There's a New-Old Sheriff in Town: Royalty Financing for Young Ventures

*This article is part of series of articles on the Huffington Post I have written in a bid to empower entrepreneurs with useful and unbiased knowledge on modern venture financing. **Exclusively for my LinkedIn followers, some special follow up information can be found under the article.*** Feel free to add a comment, ask a question or share your experience.  

Main Players in the Royalty Financing Field

Do you remember that story from the early '90s when Arthur Fox pioneered royalty financing as a new form of venture capital? No, me neither. But the fact is that's when we got the first revenue based financing model operating here in the U.S.

The model was immediately employed by a fund called Cypress Growth Capital which ever since has been quietly providing growth capital in exchange for a fixed percentage of a company's future revenue, aka "a royalty."

My business focus lays in financing for start-ups and early stage companies - so a fund providing capital to companies with recurring revenues in the $3M-$20M range was not exactly the perfect fit for most of my clients.

But as fate would have it, I was approached by Cypress's latest rival,Lighter Capital, which recently received $100 million in funding thereby upgrading it to the largest royalty based financier for not only large but small businesses as well.

Fellow writers will understand me when I say: "The dog sits on the mat" is not the story, but "the dog sits on the cat's mat" is a promising plot. Below are a few key points on which to ponder.

Basics of Royalty Financing

The idea is simple - you are selling a piece of your revenue stream in exchange for a loan when you pay the investor a percentage of your sales every month, anywhere from 2 percent or much higher until the investor has received back his principal plus the premium you initially negotiated.

If you are a fan of the popular "Shark Tank" TV series and feel like royalty payments are something you can live with, so too does their shark, "Mr. Wonderful." And he is suspiciously successful.

BJ Lackland, the CEO of Lighter Capital has clarified that their revenue loans are priced on a multiples basis, which they call "the payment cap" - generally 1.5-2x the amount borrowed. The interest rate depends on how quickly a company repays the loan, but generally they are looking at a payback period of 4-5 years when the financing provided can be as low as $50k or as high as $2 million.

The most important criteria to qualify for a royalty treatment

The existence of sales. Start-ups with no paid customers need not apply. I almost hear a disappointing gasp of "but all we thought we needed was a large following on Facebook and an awesome idea."

P-l-e-a-s-e: let's get our sense back and applaud those that have figured out that magical moment when the first hundred happily paying customers are becoming a reality.

In case you wonder, Lighter Capital likes to work with companies that have been in business at least six months and have recurring revenues of at least $200k per year; selected companies are in a broad range of industries from tech to digital media.

High margins and high growth are wanted - the average borrower has $1.6 million in annual revenue, is growing at 66%, has gross margins of 83% and is burning roughly $8k per month.

Royalty Crowdfunding Platforms

I believe royalty based crowdfunding is set to be one of the most popular models. So far we have a few market players in this particular space such as Quirky,TubeStart, AppsFunder, RoyaltyClouds, Lendpool.com and Gideen.com. And - I can certainly foresee the emergence of more incumbents once Title III of the JOBS act will become effective on May 16th this year bringing a new army of non-accredited investors.

My logic is as follows. Since equity investors under Title III are at the riskiest part of company's lifecycle (its bottom) - and liquidity events are becoming less and less frequent, the cost of capital for such equity holders will be much higher relatively to the cost of capital on royalty crowdfunding platforms.

Which business model would you choose?

Royalty financing as a next generation financing tool

Truth be told, I am surprised that royalty financing option has been overlooked by both entrepreneurs and investors and has not yet entered the mainstream of entrepreneurial finance.

On the one hand, you preserve your ownership position and control, get working capital needed so you can speed up your engine while deferring the sale of equity - which is the most expensive at the beginning of a company lifecycle.

The investor, on the other hand, gets monthly payments and is not agonizing over a liquidity event - like for example investors of Andreessen Horowitz and Founders Fund which recently sold $148 million in shares in ride-hailing service Lyft to a Saudi Arabian prince. Cash is prince, indeed.

And if the unprecedented story of NASDAQ quietly settling a class-action lawsuit arising from Facebook's IPO at the end of last year did not trigger your doubts on the viability of an old "Start-Raise-IPO" model, I don't know what will.

What I am implying is that markets are telling us: "team-valuation" is out, "team-revenue" is in. Which means - we are heading towards an era when for most investors to bet on the future sale of products will be easier than to bet on a potential liquidity event.

Fortunately, the entrepreneurs are on the same page. As BJ Lackland has stressed, "Not all founders want to build, sell and exit quickly. Some founders decide they're happy building and running a business with a recurring revenue stream and growth".

Sounds good to me.

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 **UPDATE: After publishing this piece on the Huffington Post, I received an overwhelming reaction from business professionals focused on royalty financing. With their permission I am sharing with my network the company information from some of the most enthusiastic of those respondents. Check them out here:

 Arthur Fox:

“Cypress Growth Capital, one of the largest RBF funds in the country, is operating under license to me. I am both their Senior Adviser and a Special Partner. I am working with a new partner to launch a new $100 million RBF fund in New England, called "Royalty Capital-New England". We are currently pitching to a wide range of institutional investors.”

 Aamer Sarfraz, Founder & CEO at Draper Oakwood:

“Draper Oakwood is part of Tim Draper's global investment umbrella (me: Tim Draper is a legendary VC). Unlike Lighter Capital and others, we focus on larger deals. We aim to invest $10-20m in growth companies, with a share of approximately 5% of their revenue, and are starting with $200m under management.

I come at this as an entrepreneur. We're so happy to offer entrepreneurs some relief from traditional equity and debt structures.

As for specific opportunities in the market... We would like to invest in a company that arranges funeral services for unicorns.”

Arthur Lipper, the Wall Street legend, the originator of the Lipper Index, FinTech inventor:

“Royalties are the better way of both investing in and financing of private companies. The company incurs an expense of a percentage of revenues and avoids equity dilution. The investor avoids the irreconcilable and inevitable conflict of interest with the business owner and enjoys participating in the growth of the company's revenues irrespective of the discretionary reporting of per share profits. REXRoyalties.com is the first and simplest of the website calculators I have created.”

Photo credit: Deviantart

 Victoria Silchenko, Ph.D. is a leading alternative funding expert, an economist turned entrepreneur and educator, Founder & CEO of business consultancy Metropole Capital Group , Creator & Producer of the World Funding Summit and an Adjunct Professor on “Entrepreneurial Finance” @CLU. Dr. Silchenko currently serves on the Board of the Los Angeles Venture Association (LAVA) & California Stock Xchange. LinkedIn Twitter Facebook

UPDATE 2017

Dear LinkedIn Followers - I would love to see you at our World Funding Summit at Los Angeles Convention Center on Nov 17-18, 2017 - a truly unique annual gathering of disruptive investors & top financiers (learn about our SPEAKERS here) where we will be featuring the MOST comprehensive mix on startup financing options. Our program is enriched by the expo "The Future is Now", TED style talks, debates and highly educational "fat-free" fundraising workshops. Stay tuned and spread the word - to register click HERE

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Many thanks for your support!

Very Truly Yours,

Victoria Silchenko, PhD - an economist turned entrepreneur (by choice) turned educator (by fate)