What types of companies is Revenue-based Finance best suited for?
Since most people are only now beginning to discover revenue-based financing they mistakenly assume that it’s an exotic new financing mechanism suitable for a only a small subset of companies. The fact is that it’s a form of financing better suited to the majority of businesses than traditional equity financing. Consider the fact that equity-based financing depends on a profitable liquidity event taking place, such as an IPO or acquisition by a deep-pocketed buyer, to make it worthwhile for the investors. Then consider how unlikely either of those events really is for the vast majority of companies. The answer is highly unlikely.
The only way for the majority of companies to then create liquidity for an investor is the slow way: by buying back their shares over a number of years. This is not a very attractive proposition to equity investors. So why pretend otherwise?
Why not acknowledge this reality and structure the deal so that there’s a schedule in place from the get-go for paying off your financial backers in a timely fashion and getting them out of your hair? This is precisely what revenue-based financing structures such as Revenue Royalty Certificates do. They set out a royalty-based repayment schedule to pay back the principal and interest to the financier.
The benefit here should be obvious. Both parties compromise a bit to get what they want. Since the vast majority of companies will never IPO and at best might be sold for low multiple in the 3x to 5x earnings range, if a buyer can be found at all, they should accept that they will not able to dangle the prospects of a lucrative liquidity event in front of investors. Moreover, investors are typically astute enough to know this is the case.
All this means is that it’s time for Plan B. Plan B is revenue-based financing. The company gets the capital it needs to launch or grow. The financial backers in turn understand how they will extract their capital from the company. It will be through a royalty equal to 1 to 5% of the gross revenues each and every month.
As in all cases, pure startups will have to pay more than a company with a track record but a few extra percentage points shouldn’t be an issue if revenue-based financing is the company’s only option for getting the startup capital it needs.
The takeaway here is the revenue-based financing is better suited for the majority of companies than equity-based financing when you accept that few will be able to offer investors a big bang-style exit.