Over the last few years, revenue-based financing (RBF) has made a splash across the startup world, offering founders an alternative method to raise capital. Compared to the usual equity and bank loan paths, this method has appealed to many entrepreneurs for numerous reasons. With RBF, founders retain ownership and control, pay flexible monthly payments, share alignment with investors on growth goals, and hold no personal guarantees.
What’s maybe even more appealing about RBF is that it offers an alternative financing option for the 99% of companies that are not a fit for venture capital. Of course, not every company qualifies for this type of financing and it has downfalls too. No surprise here, the most restricting piece to revenue-based financing is that companies must be generating revenue to qualify. And usually somewhere to the tune of $5K-$15K in monthly recurring revenue. The amount raised is often limited to 3–4 months runway and will take revenue off your topline until the agreed-upon payback is fulfilled.
So what does RBF have to do with angel investors? Good question — it’s still very early in this scene and may not amount to much in the long run. However, on the heels of closing our first revenue-based financing deal within our angel group, it’s worth exploring how these terms paired with angel investors could be another option for you to explore when raising growth capital.
Why do angels invest?
It’s commonly said that angels aren’t in the game to make ‘loans’. Angel investing is associated with high-risk and long payback periods, assuming any capital gets returned at all. It’s a numbers game, quite honestly. Numerous studies¹ indicate it takes a well-diversified portfolio of at least 20–30 investments to significantly improve the odds for a return that outperforms traditional investment options.
So why do angels play in this space? I love asking our members this exact question, and the answers are telling. Many angels are also entrepreneurs, have walked in similar steps, and want to support fellow founders. They understand investing in the startup ecosystem is one of the best ways to support economic growth. Many want to stay current on relevant technology, innovation, and ideas. Most are looking to diversify their portfolios with an asset class that can yield higher returns, and are comfortable with the waiting game. In exchange for the high-risk, angels often seek ownership of the investment company with the expectation of a payout upon them reaching a successful exit.
When equity doesn’t make sense.
While the exchange of equity traditionally functions for angel investments, there are situations where different types of financing options allow for better alignment between founders and investors. Does your company have the potential for a large exit? Do you (or the founding team) want to run this company in perpetuity? In situations like these, reaching the hyped “homerun” return probably isn’t likely. However, angels may find the investment opportunity intriguing for other reasons such as the backing of social enterprises, supporting local (talent, team, technology), and the option for future collaboration between investor and company (potential customers or acquisition).
Knowing that I have an extremely ambitious vision for HTI Labs, and accomplishing our mission is something I am passionate about, I didn’t want to raise capital such that investors only get paid back if I seek an acquisition — that’s misalignment. RBF provides investors with a short-term exit in which I am incentivized to do exactly what serves the company and the mission — grow sustainably.
Honest consideration of your long-term goals may open the door to alternative funding terms that could be a stronger fit for your growth plans as well as intriguing enough to entice angel investors to participate.
Can RBF appeal to Angels?
Out of a portfolio of forty-eight companies, our angel group has only invested in one with revenue-based financing terms. Comparing to similar angel groups across five other Midwestern states, only one other group has also participated in RBF terms. I mentioned RBF with angels is still in its infancy, right? However, for our own group, this specific deal generated strong investment interest and provided insights into how these terms could be appealing to more angel investors in the future. Consider the following three components when pitching angels on RBF terms to increase your chances of gaining investors.
Higher than average IRR. Expected angel returns are commonly referenced in regards to the return multiple (i.e., a 10x return on the initial investment amount). However, including the length the investment is held in the return calculation will give you an internal rate of return. Consider structuring your proposed RBF terms to provide a higher IRR than investors expect with a more typical angel investment (>20%). Pitching angels on 1.5–2x returns when they typically look for double digits will be tough to grab their attention. Highlight the investment as an opportunity to receive an above-average IRR with payback checks starting immediately based upon your revenue traction.
Short payback period. Angels expect their investments to take an average of 7–10 years before providing any returns. This is a long time to have capital tied up in assets that likely aren’t providing any type of income. As angel investors continue to diversify their portfolios (especially in a post-COVID world), I expect more openness to deal terms that generate returns in a much shorter window. Revenue-based financing with a payback over 2–3 years not only cuts that window down drastically but also starts to put cash back in the investor’s hands immediately.
Include warrants. Angels are used to receiving ownership in exchange for their investment. If they are putting their money behind you, they want to see you succeed and are prepared for the long run. Providing an option where they can purchase company stock at a set price on a future date changes what may feel more like a short-term loan to more of an “angel investment” opportunity. Not only does this give the investor an option to partake in your company’s future upside, but it also provides a future opportunity for your company to access capital from existing investors.
Find the option that best fits your need.
Founders considering revenue-based financing should get to know the key players in the space. Many funds specialize in this type of financing, all with different spins on terms and investment requirements. A few of the largest funds worth exploring include Indie.vc, Decathlon Capital Partners, Lighter Capital, and Novel Growth Partners. While RBF is still new to the angel investing space, it’s starting to get more eyes and consideration from a group of investors who traditionally have only considered the equity path. All sources of capital offer different pros and cons and need to be assessed based on your own specific needs. Do you want to raise locally or build a relationship with a more national fund? Where are your existing investor connections? What financing needs do you project for the future?
Only time will tell how impactful angel investors can be at providing revenue-based financing. As you explore future capital sources for fueling your company growth, add this approach as another option to consider.
Disclaimer: The opinions expressed do not necessarily reflect those of the Nebraska Angels organization or its members.