right circumstances, the hybrid approach of revenue-based finance for startup funding can have advantages over traditional debt or equity, but there are admittedly situations where the more traditional options still make sense \u2013 such as restaurants or infrastructure-heavy startups.<\/p>\n If you\u2019re considering raising money from angel investors, I\u2019d suggest discussing this in the event that it may align your incentives better or at least help avoid some of the painful valuation negotiations. There are a few funds \u2013Lighter Capital and Next Step in Texas, among others focused on this type of structure\u00a0and I\u2019d suggest taking a look at those options as well. There are clearly different scenarios where any number of Fred\u2019s financing alternatives could prove more appropriate for your business, but\u00a0the revenue-based loan structure can be a great option for profitable companies looking for a straightforward way to raise funding without dilution, change of control, or a personal guarantee.<\/p>\n <\/p>\n William Mougayar<\/a> asked:<\/p>\n That’s creative. Can you summarize the conditions you like to see, ie pre-revenue, revenue, or profitable? And is there a dollar range you look for? I think a hypothetical example with real numbers would help. Thanks<\/p><\/blockquote>\n To which Andy Sack replied:<\/p>\n Hi William – Sure: As an example: we’ve loaned out $200k to a company doing $1m in annual revenues and then the company pays us 3% of revenues over 10 years, or in certain instances, we introduce a “return cap” where if the company repays us an agreed upon amount within a shorter period of time, the loan terminates early.<\/p><\/blockquote>\n <\/p>\n This article was originally written by Fred Wilson and Andy Sack on October 17, 2011 here<\/a>.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" Back when we were doing our MBA Monday series on Financing Options For Startups<\/a>, I got an email from my friend Andy Sack<\/a>. Andy was one of the first entrepreneurs we funded by in the mid 90s with our Flatiron Fund. He’s done something like a half dozen startups since then and he’s a veteran in…<\/p>\nFrom the comments<\/h3>\n
\n– We look for companies with trailing twelve month revenues between $500k-$5m and growing, with 50% gross margins.
\n– We generally lend out $100-500k<\/p>\n<\/p>\n