This is Part I of a two-part series on Revenue-Financed Capital (RFC) for angels. Part II will address the question of whether angels should include RFC in their investment portfolio.
ACA member Sage Growth Capital hosted a meet-up of attendees who were interested in RFC at the recent ACA Summit in Las Vegas. On the last day of the Summit, Sage also presented a formal session on the nuts and bolts of RFC along with counsel Gary Kocher of K&L Gates and Sage investor Jb Beaird. Much to our delight (and admittedly, surprise), it was standing room only for both sessions (and that was after we were moved to a larger room – both times).
Sage launched its first fund in 2019 and has actively evangelized for the RFC model of investment in many gatherings across the country since then. We have witnessed a steady increase in individuals and angel groups who are interested, but the appetite seems to have finally taken hold. Why are so many angels expressing interest in RFC? And perhaps more importantly, is this form of capital appropriate for their portfolio companies?
Revenue-financed capital is risk capital that is not dependent upon an exit to generate a return. Instead, RFC is a purchase of a share of revenue until an agreed-upon fixed return has been paid. While there are regular payments, those payments are variable depending upon revenue. And if the company fails, we may lose all or a portion of our investment similar to equity investors.
There are four variables associated with RFC:
1. The amount of the investment. Most revenue-finance investors look to historical revenue in setting the amount of the investment. Sage will invest up to one-third of trailing twelve-month revenues.
2. The return, expressed as a multiple of the investment. It is well understood in equity investments that the investors are seeking 10 times their investment or more. This “home run” return will be received at the proverbial exit. RFC investors are willing to accept a much lower multiple because they will receive monthly cash payments starting within a few months of closing the deal, and they are not dependent on an exit to achieve their returns. Sage targets multiples of 2 to 3 times its investment.
3. The payment, expressed as a percentage of monthly revenue. Known as the “revenue rate”, most RFC investors receive between 3 and 8% each month until they have received the agreed upon return. While we call this type of capital “revenue-finance,” in fact it is collections based. That is, we apply the revenue rate to the actual cash collected each month, not the revenues themselves.
4. Time. The first three variables are established up front through negotiation. Time is the unknown variable, as it is dependent upon the company’s growth and resulting monthly cash receipts. However, each revenue-finance investor has a target timeframe they shoot for when underwriting the investment. This ranges from a few weeks to as much as ten years. In Sage’s case we generally target 48-60 months for full payment of our investment plus return.
Playing Nicely with Others
Virtually all companies that are beginning to scale require additional cash to do so. For example, the company may need to finance additional inventory and receivables; it may need to fund larger marketing campaigns or invest in additional human talent.
Raising additional equity to fund these needs may be the right decision, especially if the company is highly leveraged, or bleeding significant amounts of cash. However, selling this equity will dilute the existing shareholders and entrepreneurs, especially during a period of lower valuations like we are seeing in 2023. Likewise, angels often grow weary of having to reach into their own pockets for additional cash when the company still has significant milestones to reach.
An alternative may be to add RFC to the capital stack, either as a substitute for selling equity or alongside a smaller equity raise. If the company can meet new milestones by deploying RFC, then the company will likely be able to return to the equity market later with an improved valuation, much to the benefit of the equity holders and Founders.
Sage finds no conflict between equity investors and its capital. Rather we see this as a symbiotic relationship. Equity is required to fund pre-revenue companies, and likely will be needed to fully scale the company. But in between RFC can often be deployed to get the company to its next milestones, without incurring dilution associated with new equity or convertible notes.
What About Those Payments?
Equity investors sometimes object to RFC because precious cash will leave the company to pay the RFC investors. There is a counter argument: if the company can increase its sales by deploying RFC, and if the company produces significant gross margins from those sales (Sage defines significant as 40% or greater), then the margin from the increased sales will be sufficient to both service the RFC and to produce additional positive cash flow to the company. Indeed, we don’t make the investment unless we are confident this will be the case.
One of the Sage portfolio companies came to us as it was beginning to scale. We initially invested $250,000. Using our cash, the company was able to grow its sales with high margins. They took a total of $1 million of RFC, which we were happy to provide as their sales increased. They recently retired their RFC capital, having successfully raised equity at more than a $24 million pre-money valuation, well more than the perhaps $3 million valuation they might have received when they first deployed RFC 3 years earlier.
Today’s Fundraising Environment
While there have recently been signs the dramatic drop in private equity investments may be beginning to reverse, clearly valuations continue to be quite low. This is one of the reasons angels are recognizing RFC as a useful tool in their portfolio companies’ capital stack: a round of RFC funding may get the company the capital it needs to continue to grow without resorting to a down round.
If you have a company in your portfolio and wonder if RFC could be appropriate for its capital stack, contact us at email@example.com. We will be happy to visit with you and/or the entrepreneur.
About Sage Growth Capital
Sage Growth Capital is a venture capital firm that provides revenue-financed capital exclusively. We launched our first fund in Q4 2019 and have invested $5.6 million in 20 deals as of June 2023. We invest between $100,000 and $1 million in growing companies at any stage with “recurring-like” revenue, gross margins of at least 40%, and who can demonstrate that our capital will lead to higher sales. Our limited partners are all angels and most of our deal flow comes from the angel investor community. 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, 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.
About Revenue-Financed Capital for ACA members
For additional information on revenue-financed capital, ACA members may join the ACA Connect Community on Revenue-Financed Capital by going here to complete the form. This is a place where those interested in RFC can exchange information. Members may also download the slides from the Sage presentation to the 2023 Summit in Las Vegas, and Sage partner Kevin Learned's white paper, Revenue-Based Investing: Another Option for Angel Investors.