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How Revenue-Based Financing and Venture Capital Funding Work Together

Revenue-Based Financing and Venture Capital Work Together

As Chief Credit Officer at Lighter Capital, I work behind the scenes with the data that informs all of our decision-making regarding financing deals, from revenue-based financing (RBF) to term loans and contract loans.

Similar to a venture capitalist (VC), I try to understand where startups are in their life cycles — and where they can predictably go. Recently, several VCs asked for my perspective on how — and whether — RBF, term loans and contract loans fit into the funding life cycles of VC-backed startups.

As alternative financing solutions attract more interest from entrepreneurs, VC investors are seeing an increasing number of startups who have used these options for their growth and working capital needs, many times mixing and matching RBF with a term loan, or contract loan.

These flexible, non-dilutive financing solutions scale with a business’ growth, enabling entrepreneurs to focus on their businesses without giving up equity, personal guarantees, or board seats; it’s understandable why entrepreneurs are increasingly seeking such solutions to reach their next growth milestone.

With revenue-based financing, a company agrees to share a percentage of future revenue in exchange for up-front capital. The investor sees a return in the form of regular flexible adjusting payments based on a company’s business performance, which accommodates an early stage startup’s typical ups and downs.

Funding options by growth stage

What should VCs make of revenue-based financing? Is RBF simply an alternative to venture capital funding?

Startups can use RBF instead of working with VCs, but often, RBF is highly complementary to venture capital funding.

A quick look at where RBF typically sits in the funding cycle shows how.

Consider a typical equity path:

  1. Bootstrapping and friends and family: Founders launch their ideas with little or no funding from outside their circles.

  2. Angel and seed funding: As companies seek to grow revenue with their viable product, they turn to investors willing to fund the stages of commercialization.

  3. Venture funding: Startups with proven products and customers turn to VCs for the resources needed to accelerate growth.

Funding options by stage of growth

Often, revenue-based financing sits between angel/seed and venture capital funding rounds — or replaces angel and seed funding entirely — for entrepreneurs who go on to seek venture funding.

Revenue-based financing fuels pre-VC growth

Entrepreneurs who tap into revenue-based financing pre-VC funding come to Lighter Capital with a number of positive characteristics — many of which VCs like to see too like an established customer base and increasing revenue. Just as importantly, theses companies have developed products that have good margins, scalable cost structures, and recurring revenue. They simply need funding to invest in sales and marketing or other initiatives so they can drive even more growth.

The Lighter evaluation process also looks at how much equity C-level executives and founders own; for instance, if their equity ownership is above 50%, the company can receive a rating bump.

While Lighter companies aren’t typically profitable at initial funding, we always want to understand how and when the companies plan to get to break-even (i.e., their “path to profitability”). In fact, we use analysis to predict when a company has the potential to become cash-flow positive. Lighter Capital’s fintech lending platform pulls in 6,500 data points to reduce the entrepreneur’s time to raise funds by 90%. We use proprietary algorithms to determine a credit rating and data science to predict a startup’s revenue growth, with 97% accuracy, on average. By using objective, data-driven practices, we provide up to $4M in funding to a broad array of tech startups, promoting diversity of ideas, perspectives and leaders — ensuring that strong, creative thinkers have access to the resources they need, when they need them.

Lighter doesn’t need to see the path to explosive growth that many VCs seek in early stage investing. That’s because we’re not looking for the exceptional returns associated with venture. At Lighter, we want to see the good returns anticipated in our term sheets. Some of the companies we fund may never seek venture capital funding — rather, steady growth and stability is their goal.

Other companies we fund want to follow a path that leads to the outsized returns that VCs seek. These companies turn revenue-based financing into a solid foundation for the rapid growth that attracts interest from VCs. When they’re ready for venture capital funding, the companies have matured enough to reach inflection points in the market, and they’re ready to turn traction into market leadership.