By Rob Belcher
Owning and operating a business requires a great deal of time, effort, and perseverance. But to actually grow a business, that often also requires access to capital – and in today’s lending environment, that may take more time, effort and perseverance (not to mention nerves!) than one can afford.
Fortunately, a number of alternative funding options have emerged as a result of these lean lending times. One such alternative is called Revenue-based, or royalty-based, finance.
Revenue-Based Financing is an old idea that is now being used to help small, profitable businesses gain access to the money they need to grow. Revenue-Based Financing was originally a practice that was very popular in the early-to-mid 1900s – especially in the mining, oil and natural gas industries where it was common to provide large sums of at-risk capital up-front in exchange for a percentage, or royalty on the sales generated from the venture . And even years later, Revenue-Based Finance became common place in the music, publishing, and entertainment industries.
Revenue-Based Financing is a loan that is backed by a company’s future cash flow
Today, Revenue-Based Finance is increasingly being used as an alternative to traditional bank debt or angel and venture capital equity investments. Unlike a traditional loan that is backed by personal or company assets, Revenue-Based Financing is a loan that is backed by a company’s future cash flow. A typical Revenue-Based Financing investment provides a business with a loan that is repaid monthly, where each payment is an agreed upon percentage of the company’s monthly gross revenue. Depending on which Revenue-Based Financing lender a business chooses, these types of loans typically terminate once the borrower has repaid a predetermined amount.
Today, where bank lending is tight and venture capitalists are looking exclusively for “home run” deals, specialty finance companies like Seattle-based Lighter Capital are investing specifically in small businesses that need an alternative to bank or venture funding. Lighter Capital offers financing of between $50,000 and $500,000, but other Revenue-Based Financing organizations such as Royalty Capital Management, based in Boston, and Next Step Capital in Texas, often conduct larger sized deals.
It’s also important to note that Revenue based financing is not the best financing option for every small business or entrepreneur. For example, high-volume, low-margin businesses are not well-suited for Revenue-Based Financing. Higher margin businesses such as specialty manufacturers and niche software providers are typically better candidates because their margins allow for some flexibility around the monthly royalty payment, which is usually based off of top-line revenue. Additionally, this doesn’t mean that a business has to be generating revenue every month in order to benefit from a revenue-based loan. In fact, seasonal businesses can also benefit from the financing model because of its flexible payment schedule. With revenue based financing, if a business doesn’t generate revenue during a given month, then it’s not required to make a loan payment that month. This payment model is drastically different than a traditional loan, which typically requires a fixed payment every month – regardless of a company’s seasonality or fluctuating revenues.
With revenue-based financing, an entrepreneur can avoid losing control of their business to a VC (and avoid losing their mind when dealing with a bank), their payments are flexible, and their business can obtain financing without having to use personal assets as collateral. It is an option that today’s entrepreneurs or small business owners should know that is open to them – instead of feeling confined by the leather and marble of traditional financial institutions.
About: Rob Belcher is a Principal with Lighter Capital. He has experience in the highfalutin leather and marble, and has seen the light of alternative finance for growth-stage businesses. He lives in Seattle with his wife and 4-month-old son, and Australian Shepherd, Kora.
Lighter Capital, founded in 2010, provides revenue-based investments between $50,000 and $500,000 for early, growth stage businesses. The company has made 21 investments into 16 individual companies. For more information, click here, and to apply for funding please click here.