Ask the Expert: Freeing revenue-based financing from the equity mindset

Ask the Expert, Startup Initiatives |

This article first appeared in the Union Leader in March 2020

For many businesses that don’t catch the eye of equity investors, revenue-based funding (RBF) can be a powerful growth tool. Unleashing its potential, however, requires a mindset that goes beyond an equity-oriented investment approach.

The New Hampshire Community Loan Fund’s Vested for Growth program has deployed RBF for 16 years (referring to it as royalty, or mezzanine, financing). These investments comprise 45 deals totaling close to $15 million with a 12% internal rate of return net of losses.

RBF is gaining prominence in conversations about growth capital products for small-business entrepreneurs. The growth models of many businesses that offer moderate levels of risk and reward can look unattractive to banks and equity investors (institutional VCs and individual angels). Banks interpret insufficient collateral or a secondary form of repayment as risks exceeding what either their policies or regulators allow. On the other hand, equity investors see underwhelming reward potential.

This is where RBF enters. A deal structure based on revenue — a hybrid of debt and equity — is well aligned with the moderate-risk/moderate-reward profiles of most business growth plans.

Successful RBF deals demand a shift in investors’ attitude and approach away from an equity orientation in seven areas.

1. Look beyond startups. Those with fast-growth strategies and highly disruptive value propositions are currently encouraged to pursue equity. However, established businesses with a minimum $500,000 to $1 million revenue are among the best suited for RBF.

2. Actively seek opportunities. With no shortage of startups seeking funding, many equity investors spend so much time filtering through pitches and proposals that actively seeking investment opportunities seems like a waste of resources. Entrepreneurs for whom RBF is ideal, however, are likely unaware that such a deal structure exists and may become discouraged and dismiss growth capital entirely. RBF investors need to make themselves visible in that moment and actively present this alternative.

3. Consider opportunities beyond your expertise. Investors’ appetites are often narrowed by the belief that they personally need a high level of relevant industry expertise to be successful investors. By contrast, since RBF investors don’t have a decision-making role in the partnership, they can be useful sounding boards and seek to match the entrepreneur (the actual decision maker) with appropriate experts in their networks.

4. Recalibrate your idea of success. Equity investors who screen only for propositions capable of delivering five to 10 times return multiples overlook lots of businesses with solid growth plans. Their investments usually generate no return for three to five years, a span that diminishes their eventual internal rate of return. RBF investors, on the other hand, receive income the month after closing the deal. Those who can get excited about the prospect of an 18-percent return open a bigger window of possibilities and reward.

5. Break out of silos. Equity investors often team up with other equity investors, but RBF success often requires partnering with banks and other investors that can connect that business to other deal structures as its growth dictates. Successful investors will help entrepreneurs understand what tools they really need (our Capital Compass can help) and support their ability to tap into a range of financing structures at different stages of growth and for different reasons.

6. Commit to the long game. Equity portfolios often do better when investors cut their losses early and focus on the likeliest top earners. By contrast, an RBF investor’s bias toward “staying in the relationship” can be a sound approach. Our experience is that if company management is transparent ─ incorporating lessons learned and adapting ─ patience often facilitates success and preserves investments.

7. Create a mutually beneficial partnership. Equity investors have considerable power to set the rules, and often begin with their own business valuation and a take a “take it or leave it” approach to negotiations. RBF is built on partnership with the business’s management team, from initial discussions to the final payment. Alignment is baked into RBF investments because the return is harvested through a model based on monthly payments and does not require the sale of the business.

John Hamilton leads the New Hampshire Community Loan Fund’s Vested for Growth program. To learn more, call investor Brigid Murray at (603) 856-0770 or visit