In the world of capital finance, legal advisors are confronted with legal issues that require structured solutions. With the increasing availability of structured investment vehicles and the liquidity shortage across all major economies, revenue-based financing has grown in popularity.
The purpose of this article is to introduce RBS to the reader and explain its use in venture capital (‘seed’ or start-up financing), expansion, and early growth financing.
In one sense, this is like a debt instrument, since the investors are repaid from the revenues you earn, not the profits you make – however, it is a non-recourse debt since its liability is linked to sufficient revenues. An investor makes more money than a debtor or even equity owner would for many years, but his right to be paid back depends on the company’s revenue.
The repayment terms and liability for repayment are linked to the company’s revenue. Such payments continue until the investor reaches a predetermined amount. Here’s an example of how basic RBF terms work:
If your revenue increases, the investor would be paid off sooner. If it decreases, it will take longer.
Often, businesses are not started with the intent of being sold, merged, or taken public. The venture capital financing model assumes that you plan to sell your company within a certain period of time.
For some entrepreneurs, their business is much more about their inventions, skills, and professional experience than about money. Their business may be the culmination of their passion, way of life, or purpose.
Investors will want to see that your business generates revenue, preferably one with strong gross margins, since this model relies on you generating it. The revenue-driven financing is generally not a viable fit for companies that are unlikely to be revenue-positive for an extended period.
Professional consultants, artists, lawyers and doctors – those who do not require large funds for research and development and do not need capital to contribute to the company – will benefit from this type of financing.
An investor receives a percentage of the ongoing monthly gross revenue of the business they invest in. This form of financing prevents equity dilution for founders and provides investors with regular returns from fast-growing startups, unlike traditional angel and VC capital. Investors continue to receive such pay-outs until they obtain a predetermined amount. “new-age entrepreneurs and asset-light businesses access to debt capital with flexibility.”