Notes

Revenue-Based Financing for Technology Companies With Simply no Hard Assets
WHAT IS REVENUE-BASED FINANCING?

Revenue-based financing (RBF), likewise known as royalty-based financing, is a good unique form involving financing provided by RBF investors to small- to mid-sized organizations in exchange to have an agreed-upon percentage of your business' gross profits.

The capital supplier receives monthly payments until his put in capital is paid back, along with some sort of multiple of that will invested capital.

Expense funds that offer this unique form involving financing are recognized as RBF finances.

TERMINOLOGY

- Typically the monthly payments are usually referred to because royalty payments.

instructions The percentage associated with revenue paid by the business to typically the capital provider will be referred to as the royalty rate.

- The a variety of of invested capital which is paid simply by the business in order to the capital service provider is referred to be able to as a hat.

CASE STUDY

Many RBF capital suppliers seek a twenty percent to 25% return on their investment.

Let's use a very easy example: When an enterprise receives $1M coming from an RBF capital provider, the organization is expected to repay $200, 500 to $250, 500 per year for the capital provider. That will amounts to concerning $17, 000 to be able to $21, 000 paid per month by simply the business in order to the investor.

Therefore, the capital service provider expects to obtain the invested capital back within four to 5 yrs.

WHAT IS THE PARTICULAR ROYALTY RATE?

Every single capital provider can determine its own predicted royalty rate. Inside our simple example above, we can job backwards to figure out the rate.

Let's assume that the business produces $5M in gross earnings per year. Since indicated above, that they received $1M from your capital provider. These are paying $200, 1000 back to typically the investor each year.

The royalty price in this example is $200, 000/$5M = 4%

VARIABLE ROYALTY RATE

Typically the royalty payments will be proportional to the top line associated with the business. Everything being equal, the greater the revenues that the business generates, the greater the monthly royalty payments the enterprise makes to the particular capital provider.

Standard debt involves preset payments. Therefore , the RBF scenario looks unfair. In ways, typically the business owners are increasingly being punished for their very own work and accomplishment in growing the particular business.

To be able to solution this problem, just about all royalty financing negotiating incorporate a variable royalty rate timetable. In this manner, the increased the revenues, the particular lower the royals rate applied.

The complete sliding scale schedule is negotiated between your parties involved in addition to clearly outlined in the term sheet and even contract.

HOW TRULY DOES A COMPANY EXIT THE PARTICULAR REVENUE-BASED FINANCING SET UP?

Every business, especially technology businesses, of which grow very quickly will eventually grow out of their requirement of this particular form of financing.

As the enterprise balance sheet and earnings statement become better, the business enterprise will move up the financing ladder and entice the attention of more traditional funding solution providers. The business may become qualified for traditional credit card debt at cheaper rates of interest.

As such, each revenue-based financing agreement outlines how some sort of business can buy-down or buy-out the capital provider.

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The business owner always provides an option to get down a part from the royalty contract. The particular terms intended for a buy-down option vary for each and every deal.

Generally, the capital service provider expects to receive a new certain specific portion (or multiple) of its invested capital before the buy-down option may be exercised by the particular business proprietor.

The business owner can exercise the option by causing a single transaction or multiple lump-sum payments to typically the capital provider. The payment buys lower a certain portion of the vips agreement. The used capital and month to month royalty payments may then be lowered by a relative percentage.

Buy-Out Alternative:

Sometimes, the enterprise may decide that wants to cash out and extinguish the entire royalty financing agreement.

This often occurs when the business is being sold and the acquirer chooses not to continue the financing arrangement. Or even when the organization is now strong enough to access cheaper sources of auto financing and wants to be able to restructure itself economically.

In this circumstance, the business has the choice to get out the entire royalty agreement for a predetermined multiple of the one and indivisible invested capital. This multiple is commonly known as a cap. The specific terms for a buy-out alternative vary for every deal.

USE OF CASH

There are generally no restrictions on how RBF funds can be applied by the business. Contrary to within a traditional credit card debt arrangement, there are usually little to little restrictive debt contrat on how the enterprise can use the funds.

The money provider allows the particular business managers in order to use the cash as they see fit to grow the business.

Acquisition loans:

Many technology businesses use RBF money to acquire additional businesses in purchase to ramp upward their growth. RBF capital providers encourage this type of expansion because it increases the particular revenues that their royalty rate can be applied to.

As the business develops by acquisition, typically the RBF fund obtains higher royalty obligations and thus benefits by the growth. As a result, RBF funding can be a great source regarding acquisition financing with regard to a technology business.

BENEFITS OF REVENUE-BASED FINANCING TO TECHNOLOGIES COMPANIES

No resources, No personal guarantees, No traditional credit card debt:

Technology businesses are unique in of which they rarely experience traditional hard possessions like real estate, equipment, or equipment. Technology companies are motivated by intellectual funds and intellectual real estate.

These intangible IP assets are hard to value. As these kinds of, traditional lenders give them little to no cost. pledged share makes this extremely difficult for small- to mid-sized technology companies to be able to access traditional auto financing.

Revenue-based financing truly does not require a business to collateralize the financing together with any assets. Simply no personal guarantees are required from the enterprise owners. In a new traditional bank bank loan, the bank often requires personal guarantees from the masters, and pursues the particular owners' personal assets in case of an arrears.

RBF capital provider's interests are in-line with the business proprietor:

Technology businesses may scale up faster than traditional businesses. As such, revenues can ramp upward quickly, which permits the business paying down the movie stars quickly. On typically the other hand, a poor product delivered to market can destroy the organization revenues just because quickly.

A regular financial institution such as the bank receives set debt payments from a business borrower regardless of whether or not the business grows or even shrinks. During low fat times, the organization makes the exact debt payments towards the bank.

An RBF capital provider's interests are aligned with the business owner. In the event that the business earnings decrease, the RBF capital provider will get less money. When the business revenues raise, the capital supplier receives more funds.

As such, the particular RBF provider needs the business revenues to develop quickly so it can talk about in the upside. All parties profit from the earnings growth in the business.

High Gross Margins:

Most technology businesses generate increased gross margins compared to traditional businesses. These kinds of higher margins create RBF affordable for technology businesses in many different groups.

RBF funds seek out businesses with large margins that can comfortably spend the money for month-to-month royalty payments.

Zero equity, No table seats, No damage of control:

The capital provider shares in the success of the company but does certainly not receive any fairness in the business. As such, the cost of capital within an RBF arrangement is less expensive in financial and operational terms compared to a comparable collateral investment.

RBF funds providers have zero interest in being active in the management of the particular business. The level with their active engagement is reviewing month to month revenue reports obtained from the business managing team in buy to apply the appropriate RBF royalty level.

A traditional equity investor expects to have a sturdy voice in how a business is managed. He expects the board seat and some level of control.

A traditional equity investor expects to receive a significantly larger multiple of their invested capital if the business is sold. This is since he takes increased risk as he or she rarely receives virtually any financial compensation until the business will be sold.

Cost associated with Capital:

The RBF capital provider receives payments each month. It does certainly not need the business in order to be bought from order to earn a positive return. This means of which the RBF funds provider can afford to accept lower profits. This is precisely why it is cheaper than traditional collateral.

On the some other hand, RBF is usually riskier than classic debt. A financial institution receives fixed monthly installments regardless of the particular financials of the business. The RBF funds provider can drop his entire investment decision if the business fails.

On the particular balance sheet, RBF sits between a lender loan and equity. As such, RBF is generally extra expensive than classic debt financing, but cheaper than standard equity.

Funds can be received inside 30 to 70 days:

Unlike traditional debt or equity investments, RBF will not require months regarding due diligence or complex valuations.


As such, the turnaround time between delivering a term bed sheet for financing for the business owner and the funds disbanded to the organization can be while little as 25 to 60 days.

Businesses that need cash immediately can usually benefit from this quick turnaround period.

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