Revenue-based financing

Last updated

Revenue-based financing (also known as royalty financing [1] or royalty-based financing [2] ) is a type of financial capital provided to growing businesses in which investors inject capital (sometimes called an advance) into a business in return for a fixed percentage of ongoing gross revenues (called royalties), with payment increases and decreases based on business revenues, typically measured as monthly revenue. [1] [3]

Contents

It is a non-dilutive form of financing, which means that the company's management retains complete independence and control, as there is no equity investment or impact on the company's shareholding. Usually, the returns to the investor continue until the initial capital amount, plus a multiple (also known as a cap) is repaid. [4] Generally, RBF investors expect the loan to be repaid within 1 to 5 years of the initial investment depending on the model and the funded companies.

Overview

RBF is often described as sitting between a bank loan, typically requiring collateral or significant assets, and venture capital, which involve selling an equity portion of the business in exchange for the investment. [5] [6] In an RBF investment, investors do not take an upfront ownership stake (equity) in the business. RBF investments usually do not require a seat on the company's board of directors, and no valuation exercise is necessary to make the investment. Nor does RBF require the backing of the loan by founder's personal assets.

While revenue-based financing has been used to finance SaaS companies in the world through players like Capchase (USA), Levenue (Europe), Viceversa (Europe) or, GetVantage (India) it is also used to finance D2C and ECommerce businesses as well with players like Clearco (USA), Uncapped (Europe), WayFlyer (Ireland), Divibank (Brazil), Karmen (France).

History

RBF has long been used in the energy industries as a type of debt financing. In the late 1980s, Arthur Fox pioneered this funding model for early-stage businesses in New England. Seeing some initial success, he began a small RBF fund in 1992, which was found to perform on-par with expectations for the alternative assets industry, yielding an IRR of over 50%. [7] In 2011, he began licensing his proprietary RBF financing model to enable new RBF funds to form.

The Revenue Capital Association is the trade association representing the RBF industry. Some firms have a geographic-focused model in the Mountain States. Other firms take a more nationwide approach. [8]

Comparison

RBF can provide significant advantages to entrepreneurs and businesses. [8] The nature of RBF, however, requires that businesses have two key attributes. First, the business must be generating revenue, as it will be from that revenue that payments are made. [9] Second, the business should have strong gross margins to accommodate the percentage of revenue dedicated to loan payments. [9]

The interests of an RBF investor align with the interests of the companies in which they invest. Both parties benefit from revenue growth in the business; both parties suffer when revenue declines. [10] This is in contrast to a typical bank loan, which has a fixed monthly payment over the life of the loan regardless of business revenue. RBF helps manage rough months in the business by having a payment that traces revenue.

Cost of capital is an important consideration for entrepreneurs raising money. Usually the cost of capital in an RBF investment is significantly less than a similar equity investment, for several reasons: First, the actual interest rate on the loan is much lower than the effective interest rate required by an equity investor on their invested capital if the business should be sold. Second, legal fees are lower than with equity financing. [11] Third, because the investment is a loan, the interest payments can often be a tax deduction for the business. [12]

This cost of capital savings is a result of the RBF model and nature of the risk taken by the investor. Because the loan is making payment each month, the RBF investor does not require the eventual sale of the business in order to earn a return. This means that they can afford to take on lower returns in exchange for knowledge that the loan will begin to repay far sooner than if it depended on the eventual sale of the business.

RBF often is more expensive than bank financing, [8] However, few early-stage businesses seeking growth capital will have an asset base to support a commercial loan. Most banks will therefore require a guarantee from the founders of a business that, in the event of default, the bank can pursue their personal assets. [13]

See also

Related Research Articles

<span class="mw-page-title-main">International Finance Corporation</span> World Bank Group member financial institution

The International Finance Corporation (IFC) is an international financial institution that offers investment, advisory, and asset-management services to encourage private-sector development in less developed countries. The IFC is a member of the World Bank Group and is headquartered in Washington, D.C. in the United States.

In finance, equity is an ownership interest in property that may be offset by debts or other liabilities. Equity is measured for accounting purposes by subtracting liabilities from the value of the assets owned. For example, if someone owns a car worth $24,000 and owes $10,000 on the loan used to buy the car, the difference of $14,000 is equity. Equity can apply to a single asset, such as a car or house, or to an entire business. A business that needs to start up or expand its operations can sell its equity in order to raise cash that does not have to be repaid on a set schedule.

Private equity (PE) is stock in a private company that does not offer stock to the general public. In the field of finance, private equity is offered instead to specialized investment funds and limited partnerships that take an active role in the management and structuring of the companies. In casual usage, "private equity" can refer to these investment firms, rather than the companies in which that they invest.

<span class="mw-page-title-main">Venture capital</span> Form of private-equity financing

Venture capital (VC) is a form of private equity financing provided by firms or funds to startup, early-stage, and emerging companies, that have been deemed to have high growth potential or that have demonstrated high growth in terms of number of employees, annual revenue, scale of operations, etc. Venture capital firms or funds invest in these early-stage companies in exchange for equity, or an ownership stake. Venture capitalists take on the risk of financing start-ups in the hopes that some of the companies they support will become successful. Because startups face high uncertainty, VC investments have high rates of failure. Start-ups are usually based on an innovative technology or business model and they are often from high technology industries, such as information technology (IT), clean technology or biotechnology.

In finance, valuation is the process of determining the value of a (potential) investment, asset, or security. Generally, there are three approaches taken, namely discounted cashflow valuation, relative valuation, and contingent claim valuation.

<span class="mw-page-title-main">Financial services</span> Economic service provided by the finance industry

Financial services are economic services tied to finance provided by financial institutions. Financial services encompass a broad range of service sector activities, especially as concerns financial management and consumer finance.

In economics and accounting, the cost of capital is the cost of a company's funds, or from an investor's point of view is "the required rate of return on a portfolio company's existing securities". It is used to evaluate new projects of a company. It is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project has to meet.

Funding is the act of providing resources to finance a need, program, or project. While this is usually in the form of money, it can also take the form of effort or time from an organization or company. Generally, this word is used when a firm uses its internal reserves to satisfy its necessity for cash, while the term financing is used when the firm acquires capital from external sources.

An investment trust is a form of investment fund found mostly in the United Kingdom and Japan. Investment trusts are constituted as public limited companies and are therefore closed ended since the fund managers cannot redeem or create shares.

A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS). Like other private label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived from ratings on those bonds or assets.

Mezzanine capital is a type of financing that sits between senior debt and equity in a company's capital structure. It is typically used to fund growth, acquisitions, or buyouts. Technically, mezzanine capital can be either a debt or equity instrument with a repayment priority between senior debt and common stock equity. Mezzanine debt is subordinated debt that represents a claim on a company's assets which is senior only to that of the common shares and usually unsecured. Redeemable preferred stock equity, with warrants or conversion rights, is also a type of mezzanine financing.

In finance, leverage, also known as gearing, is any technique involving borrowing funds to buy an investment.

Social venture capital is a form of investment funding that is usually funded by a group of social venture capitalists or an impact investor to provide seed-funding investment, usually in a for-profit social enterprise, in return to achieve an outsized gain in financial return while delivering social impact to the world. There are various organizations, such as Venture Philanthropy (VP) companies and nonprofit organizations, that deploy a simple venture capital strategy model to fund nonprofit events, social enterprises, or activities that deliver a high social impact or a strong social causes for their existence. There are also regionally focused organizations that target a specific region of the world, to help build and support the local community in a social cause.

A private equity fund is a collective investment scheme used for making investments in various equity securities according to one of the investment strategies associated with private equity. Private equity funds are typically limited partnerships with a fixed term of 10 years. At inception, institutional investors make an unfunded commitment to the limited partnership, which is then drawn over the term of the fund. From the investors' point of view, funds can be traditional or asymmetric.

Impact investing refers to investments "made into companies, organizations, and funds with the intention to generate a measurable, beneficial social or environmental impact alongside a financial return". At its core, impact investing is about an alignment of an investor's beliefs and values with the allocation of capital to address social and/or environmental issues.

Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling their related cash flows to third party investors as securities, which may be described as bonds, pass-through securities, or collateralized debt obligations (CDOs). Investors are repaid from the principal and interest cash flows collected from the underlying debt and redistributed through the capital structure of the new financing. Securities backed by mortgage receivables are called mortgage-backed securities (MBS), while those backed by other types of receivables are asset-backed securities (ABS).

<span class="mw-page-title-main">Corporate finance</span> Framework for corporate funding, capital structure, and investments

Corporate finance is the area of finance that deals with the sources of funding, and the capital structure of businesses, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value.

Small business financing refers to the means by which an aspiring or current business owner obtains money to start a new small business, purchase an existing small business or bring money into an existing small business to finance current or future business activity.

A royalty fund is a category of private equity fund that specializes in purchasing consistent revenue streams deriving from the payment of royalties. One growing subset of this category is the healthcare royalty fund, in which a private equity fund manager purchases a royalty stream paid by a pharmaceutical company to a patent holder. The patent holder can be another company, an individual inventor, or some sort of institution, such as a research university.

Profit and Loss Sharing refers to Sharia-compliant forms of equity financing such as mudarabah and musharakah. These mechanisms comply with the religious prohibition on interest on loans that most Muslims subscribe to. Mudarabah (مضاربة) refers to "trustee finance" or passive partnership contract, while Musharakah refers to equity participation contract. Other sources include sukuk and direct equity investment as types of PLS.

References

  1. 1 2 "Royalty Financing". Inc.com. 2020-02-06. Retrieved 2024-08-06.
  2. ↑ Hayes, Adam (2022-12-22). "Revenue-Based Financing: Definition, How It Works, and Example". Investopedia. Retrieved 2024-08-06.
  3. ↑ Tetreault, Tricia (2019-02-22). "Revenue-Based Financing: How a Revenue-Based Loan Works". FitSmallBusiness. Archived from the original on 2019-04-26. Retrieved 26 April 2019.
  4. ↑ Rogers, Kate (2016-03-23). "Revenue-Based Financing: What's at Risk". FOXBusiness. Retrieved 9 March 2019.
  5. ↑ Khazan, Olga (8 April 2012). "Between banks and venture capital, some start-ups look to a pay-as-you-go model". The Washington Post.
  6. ↑ "AVC: Revenue Based Financing". ACV. 17 October 2011. Retrieved 9 March 2019.
  7. ↑ [ dead link ] "Revenue Capital & Disruptive Models: Venture Funding Tools for Developing Nations". Archived from the original on 2012-08-18. Retrieved 2012-09-09.
  8. 1 2 3 Stillman, Jessica (2012-09-26). "Overlooked Financing Option for Your Business". Inc. Retrieved 9 March 2019.
  9. 1 2 Randall, Lucas (2011-06-14). "When NOT to raise Revenue-based Financing". Archived from the original on 2012-09-04. Retrieved 2012-09-20.
  10. ↑ "A Sack of Seattle: Angel Investing".
  11. ↑ "Revenue-based Financing: What's At Risk". 2016-03-23.
  12. ↑ "Tax treatment of revenue-based payments". Archived from the original on 2013-01-25.
  13. ↑ "5 Typical Bank Requirements for a Business Loan".
This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.