Additional Thoughts On My SEC Interview

Over the summer, I had the honor of being part of the SEC’s “Let’s Talk Small Business” podcast with Kathryn Steinberg. It was a great opportunity to introduce Revenue Based Financing to a broader community. Because it was a quick conversation, it was hard to say everything there is to say about Revenue Based Financing so I wanted to expand on some of my comments in this blog post. 

First, what is Revenue Based Financing and where did it come from?: 

Revenue Based Financing is a form of financing that is based on a company’s revenue. As we like to say when introducing the concept to entrepreneurs and investors, RBF aligns the good parts of equity and the good parts of debt. Sage’s version, which is different from others in the marketplace, does not require a UCC lien filing (same as equity but unlike most debt) and payments are variable based on the customer receipts each month. Similar to equity, we need the company to grow in order to achieve our payback. 

I covered more of this in the Podcast, but what I didn’t talk about is the origins of RBF. I was first introduced to the concept of RBF by Clayton Christensen who was looking at ways to disrupt Venture Capital and suggested that RBF might be a way to do that. When I read one of his articles, I had just started at Lighter Capital. I was coming out of the Private Equity industry and had been doing a lot of mezzanine transactions, so I thought of RBF as the mezzanine for VC. Since then, it has evolved and grown beyond that. I now think of venture debt as more of the mezzanine and RBF as the high yield bond. RBF takes a lot more risk and therefore receives more gain, but not the same level of gain that equity receives because RBF’s potential return is capped. 

Second, what RBF is not: 

We briefly touched on this topic in the conversation with Kathryn, but RBF is not a Merchant Cash Advance (MCA) as much as MCA lenders would like to (and do) call themselves RBF. RBF was designed to be a VC-like investment. VC investments are 10 years on average. MCA is 3 months or 6 months if you are lucky. MCA loans aren’t in it for the long haul and their underwriting standards aren’t designed to ensure the long-term health of your company. They are short term players who can cost your business a lot of money. 

One thing that makes MCAs  similar to VC is that they have a lot of defaults, and for that reason they have to charge high rates to make up for the companies that are never going to pay them back. In RBF we are trying to hit singles and doubles; not swinging for a homerun to make up for all the strike-outs. Because we aren’t investing for outsized returns to make up for the losses, we mitigate our risk by conducting real diligence on the companies in which we invest. 

Third and Finally (although I have more thoughts!), Regulatory Environment:

As an RBF provider, we operate in a gray area from a regulatory perspective because we are mixing both equity and debt-like structures, as mentioned above.  This means that we have to pay attention to all the regulations for both lenders and private equity investors not only at the  Federal level, but at each State level as well. Staying informed and observing ongoing changes to so many different regulations is a significant endeavor, as we have portfolio companies in over 14 states, and will consider investments in companies located in any state within the US. 

This has become particularly more difficult in recent years as states are increasing regulations to protect businesses from predatory lenders. Since the MCAs have started calling themselves “RBF”, it has muddied the waters for regulators and we often find ourselves subject to laws that were really intended to prevent short-term, high interest loans..Since we are truly long term capital (3 years plus with an average duration of 4 years) it is frustrating to get caught up in this net.  I understand why states want to regulate the interest rate charged, but the effective interest rate on an equity investment that is going well would far exceed many of these laws. For states that want to create additional forms of investment capital for their start up businesses, we encourage the regulators to look at the entire investment community and think about the holistic impact of their regulations. 

We would love to continue this dialogue with others who are attempting to provide alternatives for companies who need growth capital, as well as state regulators. 

About Sage Growth Capital

Sage Growth Capital makes revenue-financed investments in companies at any stage who need growth capital. It is our mission to provide a more flexible funding option to growing companies who do not fit traditional equity or lending models. To learn more about Sage Growth Capital or to apply for funding visit: www.sagegrowthcapital.com.

About Revenue-Financed Capital

Revenue-financed capital (RFC), also referred to as royalty financing, revenue share or revenue-based financing (RBF), is a non-dilutive form of growth capital where investors receive a percentage of monthly revenues until a set amount has been paid. RFC differs from equity financing as the investor does not obtain ownership of the company and it differs from debt financing as there is no collateral required and payments are variable. RFC is designed to empower entrepreneurs to grow their businesses with non-dilutive capital that aligns with their sales cycles.