Traditionally, if you want to raise money, you do it in one of two ways: through debt or equity financing. But angel investors who want to lend a new business money at a reasonable interest rate are rare (for good reason), and those who want to do it for a piece of the pie typically want a bigger chunk of the company than entrepreneurs want to relinquish.
Perhaps there’s a third way.
Some innovators in the startup community have developed a new way to raise money: revenue-based financing. Instead of giving away a piece of your company, a lender receives a cut of all top-line revenue the company receives. If the company grows faster than expected, the loan gets paid back faster. And vice versa.
It may be structured in a number of ways. A few years ago, blogger and author Seth Godin posted about revenue-based financing and suggested that the investor would receive a stream of revenue forever. Others who use revenue-based financing implement a hard cap when a certain dollar amount is reached. The latter strikes me as fairer to entrepreneurs.
The risk profile for an investor falls in between that of an equity or debt investor. An investor stands to gain more than they would normally for loan, but not quite as much on the upside as is possible for equity. That said, unlike with a pure equity investment, the downside isn’t quite as severe, as the investor would automatically receive compensation from every dollar the company receives.
This approach makes sense for a company with some operating history and income. From an investor’s perspective, it would likely be too speculative for a brand new entity.