Today we are seeing interesting shifts in the funding world. One of the shifts is venture capital becoming the less common funding source for entrepreneurs. Since 2001, the number of VC firms has decreased by about 50%, while it is still setting records for the capital deployed. In the past a $100M fund was considered huge, and now there are plenty of billion dollar funds. This means that funds are growing bigger, but the spread of funding is tighter: firms are focusing more on the later stage rounds and angel groups are coming into play. At the same time, funding stages are evolving too: in the past, Series A was when first institutional money comes in. Today, the seed is becoming the new Series A. This means that business ownership gets diluted faster – but the good news is that today there are more options for entrepreneurs to grow and capitalize their businesses. Alternative forms of financing – from micro-VC to super angels, to peer-to-peer lending, and crowdfunding – are democratizing access to capital.
Capital is a necessity for small business owners trying to grow their venture – companies need to be constantly investing in their inventory, storefront, staff, and marketing campaign. Unfortunately, a lot of entrepreneurs face a problem of raising capital: getting a bank loan requires profitability, most of merchant loans are too expensive and venture capital is not always an option. And even if you qualify for the traditional loan, it is usually a smaller line of credit that is not really designed for growth capital. Revenue-based financing might be the answer for entrepreneurs in need of capital to grow.
- It’s a loan, but different from the one you would get at a bank
Revenue sharing is a structure that sits nicely with banks, VCs, and angels. Essentially, it’s a loan that is paid back based on a percentage of the future revenues. So if the business grows fast, the loan will be paid back quicker, and if the business grows slower, the loan is paid back slower. It all depends on the growth and flow of the revenue. Unlike VC capital, this funding is not dilutive (no equity involved). Even though technically it is a loan, there are no fixed payments, no set time period for repayment and no collateral to secure. Instead lenders assess the business finances and projected business growth to determine the eligibility and loan amount.
- Revenue-sharing process
Revenue sharing works by having business owners pay a fixed percentage of their revenue (usually per specific time frame: e.g. monthly, quarterly, annually) – so payouts are directly related to how much revenue the company makes. The loan is fully repaid when payments reach the “repayment cap” — a number that is set when the loan is funded. The repayment cap is the principal amount multiplied on the return multiple (which could be 1.3x or 1.5x or 2x, etc.). And since there is no due-date, the growth and performance of the company is what determines how long it takes to reach the cap.
- One fits all?
While revenue based funding provides a viable alternative to traditional lending, it is not the best funding path for every business. According to Bloomberg, for businesses with low profit margins, revenue based financing is not ideal because fixed monthly/quarterly revenue percentage will further impede on the business’s finances.
4. It aligns entrepreneur’s and investor’s interests
While revenue-based financing investors don’t own shares or sit on the board of the company they fund, this approach is similar to equity in that it’s in the investor’s best interest for the business to grow quickly and successfully. If the company grows more quickly than expected, the investor receives the repayment cap more quickly what greatly increases the investor’s return on investment (ROI). As the result, these investors have every incentive to help the company grow, either through bringing sales opportunities, word-of-mouth marketing or additional financing.
StartWise is a crowdfunding platform enables individuals to invest in companies they care about in return for a fixed percent of company’s quarterly revenue. The company pays its investors until they have received a multiple return on their investment.