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Revenue-based financing re-emerges for small business

Posted by Chad O'Connor  October 28, 2013 11:00 AM

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It happens to a number of terrific, small businesses. Operations are moving along swimmingly. Your margins are high. Profitability is within reach, and you’ve got a number of customers lining up – but you need a quick infusion of cash in order to scale your operation and meet the oncoming demand.

It’s too much debt for your credit card to handle, so you turn to the bank for a loan – only to be rejected because you’re ultimately still viewed as too much of a risk. And on the other hand, every venture capitalist you’ve managed to gain some interest from wants to take half the company and a board seat.

So where can an entrepreneur turn?

While a number of alternative options like peer-to-peer loans have emerged in recent years, there’s one form of financing that’s actually a number of years old that has suddenly become en vogue once again. It’s called Revenue-Based Financing (RBF) and it was a very popular business practice in the early-to-mid 1900s – especially in the oil and natural gas industries where it was common to provide large sums of cash up-front in exchange for a percentage of the royalties generated. And even years later, the RBF model became commonplace in the early music, publishing, and entertainment industries.

Today, a number of small businesses are again looking to the Revenue-Based Financing model to fuel their growth. Here’s what you need to know about this type of financing:

What is Revenue-Based Financing?
The concept is pretty simple. A company receives an upfront investment in exchange for an on-going monthly or quarterly payment calculated based on a percent of top-line revenue until some pre-determined point in the future. The termination can be time based (eg. 5 years from the funding date) or total return based (eg. when cumulative payments reach 3x the initial investment amount).

Why are entrepreneurs beginning to look at this type of financing?
In general, Revenue-Based Financing is non-dilutive to the equity holders, as it is always in the form of a loan. And even though it’s a loan, most RBF providers do not require a personal guarantee – unlike your typical bank loan. Instead, a company’s loyal customers and high-quality revenue streams act as the collateral.

What are the drawbacks?
It’s expensive money – typically more expensive than your standard bank loan. However, it’s ultimately not as expensive as surrendering a large equity stake in your company.

Where can you find this type of financing?
A handful of RBF providers, like Boston-based Arctaris Partners and Lighter Capital in Seattle, have emerged in recent years – but each has its own specific criteria and investment structure. For example, some providers, like Arctaris, will look to invest several million dollars into established, cash-flow positive companies with at least $5 million in annual sales. Lighter Capital will provide $50k to $1M to companies with as little as $200k in annual revenue and up.

Who is tapping into Revenue-Based Financing?
A number of small tech companies from around the country – like Cloudbilt (Charlotte, NC), SteelBrick (Palo Alto, CA), HarborCloud (Bellevue, WA), TheDataBank (Minneapolis, MN) and SaaS Software, Inc. (Dallas, TX) – have all been funded with the RBF model.

It’s like the old Peter Allen song, ‘Everything Old is New Again’ – as this old financing model is proving to work quite well for a number of today’s growth-stage businesses. If you’re exploring alternative financing options for your business, it may be worth your while to take a closer look.

Rob Belcher is a Vice President at Lighter Capital (@LighterCapital). He has experience in the high-falutin, leather and marble world of investment banking – and has seen the light of alternative finance for growth-stage businesses.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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