Recently, I was introduced to a new type of funding mechanism available to entrepreneurs that I found fascinating: revenue share financing or revenue share loans. In short, a revenue share loan is money received by investors as debt issued to a business. The terms of repayment are based on a percentage of recurring gross revenues.
This type of debt financing, also known as royalty-based financing, is a hybrid between traditional loans and equity financing and has a number of benefits that differentiate it.
No equity is exchanged for the investment.
Businesses are not required to provide collateral, personal guarantees, or other security interests.
The investment may be subordinated to future debt.
Interest is not paid on an outstanding balance.
There are no fixed payments, but rather payments dependent on the income of the business.
This last distinction is important because payments are proportional to how well the firm is doing. During months of poor sales or seasonality, businesses are required to make lower payments. On the flip side, when sales are strong, entrepreneurs should expect to pay more.
Of course, this type of financing is dependent on two very important aspects of the business.
The business has generated and is projected to generate ongoing and recurring revenues.
The business has gross margins high enough to afford the revenue share payments.
Again, this last distinction is important and, if not considered or underestimated, can have a very detrimental affect on the growth of the company.
Because this type of financing is higher risk for investors, their expected return on investment is higher than traditional loan instruments. According to Zendesk.com, typical terms for revenue share loans are as follows:
Revenue Share Payments: Between 2 and 10 percent
Percentage of revenue to be applied to repaying the loan as a percent of top-line revenue, which means revenue before any expenses or cost of goods sold is considered.
Total Return: 1.5x to 3x
The multiple of the amount invested that investors will expect returned. The range will depend on the level of risk assumed by the investors.
Loan Duration: 3 to 5 years
The amount of time it would require, based on the financial projections of the business, to pay back investors the Total Return. Revenue share payments are based on this assumption.
Maturity: 6 to 8 years
The time at which business would make a full and final payment to investors to reach their maximum total return, if that amount had not been reached yet.
Like any financial decision for your company, entrepreneurs should be consulting their financial planners, accountants and attorneys before assuming any type of financing to make certain it fits into the growth strategy and ability of their company.
With that said, for companies that have established revenues but may have found attempts at growth slow and cumbersome, using debt as a way of fueling that growth can be a good strategy, and revenue share financing is a worthy hybrid to consider.