Securities Law – Revenue Capital Investing
Many companies in need of growth capital have grown beyond the traditional equity investment phase, but are still not the correct bank-profile fit for straight debt. In addition, some companies are not prime exit-scenario candidates, which can also limit their ability to raise venture funding. Similarly, some investors prefer to balance their startup company investment portfolio with placements that lead to regular investment return. Unlike early stage equity investing where investors purchase stock or units in an entity and must wait for the sale of the entity (or its IPO if it goes public someday), revenue capital investing can provide a return to investors the moment the company begins revenue.
Sometimes referred to as revenue based financing or royalty based financing (or even RBF), revenue capital investing can be the perfect hybrid for certain scenarios. While it can be structured as equity investing or debt investing, a typical scenario would involve the company selling redeemable shares or units to the investor, and then allocating a set percentage of gross revenue each month to buying those shares or units back. The purchase price used to buy them back typically depends on how long it takes the company to redeem them (and the longer the investors have to wait, the greater their return). A common example would provide a redemption mechanism that would double the investors’ money in the contemplated timing, and then provide for a three times return instead if a longer cycle is needed. For example, if a company has allocated 5% of gross revenue to the return and has $100k in monthly revenue, the company will use $5,000 to purchase back shares or units. If the units are purchased by investors for $1 per share or unit, the company will pay $2 per unit (in order to double the investor’s money) and buy back 2,500 shares or units. This continues until all of the shares or units have been bought back, at which time the investor is no longer an owner in the company.
The payment timing of the return is flexible (unlike typical debt payments), which can be an important value add for the company’s ability to service the return. If revenue is up, the payment to investors following that month is higher. If revenue is down (or non-existent), so is the payment to investors.
And perhaps most note-worthy, this structure negates the need to place a valuation on the company (or the need for complex voting protections or shareholder agreements). Valuations are used to determine how much of the company an investor will purchase, but because investors are automatically to be paid based on revenue until the return is achieved, percentage ownership in the company is irrelevant.