Angel Investors Vs VC Funds Vs Revenue Based Funding

Which Funding Heroes Will You Go With?

With the pandemic fury a little behind us (though it still exists, the uncertainty around is far less) the startup funding frenzy is again on the upswing. And thankfully, for founders who are looking to raise funding for their ventures – have a new funding model on the horizon – Revenue Based Funding.

Over last one year – atleast four revenue based funding platforms have emerged in the country – Klub, GetVantage, Velocity and Aavejak – each with their own differentiated model. (The differences amongst these platforms could be a subject for my next article). Essentially, Revenue Based Funding is a quasi-debt structure – where you can raise the funds against a pre-defined portion of your forthcoming revenues which you have to periodically pay back to the investors. You can hop onto www.aavejak.com for more detailed FAQs on various parameters around Revenue Based Funding.

What this article endeavors to do is to help you briefly understand the Pros and Cons of three key funding models that are often available to the founders – to help you decide which one could be a preferred model for you.

Angel Investors

Angel Investors essentially could be High Networth Individuals who could invest an average of INR 5 – 10 Lakhs each to obtain equity or convertible debt instruments (with an objective of these being converted to equity later) in your venture. Normally – a group of 4-6 angel investors can team up to fulfil the capital requirements that you may have.

While I’m mentioning the pros and cons of equity investments in general under the ‘Venture Capital’ section below: you may evaluate following observations typical to raising angel investments:

·        Multiple Stake Holders: Given that you would have multiple angel investors on your cap table – this could be beneficial or restrictive in the ways it could turn out. Beneficial as stake is distributed amongst multiple investors, so founders may still have deeper say in the operations of the company. The downside could be in regards to keeping various investors aligned on common goals and informed on the progress. Any dissent amongst even one investor may create challenges and operational delays.

·        Accessibility and expertise: While on one hand multiple investors can mentor you on various operational metrics – there is always a challenge of most of these investors playing just a passive role and hence may not be there to guide you as you may seek at various stages of your business growth.

Venture Capital

VC’s essentially offer institutional support to your firm and can play a significant role in its growth.

Pros:

·        Capital: VC Funds can offer you strong capital support – giving you all the fuel that you may need to grow rapidly

·        Network: A VC Fund may bring immense network strength and connections that may help you to operate better and build stronger customers

·        Guidance: A VC Fund may offer its deep expertise to help you cross over various growth challenges

Cons:

·        Ownership: A VC Fund takes significant equity and thus hold on the company. And if your firm is doing good, the relative returns that you may end up paying VC funds could be more than 100% annual interest! (Refer to: Costs and Benefits of Taking Venture Capital Funding - Bill D'Alessandro)

·        Control: Given the various protection rights that a VC Fund would have imposed on founders – the founders end up giving significant control to these funders – even the right of being ousted from their own firm!

·        Hamster Wheel of Continuous Fund Raising: Typically a VC Fund – driven by valuations of your company – would keep insisting on your growth and subsequent fund raising rounds – as that is only how they would mark their returns to their investors

·        Distraction: Not only seeking a VC Fund would take you off the core operations of your firm by few months, it could actually become a continuous cycle – keeping you away from the core passion and purpose for which you started the business anyways.

Venture Capitalists normally seek companies with high growth potential and disruptive business processes – so that they can seek higher valuations basis these. Unfortunately, most of the businesses may not fit the bill here – and that brings me Revenue Based Funding, which today is rapidly becoming more accepted funding model.

Revenue Based Funding

The RBF model is a good fit for startups that are growing, have sustainable revenues, wanting to retain control and grow it organically without excess external fund pressures.

Pros:

·        Less expensive than Equity: Raising equity capital – be it from angels or VC funds – is perhaps the most expensive funds that you’d be raising – with these investors expecting almost 8-10X returns on their capital within a span of 6-8 years. Revenue Based Funding is far more economical and averages out the returns in sync with your revenues.

·        Retain Control and Ownership: Since RBF involves no or very minimal equity dilution – you as a founder have complete control and ownership over your firm. And once you have repaid the RBF liabilities, you are done with in independently deciding the future course of action for your firm.

·        Alignment towards Growth: Since RBF is dependent on revenues and real value that your business could create – all the investors are equally aligned towards your truer and practical business goals and doesn’t have any lofty valuation expectations or pressures on you and your operations.

·        No personal guarantees: As opposed to taking debts – where your personal collaterals have to secure the debt – RBF Investors do not seek any personal guarantees and are betting on the company to make them returns.

·        Ease of access to capital: A RBF Funding deal can let you access the capital within just few weeks of you approving the term sheets – as compared to a VC Fund which may normally take few months to transfer the said funds – thus delaying up the plans.

·        Maintain Optionality: A VC Fund or any form of Equity Fund participation normally would have multiple conditions on founders in regards to the future course of action that they want to take. But RBF funding allows them complete freedom and optionality:

o  Taking VC Route later: A firm, after taking RBF initially and leveraging the funds to register growth, can then decide to go for larger VC rounds and even get better negotiation terms

o  Selling the business: While a VC fund may inhibit a founder to outright sell the business till a particular return multiple isn’t received – a RBF investment may not put any such limitation and after repaying the said RBF liabilities, the founder is free to decide the future course of action

o  Keeping the business long term: Since RBF investments do not look at any ‘exit’ as compared to VC Funds – the founder are free from such pressures and can continue to operate and grow their business as long as they wish

Cons:

·        Fit only for revenue making companies – and preferably ones with positive or soon-to-be-positive EBIDTA: A RBF Funding model essentially works only for companies which are already making sustainable revenues. A RBF platform hence may not be able to support very early stage firms.

·        Limited Capital: Since the RBF funding is subject to revenues – a RBF Fund may not extend astronomical capital amount and normally is 3-5X your projected annual revenues. However, the funding amount may increase and there could be subsequent rounds – as your revenues improvise over time

·        Commitment to returns: Since RBF funding is a quasi-debt structure, which is required to be paid back, it is important for the founders to be careful of return commitments and impact it will have on their operations till they have repaid the liabilities.

I do hope that the above will help you look at various Funding Heroes in objectivity and take the right the funding support that’s best for your venture.