In early April, I wrote about four traditional sources of capital for early-stage businesses: founder’s savings, family and friends, angels and professional capital. I have recently learned about a new type of financing called revenue-based lending.
Under this financing model, the investor loans the company money in exchange for a percentage of the company’s sales until it has received a fixed amount back. For example, you may borrow $100,000 and pay the lender 10 percent of your sales until you have paid it four times the loan, or $400,000.
The advantages are that the loan is not collateral-based, the lender doesn’t want control of the company or any board seats, and the entrepreneur doesn’t have to give up significant ownership. Since it’s not collateral-based, the borrower doesn’t have to have significant inventory or receivables to secure the loan like he or she would with a bank loan. The company also doesn’t have to have a track record of earnings for the previous several years, a condition impossible for most early-stage companies to meet.
Selling stock to raise money involves significant legal fees and will result in the entrepreneur losing some degree of control, as well as giving up a percentage of the company. Revenue-based lending appears to avoid these issues.
The disadvantage is that the borrower pays for the loan from its business’ revenues, not from its profits. This means it will only work for high-margin companies that can afford to pay out a percentage of sales and still produce a margin sufficient to cover overhead and produce a profit. I am told that a company should have a gross profit of 50 percent or more in order for this to work.
In certain deals, revenue-based lenders also may negotiate a small warrant as a part of the package. A warrant is an option to purchase a certain amount of stock in the future at a fixed price. This gives them some upside to their loan in the case that the company goes on to have truly exceptional growth. However, the size of the warrant should be significantly smaller than the amount of stock you would have to sell to raise an equivalent amount of funds, and warrants don’t convey board seats or controls that may come with pure stock sales.
One such revenue-based lender is Revenue Loan of Seattle at www.revenueloan.com. It looks at your current annual sales and, based upon that, is willing to loan a certain amount. Its website has a calculator to enable you to see how much you might be able to borrow. For example, a company with $100,000 in sales last year might qualify for a $20,000 loan. A company with $1 million in sales might qualify for a $300,000 loan.
I have had no experience with this type of financing. I would love to hear from any readers who have sought funding from this or other revenue-based lenders. Write me at my email address below.
Kevin Learned is a member of the Boise Angel Fund and the finance committee of the Idaho Technology Council. kevinlearned@boisestate.edu.
