Revenue Royalty Certificate Financing
A fairly old, tried and true financing method for both startups and small businesses needing growth capital is generically referred to as revenue-based financing. It’s also sometimes referred to as revenue participation or revenue sharing funding. The actual document used is typically called a Revenue Royalty Certificate (RRC) or Revenue Participation Agreement or some combination of the two.
I first learned about revenue based financing from one of the greats among angel investors, Arthur Lipper, who had a particular fondness for the instrument. This was back in 1985. Since then I have used it myself and seen others use it as well to both launch startups and provide growth capital to existing small businesses.
One thing to keep in mind, is that revenue-based financing is not considered acceptable for those rare startups that have the potential to go through an IPO. In cases where financiers see such potential they will want to participate as equity investors so that they can get their 50X or 100x return on investment.
In contrast, people who fund a company via revenue participation are accepting a more conservative payback of two to five hundred percent. In other words, if they lend you $100K they expect the revenue royalties to pay them back $200K to $500K over the term of the agreement which can be anything from two to ten years. The cash flow projections will determine the term of the instrument.
In a nutshell, revenue financing is a loan to a company which is paid back as an agreed upon royalty on the revenues. Typically this royalty is in the 2 to 5% range. A company with fat margins maybe able to afford a higher royalty. The key is to find a rate that’s neither too low nor too high. You want to pay off the loan as quickly as possible without jeopardizing the company.
Stay tuned for more articles on how you can use revenue-based financing instruments like an RRC to close a foot-dragging angel investor.
4 Responses to Revenue-based Financing for Startups and Small Business
Leave a Reply to Peter Cancel reply
We average 55% margins. Have you heard of an RRC that has a payback of 9.5% of topline revs (less some G&A) that is paid back upon 4.5 times the original loan amount with an equity carry of 7-10%?
That’s pretty attractive. However, you can’t deduct and G&A from the top line before calculating the RRC royalty. The RRC is the first thing that gets covered.
Hi Peter. I just joined a fund that invests in start-ups that is in the Middle East. Given that courts may not uphold Preferred stock shares over here (Shariah Finance Law), it seems like the revenue participation notes offer a better risk/return profile. My question is, what happens if a Company is successful and they are sold after a few years. Is there some make-whole calculation to make the investor whole in the Event of a Sale or Change of Control?
Many thanks.
Kevin
You can easily add such a clause after deciding what exactly you want to happen if the company you have money to is sold..