Revenue-based Financing

Raising funds for working capital remains the topmost priority for founders. Traditionally, for such needs the companies have been dependent on a) Bank Loans b) Venture Capital c) Private Debt

Such financing options have their benefits as well as drawbacks:

• Bank Loans: Require the company to be profitable and need collaterals and personal guarantees
• Venture Capital: Typically, VCs look for hyper growth ideas and will involve equity dilution
• Private Debt: Though there is no equity dilution in this case, the repayments invariably require fixed payments and may involve collaterals. The repayment schedules are independent of the actual revenue or profits of the borrower. Further to safeguard the investor’s interests against a default, convertible notes are used to convert the debt into equity in case the borrower is not able to honour the repayments.

Off late the financial structures used by PE and VC firms have been evolving and investors are increasingly becoming comfortable with new financial instruments that are based on revenue sharing. One of such models which has gained popularity is the Revenue based Financing.

This type of method is dependent on the investors providing capital to a company based on receiving a certain percentage of the company’s ongoing revenue.

Key features of Revenue Based Financing:

a) The repayment schedule is driven by:

• Return multiple – From investor’s standpoint a fixed multiple (say 1.5x) should be achieved on the loan amount. The term of the loan will vary depending on how quickly the return multiple is achieved which in turn is dependent on the company’s revenue
• Revenue Multiple - Periodic payments are dependent on a fixed percentage of the current revenue of the company, say 2% of the revenue will be repaid periodically

b) No collaterals are required

c) No equity dilution in case of defaults

Businesses which can be attractive for revenue-based financing:

• Small to mid-sized businesses looking to raise funds for working capital for future growth.
• Companies maintaining good margins ensure repayments can be made easily
• Businesses with recurring revenue businesses – ecommerce, SaaS, DTH are ideal candidates
• Only works when the company has reached a consistent revenue stream. A company with heavy capex followed by a gestation period may not attract RBF investors in the initial years

Every investment comes with risks and so does Revenue-based financing. Since the repayments are a direct multiple of revenue, the VC firm may experience lower than usual returns in case there is significant decline in company’s revenue.

Conceptually Revenue Based Financing seems to be the future model however it has its own challenges when it comes to managing such debt instruments.

• Frequent Payments from multiple companies: How do you capture such frequent payments accurately and efficiently?
• Track projected and actual payments: How do you keep a track of future revenue, associated payments and the dates on which payments are expected and actually received?
• Real time Investment Performance: How do you collate all data in real time and see your IRRs and other performance metrics
• Monitor health of the company: How do you monitor the business health of the company you have invested in to ensure your projections are in line with the expectations?

As a VC who is starting the journey with RBFs, you can manage the initial debt instruments using MS Excel however it may soon go out of control as and when the volume increases, and the above-mentioned challenges start showing up. Therefore, you will eventually require a technology platform to manage your RBF investments.

There are software available which can help you manage RBF investments. Few pointers to keep in mind while shortlisting your software vendor:

• Flexibility to model different nuances of the Revenue based financing
• Track the actual and expected repayments seamlessly
• Reports are available to measure the portfolio IRRs as well as reporting to Investors
• Alerts and Notifications – Quick to configure notifications, for example upcoming repayments reminders to borrowers, KYC reminders to Investors
• Mailbox plugins and mobile apps
• Integration with third party data providers – Fetch details of the prospect or benchmark interest rates, such as LIBOR or SONIA
• A centralized document repository - over a period this repository serves as an institutional memory

As a VC, evaluating and selecting a software vendor can be an interesting journey as long as you are clear about the steps involved and the questions to ask.

A journey worth your time!