Finding capital for a business startup is one of the most difficult aspects of getting a new company off the ground, but a company called Lighter Capital is demonstrating that a revenue-based model of investment can provide an alternative to businesses that can bring in money. It works by Lighter Capital making an initial investment and then collecting payments on that investment (plus interest) that are made with the business revenue. The amount paid is a pre-negotiated percentage of the revenue, which helps keep the payment in line with earnings. The system works well for companies that have high-growth potential that only need 10% to 30% of the total revenue. For more on this continue reading the following article from TheStreet.
What do bouncy castles, online yoga classes, online medical-solution software, a chocolatier and social media tools have in common? They’re all businesses that have been funded through revenue-based financing.
Lighter Capital specializes in revenue-based financing. In just over a year since it launched, the company has done 20 transactions in 14 companies totaling roughly $2 million through its RevenueLoan product. The company mainly invests in software and high-margin, high-growth companies like software firms, but also seasonal businesses.
Rob Belcher, Lighter Capital’s vice president, explains what revenue-based financing is and how to make it work for your company.
How does revenue-based financing work?
Belcher: Revenue-based financing is a loan [where] we get a percent of revenue going forward until the loan principal is repaid plus interest. Payment is variable and it fluctuates in any given month. That’s the beauty of the royalty of the revenue-based financing. The payment is based on a royalty or percentage of revenue.
We invest $50,000-$500,000 and that generally is into companies that are doing at least $300,000 in trailing 12-month revenue up to $5 million in revenue. Obviously that means that they’ve got to have revenue, [it’s not for] pre-revenue startups.
What do these companies generally use the funds for?
Belcher: [The company] had a boost in sales and funds are tied up [to execute]. They are poised to explode on the sale and revenue front and need to hire a salesperson or marketing campaign. Those are generally good use of funds on the model.
We tend to lend 10%-30% of a company’s annual revenue.
The model works very well with companies that are high growth — 50% growth margins or better — and able to scale their sales.
It’s not a good use for working capital because working capital doesn’t grow sales. The core use of our [loan] is sales or marketing related.
To some degree working capital constraints are a good fit for us when it means you have more sales that you are making but you’re not getting paid yet, but you have expenses. If you’re a pretty flat business and you need working capital, that’s not a good business.
Why should businesses use this method of financing?
Belcher: In today’s environment banks really aren’t lending at all. They only lend to companies that don’t need the money or that require a personal guarantee. We don’t require a personal guarantee. Our payments are flexible. It is especially good for a company that has seasonal sales. We’ve actually had companies not pay us a single dollar in a given month. We’re quick. SBA loans take six months to clear. Our general closing time is about a month. You maintain full ownership and you maintain full control. We can’t fire you. We can’t cause you to change your product like an equity investor can.
On the downside, again we can only lend up to 10%-30% of a company’s revenue. Equity is great for the next Twitter or other huge opportunity. That’s not a good fit for us, but truly there are more companies that just need cash and are growing their business pretty leanly and maybe just need a little help from us.
You said that there have been times when a company hasn’t paid you anything at all some months, so how are you able to ensure that the companies you are transacting with are good companies?
The core thing we look for is recurring revenue. That’s a good way to ensure payment going forward. The high-growth margins are important and that scalability piece is key: as they put that money to work it provides them even more headroom.
What else should businesses be mindful of when engaging in this type of transaction?
Belcher:First is the amount you want to borrow. Oftentimes we get applications from people who want to borrow a lot more than we can lend. Some people don’t understand the relationship. This is only a good fit if you have revenue and you know you only need a little bit of money for your opportunity. Make sure you’re being really honest about what you want the money for.
Most people have the assumption that it’s a fixed payment. Understanding the math and the relationship to the principal amount is key.
This article was republished with permission from TheStreet.