It's interesting how some things become popular, then fade away for a period of time before becoming en vogue again. Just look at drive-in movie theatres, skinny jeans, Betty White, and revenue-based financing. Yes, revenue-based financing. Never heard of it? Well, if you own a growing business, it's a re-emerging trend you should know more about.
It might not have been as mainstream as other trends, but revenue-based financing was a very popular business practice in the early-to-mid 1900s -- especially in the mining, oil and natural gas industries where it was common to provide large sums of cash up-front in exchange for a percentage of the royalties generated. And even years later, revenue-based finance became commonplace in the music, publishing and entertainment industries.
But as time passed, the practice eventually faded as more and more entrepreneurs financed their busThat'siness growth by selling equity to venture capitalists -- replicating the path to success that companies like Apple Inc. and Genentech took in the 1980s.
Fast-forward to today. With banks small-business lending banks at its lowest point in more than a decade (down 54 percent since 2008 alone) and venture capitalists only willing to offer term sheets for billion-dollar market opportunities, we're seeing revenue-based finance (RBF) make a strong comeback.
In fact, a wide range of early-stage companies, such as Jive Communications, Vibrant Chocolates, HiveMine, Valant Medical Solutions and BouncyHouse.com have all recently embraced the RBF model because it provides a unique set of benefits to both the small business and the investor.
A revenue-based finance investment provides working capital to a business by "selling" an ongoing percentage of a company's future revenues to the investor. Or to put it another way, you can think of it as a revenue share arrangement where the investor gives capital to a company in exchange for a small percentage of gross revenues.
For small businesses, revenue-based funding is uniquely valuable because payments adjust as revenues go up and down. In other words, if a business beats their financial projections and grows faster, their "rate" goes up -- but if they miss their projections, their "rate" goes down. And from the entrepreneur's seat, there's also no personal guarantee (as there is with bank financing) or loss of company control (as there is with venture capital). It's a very "light-weight" funding option that can help small businesses get to revenue quicker.
Meanwhile, investors benefit by receiving increasing payments as revenues increase. However, terms of the RBF model are typically negotiated to allow some time for revenue to accrue before payouts need to be made, and typically there is a time period limitation and a payout limitation that is included in the negotiated terms.
The RBF model is now even being used by many investment companies, as well as local and state government agencies. However, not all small businesses or investors will benefit by using this model. Investors who agree to RBF terms need to accept the "capped" earning potential of the investment. And some businesses with low profit margins and limited flexibility on pricing may not be appropriate for an RBF loan.
However, for revenue-generating businesses looking to obtain capital to fuel their growth -- without taking out a second mortgage on the house, or selling an ownership stake in the business -- revenue-based financing is a terrific solution. Again, there's no dilution, no loss of control, and no fixed repayment schedule.
So while you may not have heard about the original RBF model, you probably will because like those old, tight jeans, it's coming back into style.
Andy Sack is Co-Founder of Seattle-based Lighter Capital, a revenue-based financing source for early-stage companies. He has more than 15 years of experience running and investing in high-tech businesses, and is also the Managing Director of TechStars Seattle and a Managing Partner of Founder's Co-op.
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