The Beauty of Revenue Based Financing

For the most part, early stage company financings fall into two categories:

1.​Fixed price financings (e.g., a Series Seed or a Series A Preferred Stock financing); and

2.​Non-fixed price financings (e.g., convertible notes, or convertible equity).

Fixed price rounds are great when you can fix the valuation of a company, price the shares, and you are raising enough money to justify the legal costs involved. An example of when a fixed price round might not make sense: Suppose you are only trying to raise $200,000. A $200,000 round is probably not big enough to justify the legal fees and other expenses of a preferred stock financing (and if you are raising money from angels most won’t want common stock).

Convertible note or convertible equity (such as Y Combinator’s SAFE) financings are great for smaller rounds and for when you can’t settle on a valuation and fix the price per share. For example, in the $200,000 round example mentioned above, convertible debt or convertible equity would work great for that size round.

However, there is a new variant: Revenue Based Financing.

Revenue based financing is debt financing, but the repayment terms are determined by your company’s net receipts. For example: You might borrow $200,000 but your monthly payment would be 8% of the prior month’s net revenue until you have paid the lender some multiple of the initial loan amount (e.g., 2x).

Revenue based financing is nice because:

(1)​As an investor you can start receiving a return on your investment immediately. You do not have to wait some number of years until the company is sold.

(2)​As a company you frequently don’t have to give up equity in your company to raise the money. Non-dilutive financing is a beautiful thing!

There are certainly “knocks” on revenue financing:

(1)​You might say it is more expensive than a regular bank loan, and you might be right. But you might not be able to get a regular bank loan, or that might require a personal guarantee (some revenue based loans might not require a personal guarantees, e.g., Lighter Capital).  

(2)​Depending on the stage your business is at, revenue-based financing might not be the best financing choice available to you – e.g., your revenue is too unpredictable, or conversely, your revenue is so steady that a regular bank loan makes more sense.

(3)​You won’t be able to get any revenue based financing if you are pre-revenue (obviously).

(4)​It is debt, real debt, that must be repaid and “sits on top” of all equity.

Revenue based financing is something to keep in mind as you go about looking for different financing alternatives for your business.

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  • Alexander Davie

    Joe,

    It’s certainly an interesting option for early stage companies. Is there any effort to put together a set of standard documents similar to the way we have NVCA VC round docs, TechStars Series AA, and SAFEs?

    Alex

    • Thanks Alexander. I am not aware of any efforts like this. But it is a good idea!