A recent webinar co-hosted by Lighter Capital and Founders First Capital Partners offered insight into how revenue-based financing (RBF) can be a good source of growth funding for entrepreneurs from underrepresented communities.
Kim Folsom, CEO and founder of LIFT Development Enterprises and Founders First Capital Partners, and BJ Lackland, CEO of Lighter Capital, discussed what makes RBF unique and attractive, and shed light on whey it can be an effective option for women and minorities. Then RBF-funded entrepreneurs Linda Amaro, CEO of Klarinet Solutions, and Adam Riggs Zeigen, co-founder, and CEO of Rock My Run talked about how this type of funding has been helpful to their growing businesses.
What is revenue-based financing?
Lackland described RBF as an “in-betweener,” (in the capital stack) meaning that it is intended to fill a gap between debt (low risk, low return) and equity financing (high risk, high return). It is structured like a royalty agreement, in which the provider gives capital to a company in return for a certain percentage of that company’s revenue each month. The entrepreneur does not give up any ownership, so there is no equity dilution.
Revenue-based financing is a flexible financing instrument, with the payment to the investor going up and down according to the rise and fall of the company’s revenue. This model means that the entrepreneur and the capital provider both have an incentive to grow the business. Faster growth will result in faster repayment and a higher IRR for the investor. So, the investor has an authentic motivation to cheerlead and support the entrepreneur’s success.
“There’s a deep alignment between the entrepreneur and the capital provider toward growth,” said Lackland. “When you have a typical loan, you don’t have a lot of incentive for the capital provider to push growth. They just want to make sure they get their set payment every month.”
How Does RBF benefit underrepresented communities?
Compared to VCs, RBF tends to lend a higher volume of smaller loans with a lower average rate of return. So, the process of evaluating candidates tends to be more streamlined and automated than the high-touch VC funding process. The bulk of the process is data-driven, based on the performance of the business. As such, RBF decisions are less affected by prejudice and bias, allowing more opportunity for those who have traditionally been shut out of the “birds-of-a-feather-flock-together” world of VC funding.
RBF funders can also pick and choose which data and metrics they use to evaluate candidates, further reducing bias. “We really don’t look at traditional credit metrics that a lot of banks have historically used and used at times in shady ways to exclude lending to minorities and women,” said Lackland.
Folsom, whose firm helps companies transition from a project-based to a recurring-revenue model, sees a great opportunity for revenue-based funders to partner with female and minority entrepreneurs.
“There’s such a growing space in this underserved market, and we have had the opportunity of working with great companies,” she said. “Revenue-based financing allows them to get access to nonbiased, flexible growth capital that works with them.”
She also noted that maintaining ownership of one’s business is a way of building wealth, which these populations have historically been prevented from doing by various explicit means and de facto realities: “With RBF there’s no selling equity or dilution; it allows these individuals to build wealth.”
When Is RBF the right choice?
Companies in growth mode can benefit from RBF but must be able to control their cash burn. Lackland said Lighter Capital funds companies that are growing anywhere between 10% to 500% per year, with the central concern being alignment between the intentions of the funder and the entrepreneur, not the rate of growth.
“As long as we understand their intentions with the business, we’re all in,” said Lackland. “As long as we understand how fast they can grow, we can be happy as investors.”
RBF can be a good fit for entrepreneurs who have either a “never-VC” or a “VC-later” mindset. The former group doesn’t want to give up any equity, while the latter wants to push off an equity raise until a point when the company is bigger, more highly valued, growing faster, or has reached some other particular milestone.
Whether an entrepreneur is inclined to pursue VC funding eventually will depend on his or her vision for the business. “It really comes down to: What do you want to accomplish? What are your goals, your timeframe? And what type of business do you want to run?” said Riggs Zeigen. “Do you want to charge fast, grow quickly, and have the associated risk? Or are you looking for something slower in growth, and to hang onto your percentage ownership?”
One central benefit of RBF for businesses that intend to raise significant capital is that it allows them to skip a round of equity financing, allowing them to maintain a 10-15% ownership stake at the series C or D stage, as opposed to the typical 5-10%.
RBF also allows for a faster, easier onboarding process: At Lighter Capital, it typically takes 45-60 days from initial contact to funding. And businesses with uneven monthly revenue can benefit from the RBF structure.
Amaro didn’t pursue a startup business loan because of the high level of risk accompanying being locked into a set fee every month. “We had a lumpy cash flow; we couldn’t predict when our clients were going to pay us,” she said. “That could have a devastating impact if we were not able to service the loan.”
It’s such benefits that make RBF such an excellent choice for a range of businesses. Growth can occur organically, without pressure, fear, or loss of control.
“One of the reasons we dove into making Lighter Capital was to make an alternative for entrepreneurs who wanted a different path for growing their businesses,” said Lackland. “We’re happy to be associated with great entrepreneurs and an alternative way for companies to get funded.”