TL;DR - Definition and explanation of revenue-based financing (RBF) and its primary structures with examples
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Tags - revenue-based financing, RBF, RBF structures, RBF structuring model, Bigfoot Capital
- What is revenue-based financing (RBF)?
- Who is RBF financing for?
- What are the primary structures of RBF?
- What do RBF investors look at?
- Revenue-based financing (RBF) is an alternative growth investment method in which investors receive a percentage of the company’s future ongoing revenues until a multiple of their principal investment has been paid.
- RBF is first and foremost a debt instrument (with different mechanics, provisions and return profiles than either equity capital or traditional lending products).
- RBF is for growing companies that either do not have the current revenue growth rates/scale or lack the assets and meaningful profitability/cash flow to secure traditional debt products (bank financing).
- The return is typically IRR-driven (Internal Rate of Return) based on the timing and volume of the cash receipts that investors receive the term of their investment.
- Higher revenue growth = Higher IRR for investors; investors capture cash and recoup their investment more rapidly.
- Lower revenue growth = Lower IRR for investors; investors wait longer for their cash share which deters their recoup.
- 2 main approaches to RBF
- Pure debt instrument:
- Expectation: the investment will be paid back and a return cap will be achieved over time (24-34 months) based on monthly payments delivered as a percentage of the company’s cash revenues.
- Does not impact the founder’s cap table (i.e. no ownership given up).
- Generally senior capital; first priority of payment in a capital stack that may include equity
- Hybrid debt/equity investment:
- Similar to a traditional convertible note
- Key difference: if the company fails to raise a certain amount of capital within a certain timeframe, the investment will not convert to equity and will need to be repaid at a significant multiple of the investment.
- Can be considered as redeemable equity where the founder sells equity and can redeem by purchasing it back at a premium.
- The time frame is generally longer than a pure RBF (e.g. 5-7 years vs 2-5 years), and the return cap requirement will be higher (3-4x).
- Before investing, RBF investors evaluate: existing revenue traction, revenue growth (at least 20% YoY), revenue quality, and fundamental quality of operations.
Follow up links:
- Internal Rate of Return (IRR), https://www.investopedia.com/terms/i/irr.asp
- Time value of money, https://psu.instructure.com/courses/1806581/pages/introduction-what-is-time-value-of-money
- Comparison between pure debt instrument and hybrid debt/equity investment, https://medium.com/swlh/alternative-funding-calculus-a-quant-comparison-of-tiny-indie-and-earnest-8d61d35d5ad5
- Determining the quality of SaaS Revenue, https://www.bigfootcap.com/determine-quality-saas-revenue/