While revenue-based financing (RBF), also known as revenue-based investing, may seem to occupy a unique space in funding, there is actually quite a lot of overlap with traditional equity (VC) in terms of investment stages that startups go through. That is, many startups, particularly early-stage tech companies, that are not right for traditional debt-financing are faced with a decision between a special form of debt-financing known as RBF, and VC equity financing. In that sense, these opportunities each occupy the same niche of the market in terms of early-stage financing beyond incubators and angels. Revenue Based-Financing initially served as a form of pure debt-financing, but many innovative funds have devised structures that mix debt with equity, or in the case of Bryce Roberts' fund Indie.vc, provide almost entirely redeemable equity-based loans that can be bought back as a percentage of revenue over time. Structurally, debt and equity-based RBF is quite similar. The gross revenue share percentages and repayment caps are essentially the same and the cost of capital is comparable. But before we go into further detail, let's review the basic RBF model.
RBF was introduced as an alternative to traditional venture capital/traditional equity, which is infamous for causing many unremarkable startups to expand too quickly and fail as a consequence. This is because VC relies on high-risk, high-return investments such that the only profitable investments are unicorns like Amazon or Airbnb. This means that countless companies and tech startups are left by the wayside. Traditional debt-based financing has always been an alternative, but often startups do not qualify for such loans or do not cover the founder's cash needs. This is where RBF comes in as a so-called "happy medium" between the two and is essentially capital with payments. Typically, RBF is a debt-based loan that is paid back over time as a percentage (2-8%) of monthly revenue until the repayment cap is met. The return cap is a fixed multiple of the initial investment that must be paid back eventually via monthly payments. The return cap varies between 2-4 times the principle. Therefore, one obvious downside is the cost of capital. On the flip side, since payments are tied to revenue, higher future revenues means that the return cap will be hit much sooner. [To learn more on revenue-based financing, visit our in-depth guide titled The Ultimate Guide to Revenue-Based Financing (RBF)].
This is where Equity RBF comes into play. One of the key players in equity RBF is the aforementioned Bryce Roberts' Indie.vc. The VC firm has an equity instrument that allows early-stage companies to buy back the equity as a percentage of monthly revenue under the RBF model. Roberts explains the model succinctly, in a Vox Interview in 2019, "We’ve created a new investment instrument that functions similarly to a standard convertible note, which, in venture world ... [is] an investment instrument that anticipates either a future round of funding that we would convert into and then have an ownership stake in that business, or if you sell the business, we convert in and have a percentage of that sale go through to us. What’s unique to what we do is we have a track that, if an entrepreneur decides they never want to raise money anymore and they want to grow their business on cash flow and they want to get rich off of profits, then we have the option of allowing them to
repurchase our ownership stake through a revenue share. And so, after they’ve paid us out... After they’ve repurchased our shares, the return on that investment for us, or the return on those, we cap at 3x." So essentially Indie.vc and many other firms combine equity VC with the RBF model in a way that effectively ties investors and founders at the hip in an often long-term and mutually beneficial relationship that gives founders an easy avenue to eventually buy-back stake in their companies. So in the space of RBF now exist the subspaces of Debt-RBF and Equity-RBF structures.
The RBF structure was built specifically for firms looking for growth capital beyond the incubator and angel stage without entering into the world of dilutive financing methods.
The thing that differentiates Debt-RBF and Equity-RBF is the way in which the startup compensates the investor. With debt, a tech startup would pay for the loan in debt as a multiple upon the initial revenue-based investment. With Equity, the startup pays by affording the investor with equity in the company with the option to be "redeemed" through revenue-based monthly payments in the same way and under the same terms as debt-RBF.
The Indie.vc and similar equity-RBF models operate under the following terms. If the company meets the investor's standards after due diligence, the company will enter into a contract with the investor that gives the investor the right to a fixed percentage of the company's monthly gross revenue and a proportion of stake in the company that is redeemed through the monthly payments which are a percentage of revenue. The revenue must be paid up to the return cap when the debt has been squared. The caveat is that there is typically a residual stake that cannot be redeemed. Under the Indie.vc model, the residual stake is 1/10 the initial equity. This is not necessarily a bad thing though. Residual stake can solidify a long-term relationship between the founder and investor and give the investor a vested interest in the company's long-term success. One final thing to mention is that there is a "follow-on" financing of capital that needs to be raised before the investor converts the debt into equity. For Indie.vc this is anywhere from 500,000-$5M before the conversion is triggered.
In either case, debt or equity RBF, companies should be cognizant of the cost of capital. That is, in many cases a company might be better off supplementing their RBF investment capital with traditional debt because a 3x return cap on the principal investment can be a large burden to manage. And because of this cost of capital, when negotiating the revenue share percentage, the founder should obviously shoot for a low percentage so that they have enough cash flow; the investor is incentivized to negotiate a higher percentage, but not so high that the company cannot pay it and their investment falls through. Therefore, a win win situation is when the revenue share percentage is not too high, but the return cap is still paid off in a reasonable amount of time. To that end, many startups would be well-advised to seek traditional debt-loans to supplement the RBF instrument.
There are two options to choose from: Debt-RBF or Equity-RBF. Both products are unique and serve different audiences and markets.
Notably, the pioneer fund Indie.VC collapsed in early March, 2021. The fund was launched by OATV and has been described as more of a strategy than an individual fund itself, some even calling it a movement. Despite this, limited partners have been seemingly allergic to Indie.VC and alternatives favor the tried-and-true VC that has consistently spawned miracle companies overnight. In a Medium post, Roberts commented on the matter, saying "In addition to the investments, the post kicked off an extended conversation about how who, and what gets funded by traditional venture capital and the need for funding options that sit between bank loans and blitz scaling. Being part of that conversation has been incredibly rewarding. But it has come at a cost. We’ve not been shy in sharing the challenges of departing from the well-known narratives of startups and VCs. 4 years ago, it cost us 80% of our LP base. Unfortunately, as we’ve sought to lean more aggressively into scaling our investments and ideas behind an 'Indie Economy' we’ve not found that same level of enthusiasm from the institutional LP market." But Roberts' confidence in the so-called "Indie Economy" and its financial instruments remains strong. The Indie Economy refers to a new wave of entrepreneurs that are aiming to create sustainable business models that focus on quality over quantity. That is, artistic value and creativity is given more attention than the status quo of mass production. Indie.VC and RBF is the lifeblood and fuel, so to speak, of the Indie Economy where entrepreneurs seek to expand at a sustainable rate that isn't going to compromise the integrity of their product. These trends don't seem to be changing anytime soon so many claim that the strategy of Indie.VC is bound to show up once again sooner or later. So, in that light, the fund known as Indie.VC may be dead but its vision will carry on into the future to fill a much-needed niche market in the new economy.
Indie.VC's demise was fueled by limited partners having a knack for the tried and true VC method, which has spawned miracle companies overnight with insane returns.
Revenue-based financing, or revenue-based investing, instruments are taking off mainly in the U.S. But while Europe is lagging behind, there are some exceptions in Berlin and London with major revenue-based investing VCs such as Uplift1 and Uncapped, respectively, but by and large European tech companies lack viable alternatives to VC and traditional debt-loans. This is no surprise as the U.S. is usually ahead of the curve on innovation. However, Being in the Anglosphere and being Europe's first RBF provider, the London based Uncapped fund is a notable mention. Uncapped provides 10,000-£1M of capital at a usual RBF rate of 6% of gross monthly revenue up to a return cap. When interviewed by tech.eu, the cofounder commented "Having spent a lot of my career in venture capital, I’ve always been shocked at just how little equity founders end up with. Current statistics show that at exit the founder will likely own less than 15% of their business. Equity is the most expensive way to fund a
company’s growth, it takes a long time to raise, and can mean founders end up losing control of their companies. With European companies monetizing sooner than ever, we know that founders deserve a more creative and affordable solution." Like RBF funds in the States, Uncapped focuses on Ecommerce and SaaS companies. This is only sensible, given these types of companies' affinity with RBF capital. With constant innovation and lesser barriers to entrepreneurship in the digital space, the expansion of RBF models into Europe is probably inevitable. The digital space is very global in nature after all, so we may see this trend become more commonplace globally.
Revenue-based financing is relatively new in Europe. Due to its high potential, however, there will be a rise in the number of RBF funds not only in Europe but across the globe.
We hope that this article helped you gain an understanding of Revenue-based financing. We will explore more questions surrounding the field in the weeks to come. Please let us know any remarks you might have or topics you’d like to see covered. Read more at: igotham.com/blog.
Recap: Revenue-based financing is a non-dilutive form of funding and an alternative funding method to equity investments provided by venture capital firms. In simple terms, the business will receive a lump sum from the RBF provider to fund its operations and, in return, will pay a portion of its monthly revenues over the term of the contract a percentage over the original amount (often 150% to 200%) has been repaid. This method of financing is especially suited for Software as a Service (SaaS) companies.
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