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Revenue Royalty Certificates: Advantages of Revenue-based Financing Instruments

I have been writing about some of the advantages of raising startup capital using instruments such as Revenue Royalty Certificates (or Revenue Royalty Agreements, if you prefer). As soon as you sell any equity for capital the pressure starts to mount for a liquidity event of one type or another. As I mentioned earlier, investors can only make money through a liquidity event. That’s when they normally recover their principal plus any capital gain that has hopefully accrued.

The Holy Grail of Investing: the Liquidity Event

While your investors may pretend to be patient for a year with each month after that they typically start becoming more impatient to see something on the horizon that resembles the the Holy Grail of Investing, namely the liquidity event. This normally happens one of three ways:

1. a venture¬† capital firm puts A Round money into the company which can sometimes be used to buy out the original investors (and more oftentimes not because later investors don’t like having their money used to enrich earlier investors. They want to used for things that will make them a good return.),

2. an acquisition by a larger company,

3. or in rare cases, an IPO, if a whole lot of things go right for the company without venture capitalists getting involved.

Since the investors want to take advantage of every opportunity to take the company closer to an exit they will begin to differ if not downright clash with the founders whose vision is more long term. In most cases, the founders are committed to making the company a huge success instead of just something to be flipped at the soonest opportunity.

Revenue-based Financing Builds Cooperation

When you use an RRC to fund the company everyone is basically rowing in the same direction. That direction is towards enabling the company to generate revenues which can then be used to pay back the capital with interest. So long as the company is paying its revenue royalties as agreed upon there is little incentive for its backers to meddle in the affairs of the company.

 

 

2 Responses to Revenue-based Financing: Getting Everyone to Row in the Same Direction

  • Regarding using an RBC to funding the company, would this work well for companies with residual income? Meaning – companies that auto-fill orders each month with standing orders? We often get our clients to pre-purchase the products, getting their cash up front and delivering each month as ordered. The comments above relating to VC’s pushing to an exit – would work against our ability to generate residual contracts with our clients. RBC funding seems a better option.

    Cindy

    • Hello,

      I’m not clear on how your revenues work. Do you have revenues every month? If so, then there’s no problem. In that case, you pay a royalty on each month’s revenues until the investors have been paid off in full. In the unlikely case that you have some very odd business where everyone prepays you in January for the the entire year and then you have no more revenues until the following year, you’d probably have a problem attracting backers with a revenue-based financing strategy.

      Peter

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