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:
Bootstrapping and friends and family: Founders launch their ideas with little or no funding from outside their circles.
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.
Venture funding: Startups with proven products and customers turn to VCs for the resources needed to accelerate 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.
Lower-cost capital post-VC funding
Revenue-based financing can play a role in growth post-VC funding, too. Often, a company that receives support from venture investors has a plan to seek more funding at key milestones. As the company grows and its valuation climbs, exchanging equity for additional fuel makes sense for both founders and existing investors. Yet sometimes a company needs funds earlier than planned to stay on track and to become more attractive to VC’s at a future point.
Traditionally, a board facing that scenario has a few options. They could seek funding early at a hoped-for valuation. Venture debt may also be a consideration, but venture debt comes with stock warrants that involve surrendering equity. Some boards might even consider recommending a down round. However, adding RBF to the funding mix can be an alternative to more traditional dilutive options.
At Lighter Capital, we’re finding that boards that recommend exploring debt increasingly point to RBF as a possibility. Revenue-based financing makes sense at this stage for the same reasons it does earlier in the funding life cycle: this funding model doesn’t dilute equity. Plus, the time between initiating the funding process and receiving funding is weeks, not the months as it is with venture funding options. Then, as the company's revenues grow, so does access to more non-dilutive capital to extend runway.
Tapping into different funding sources to maximize success
Valant Medical Solutions provides an excellent example of how RBF and venture capital funding can work together. A SaaS company focused on bringing efficiencies to behavioral healthcare, Valant turned a combination of RBF and venture capital funding into a 500% growth rate.
To learn more about how a mix of revenue-based financing and VC helped Valant Medical Solution stimulate healthy growth, read Valant’s story.
VCs, let’s chat about how we can help startups grow together
Together we can bi-directionally refer companies that would be a better fit for the other — giving startups the right funding choice at different stages → Partner with Lighter Capital.