Revenue Sharing? What the heck is that?!
7 years ago, if you had mentioned Revenue Sharing and FinTech in the same sentence, I would have had the same reaction as our Canadian pal below…
To be honest, it’s a totally legitimate and expected reaction. I have been a Product Manager my entire career. I didn’t major in finance, unless growing up while hearing your parents talk about banks and the financial industry around dinner time counts as one… I totally get it! But seriously: What is Revenue Sharing?
You are a startup or a young business and your business is gaining traction in the market. Customers are excited about your product, and some potential huge sales are on the way. That’s great! But in order to take full advantage of your momentum, you need to scale your operations, increase headcount, and ramp up spending and marketing efforts. You need access to some capital. What else is new, right?
Early Businesses usually rely on two sources of funds to fuel their growth — debt and equity financing.
I’m not sure if you have heard the news lately, but as it turns out, Banks aren’t excited to lend to risky businesses. Okay!
So you decide to pursue equity financing through Angels and Venture Capitalists. Fun right?! And even if you manage to land a deal, you are probably not all that excited about giving up ownership and control at this point, nor spend the next 6 months chasing investors for capital when you have a business to build.
This is where Revenue Sharing comes into play.
Revenue Sharing has taken off in the recent years. Entrepreneurs and business owners in the US and UK are increasingly finding it a compelling and suitable funding option. Revenue Sharing mixes the best aspects of debt and equity financing without the restrictions associated with traditional loans or equity dilution.
Did I lose you already? Okay, let’s break it down a bit!
In the traditional form of equity financing, investors expect a “10x” return on their investment, meaning they expect that the company will exit at one point for a sufficient amount that will earn them at least 10 times their money back.
That’s a $5 million return for a $500,000 investment.
In comparison, Revenue Sharing is provided by investors that see potential in a business, just like an Angel or Venture Capitalists might. However, the investor doesn’t obtain ownership and offers the business a loan that gets repaid by taking a portion of the business’s “top-line” revenue.
In a way, Revenue Sharing still uses equity, but the business buys the equity back using a small percentage of revenues, typically between 1–10%, returning 1.5 to 3x the amount invested over 2–5 years. An investor’s expected annual return — at least at Corl — is ~15–30%.
That’s $750,000-$1.5 million for a $500,000 investment.
Revenue Sharing is a loan, but there are no fixed payments, no set time period for repayment, and no interest rate. Every month, the business pays the investor a fixed percentage of the top-line revenue — say 5% — until a return cap has been paid back. If revenue next month is $50,000, then the company pays the investor $2,500. However, if the revenue drops to $40,000 the month after, that month’s payment is $2,000.
Wait a minute! Aren’t you hurting the business this way? “Cash is King”
“Cash is King”. I agree, but what is really meant by cash? That’s a long story on it’s own and I will discuss it in the next episode.
What else do you need to know?
1. Revenue Sharing is not a loan
Revenue Sharing usually — at least at Corl — won’t require a personal guarantee. If your business fails, your personal possessions won’t take a hit. You are less likely to default in the first place as payments aren’t based on cash in your pocket, but on cash coming through the door. It’s literally a pay as you grow model.
2. Revenue Sharing is more expensive than bank loans, but cheaper than equity
In the example above, a $500,000 startup equity investment will cost the entrepreneur $5 million. In revenue sharing, at a 3x, it costs $1.5 million. That’s a 70% lower cost of capital.
But isn’t this discouraging for investors? Not really! Take a moment to do the math and think through the risks. You will discover that Revenue Sharing greatly lowers the investment risk for the same return.
Revenue Sharing Financing is a Win-Win.
3. Revenue Sharing is not for every small business
Revenue Sharing is not the best option for every small business or entrepreneur. Revenue Sharing is not suitable for businesses with low gross margins as the investors are being paid a percentage of revenue, which ends up squeezing gross margins more. Businesses with SaaS, tech, or speciality services products are a better fit due to their high margins and scalability that allows for significant increase in cash flow despite paying the investor a percentage of revenue.
4. Entrepreneur’s and Investor’s interest are aligned
Similar to equity financing, the Revenue Sharing investor’s ROI depends directly on the company’s success. If the company grows faster than expected, the investor receives the return on investment more quickly than expected.
To conclude, deciding on a funding model is a personal decision that you have to make as a business owner. You need to consider your history, your credit, your assets, how fast do you need the money, how much can you afford to pay, and who you want to owe money to.
If Revenue Sharing is your choice, check out Corl Financial Technologies. For more tips and information, visit https://corl.io and connect with us on Twitter & Facebook.
What do you think of the Revenue Sharing model? Let me know in the comments below.
