Revenue Based Financing

Description

Alex Moore:

"A Seattle group, Revenue Loan, highlights an innovative method for financing where the return occurs from the revenue gains. While their focus is on tech development, the financial model can be used with food enterprise development.

What is Revenue Based Financing?

Revenue Based Financing (Revenue Based Finance) is a new way for promising early-stage companies to finance the growth of their business. In a nutshell, Revenue Based Financing is a special kind of loan. Instead of requiring a business to pay a fixed amount and over a fixed amount of time (i.e. think of your typical bank loan), a RBF loan entitles the lender to a fixed percentage of gross revenues, “capped” at a multiple of invested capital (typically 3 – 5x). Revenue Based Finance lenders trade steeper default, timing and rate of return risk for richer potential returns than those offered by traditional business lending (i.e. banks).

How does Revenue Based Financing work?

Here’s a hypothetical example:

Tom is the CEO of a promising Software as a Service (SaaS) business. He’s built the business with no outside capital and is operating close to breakeven. He sees an opportunity to ramp up sales by investing in business development. He doesn’t have enough cash in the bank to make this happen.

Most banks won’t lend to a company like Tom’s because his isn’t an asset-intensive business. Tom doesn’t want to raise venture capital because he doesn’t want the dilution and he isn’t sure his business has the potential to scale as quickly or or as big as most VCs would expect.

Tom learns about Revenue Based Financing. He lines up a group of angel investors willing to invest $500,000 for a royalty rate of 10% of gross revenues. The royalty payments don’t begin for a year – giving him time to invest and build the business – and have a 3x cap (limiting Tom’s total royalty payout to a maximum of $1.5 million).

With the help of this additional capital, Tom builds a profitable small business with revenues of $3 million a year — and still owns 100% of the equity. The investors get their 3x return paid back over 5 years — without having to force Tom to sell his company or buy their shares. In this scenario, everyone wins.

The innovation here lies in bringing the Revenue Based Finance approach to riskier, earlier-stage investing, while receiving the expected return in the form of cash flows. The fact is, most well-run businesses look more like the firm in this example – growing, profitable, but not a shoot-the-moon success – than like the Google and Amazon.com rocket rides that the traditional venture industry is geared around.

This seems a great tool to use when dealing with growth stage food enterprises, those with an established track record that are looking for expansion capital." (http://www.slowmoneynw.org/2010/07/revenue-based-financing.html)