For the past year, the partners at Sage Growth Capital have been relentlessly singing the praises of revenue-based finance in an effort to help entrepreneurs and angel investors understand whether this newer form of finance is a good fit for them. The # 1 question is always, ‘Yea, but how does YOUR fund work?’ So in honor of our 1 year anniversary this month, rather than talking about RBF in general, this blog post is about Sage’s model in specific.
Revenue-Based Investing in General (because we can’t help it)
A revenue-based investment is one where the entrepreneur pays the investor a percentage of monthly revenue until the investor has been repaid their original investment plus a multiple. For example, an investor might invest $100,000 in exchange for the right to receive payments of 5% of monthly revenue until a total of $250,000 has been paid.
There are a number of groups in the U.S. making investments based off of this general concept, with many variations.
So, How Does Sage’s Fund Work?
Amount of Investment. We can invest up to 1/3 of your revenue over the past 12 months. Our fund’s limit in any company is $400,000. If you need (and qualify for) more than that, we may be able to syndicate the investment to other groups or help you design and implement a larger offering you can present to your own investors.
Instrument. We use a convertible note that specifies a multiple rather than an interest rate. If, and only if, some amount remains unpaid at the due date, then Sage has the option to convert the remaining balance into equity. We hasten to point out that we really, really do not want to end up holding equity, but this is a remedy available to us as a last resort.
Pricing. We combine principal, multiple and revenue rate to “price” the investment and estimate monthly payments:
Principal. Like all loans, principal is the amount we invest. In our case, we will invest as little as $75,000 and as much as $400,000.
Multiple. The multiple is the amount times our principal to be paid. Typically, our multiples are between 2-3 times the investment. The multiple we offer is dependent upon the company’s risk profile and the expected time to complete repayment.
Revenue Rate. The revenue rate is the percentage of cash receipts from sales that is paid each month until the note amount has been paid. Our revenue rate varies between 3 – 8%. Sage only considers cash receipts from revenue-generating transactions. This would include what was actually collected on accounts receivable (for those organizations that sell on credit), cash receipts from direct sales, or license fees paid for SaaS sales. We do not take a percentage of non-sales cash receipts such as the sale of securities, travel refunds, or the sale of fixed assets.
Payments. The monthly payment is the revenue rate times the deposits from sales activities for the month. This means the payment amount fluctuates with sales each month: when sales go up, the payment goes up and when sales go down, the payment also goes down.
What we don’t know but must be taken into account when pricing the investment, is future sales. Sage makes our own estimate of future sales, and sets the principal, multiple and revenue rate accordingly.
There is some pricing flexibility for each investment. For example, some companies may prefer a lower revenue rate in exchange for a higher multiple. Others may prefer a higher revenue rate in exchange for a lower multiple. Or companies may accept a lower principal investment in exchange for a lower multiple and revenue rate.
We try to offer preliminary pricing very early in the due diligence process so both we and you know whether we should continue to conduct due diligence and draft documents.
Interest Rate. There is no stated interest rate. This is for the very simple reason that we invest for a multiple of our investment, not for an interest rate. The effective interest rate can only be computed once the investment has been retired, as we don’t know how long it will actually take for your company to pay back the agreed upon multiple.
Timing and Collection
Reconciliation. In order to determine the monthly payment amount, there is a reconciliation process. By the fifth business day of the month we expect a report from you on the total deposits to the company bank accounts, and of that, any deposits that are not from sales activities. We require read-only access to the company’s bank accounts and will verify total deposits. We will review any deposits not from sales activities and agree with you on the total deposits from sales activities that are subject to the total amount due.
Making the Payment. On the tenth business day of the month we will issue an ACH transaction to withdraw the payment amount from your account.
Grace Period. We want you to have time to deploy the capital and start to see the benefit from that capital before starting repayments. Consequently, we give you a three-month grace period before your first payment is due. If we write you a check for investment on July 1, then we will compute your first payment based upon October’s sales. That payment will be made on November 10. Because the first payment is made on the tenth day of the fifth month following the investment, you end up with an effective grace period of four months.
Final Payment Due Date. When we price the investment, we estimate how many months it will take you to completely pay the total note amount (principal times multiple). We then add twelve months to that estimate to set the final due date. On that due date any amount remaining unpaid comes due, and we can, at our option, convert that amount to stock or ownership interests in your company.
Prepayment. You can retire the obligation at any time by paying the remaining balance of the total note amount. This means if your company conducts a successful equity raise, you have the option of leaving our note in place or paying it off. Likewise, if there is an exit event, the investment can be left in place, or paid off.
Collateral and Guarantees. We do not take collateral or require personal guarantees. We are general creditors of your company with a contractual right to a percentage of each month’s cash receipts until we have been paid the agreed upon multiple of our investment.
Warrants / Equity. As we mentioned at the beginning, we greatly prefer that our investment never converts to equity, but we do have the option. Unlike other funds, we do not take equity or warrants along side our principal investments.
The past year has included numerous local, regional and national presentations by our Partners on how we utilize revenue-based investing. We have links to some of those presentations on our website if you would like further information: www.sagegrowthcapital.com/resources .
If you think revenue-based capital might be appropriate for your business, we want to hear from you! The easiest way to start a conversation is to submit our simple application found at www.sagegrowthcapital.com/apply-now.
Sage Growth Capital makes revenue-based investments in regional companies 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.