When Tweens Need Cash

What kind of business is revenue-based funding (RBF) good for?  That’s one of the most frequent questions startups and investors ask as they explore RBF.  While there’s no limit to how big or small a company has to be, a lot of deals have been circling startups with between $2 million – $15 million in annual revenue.  It’s becoming a sweet spot.  The question is… why?

The short answer is – these companies ($2-$15M) are tweens.  They’re the Miley Cyrus’s and Justin Bieber’s of startupville.  Like girls ages 10-13 who are “too old for toys but too young for boys,” startups between $2-15 million can need money that’s “too small for institutional investors but too much for grandma.”

Imagine you’re a $2 million company looking to raise, say, $300K.  That’s a number few VCs or mezzanine debt-types get excited by.  It’s “too small to be interesting.”  Meanwhile it’s too much for grandma (at least my grandma) and the local credit union thinks it’s a lot of money for a new business unless they can saddle it with draconian covenants, personal liability and collateral liens.

This leaves few options for tweens other than RBF and equity-based “angel” investment.  Seen this way, the choice gets narrowed down to (a) giving up a percentage of revenue (RBF), or (b) giving up a percentage of ownership (angel equity).  Now what?

The choice depends on what you really think about your business.  If you think it’ll be a disaster or mediocre at best, it may make sense to give up a percentage of ownership to an angel investor.  This is especially the case if there’s no chance in Sam Hill you’ll ever get bought or go IPO.  In this scenario your business keeps the cash and the investor gets nothing.  Of course, to get this money you’d have to lie through your teeth, all the while convincing the investor you had every expectation of a massive acquisition or IPO in the near future.  In other words, you’d have to be a lying, cheating fraud.

Yet things change if you really think your business is something special.  Something with huge potential.  Something worth investing in.  In that case you’d be hard pressed to give up even a scintilla of ownership if there was any alternative.  Think about it – equity in a great company can appreciate astronomically more than any fixed financial instrument.  For example, Apple stock has appreciated around 380% over the past five years (that’s an average of about 76% per year).  If you really thought your company was the next “Apple,” why on Earth would you give up those rewards by frittering away your equity?

If you’re really the next Apple or something like it, RBF can be a better option – if for no other reason than you don’t have to give up equity.  Instead, you give up a percentage of your revenue up to a predetermined maximum.  That’s right… a maximum.  In other words, you keep your equity (and its upside potential) while raising cash that’s hedged by a maximum possible obligation if all goes well.

Myley Cyrus says “if you believe in yourself anything is possible” (although I’m pretty sure she borrowed that quote).  So like any tween, your choices are a function of your self-expectations.   If you think your business will be the lowest ranked meth addict in cell block 6 someday, you may want to sell out now because it’s only going to get worse.  But if you think you have the next American Idol, Glee cast member or Twilight heartthrob on your hands, you may want to give RBF a second look.

Author: Thomas Thurston


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