Revenue-based finance, an innovative funding option for technology intensive fast-growing companies

Over the last decades, business models and the way companies create value have changed fundamentally. We could observe a shift from material assets to immaterial assets as the primary source for value creation. In 1975, material assets represented 87% of the market capitalization of the S&P 500 while immaterial assets, such as intellectual property, licenses, brands accounted for only 13% of market capitalization. In 2015, this relation was reversed. Today “asset light” companies like Apple, Alphabet, Amazon, and Facebook are among the most valuable listed companies.

This fundamental transformation from an economy built on tangible assets towards an economy of intangible assets has a profound impact on how companies are financed. Young and fast growing companies typically based on technological innovation also face this problem. They need less capital for investment in machinery and equipment than into software development and the scale-up of sales organizations. However, traditional banks only lend against tangible collateral or personal guarantees, which those companies cannot or do not want to provide. Thus, the most frequent reason for not obtaining access to bank financing mentioned by young companies is lack of collateral. Equity is an important source of funding but it cannot fulfil market demand because it is scarce, expensive, and dilutive to entrepreneurs.

Revenue based loans are an innovation in continental Europe and can significantly help to close the funding gap for young growth companies, especially those based on intangible assets with recurring revenue streams.

This form of financing is not new however, in the U.S. a model with a fix repayment cap has proven to be the most successful. The company receives a financing amount and the investor is repaid by getting a percentage of the company`s monthly revenues (revenue share or royalty payment) of 3-6% until the pre-agreed cap has been reached. The maturity is open but estimated to be 3-5 years. The reverse model with predefined maturity and open repayment amount can be an interesting alternative. The investor will take some collateral to secure his claims but will limit this to material and immaterial assets available within the company and might also have conversion rights in case of default. The key advantages of revenue-based finance are that it does not dilute ownership and that repayments are flexible and adapted to the success of the company in terms of revenue growth.

Revenue-based loans are a highly attractive funding alternative for owners of fast growing early stage companies that need to bring in additional capital for growth but not wanting to give up major stakes of their ownership. As such, it is an excellent complement to other funding sources such as business angels and seed capital funds. Furthermore, a revenue-based loan fund doesn´t need a sale of the company to exit the investment and can thereby support buy-and-hold strategies and long investment horizons of private or strategic investors.

The typical investment case for a revenue based loan is a growth initiative that yields short term revenue growth. Revenue based financing can thus be an interesting addition to equity financing and help companies to grow until they become eligible for bank financing. Round2 Capital Partners is the first fund in the DACH region to provide this form of risk capital to growth companies.

The aaia thanks Christian Czernich, Isabella Hermann-Schön and Jan Hillered from round2capital for the insights!