When sourcing capital, startup founders typically utilize one of two basic structures: debt or equity. We’ve discussed the differences between debt and equity in the past, but here’s a refresher:
With debt financing, the startup must pay back an investor’s loan within an outlined amount of time – with interest. Equity means the startup provides a portion of the ownership of the company to the investor in exchange for capital.
In the venture capital space, convertible debt is typically preferred because it combines the benefits of debt and equity into a single capital source. Convertible debt, usually in the form of a convertible note, is essentially a loan which converts into equity at an agreed-upon milestone or the maturity date.
But revenue sharing can be an interesting alternative. At its very basic, revenue sharing is a form of lending that involves sharing operating profits with investors as return on their investment.
Breaking Down Revenue Share
The primary benefit of a rev share investment structure is that both startup founders/management and investors are aligned towards the goal of creating sustainable revenue. Investors are repaid incrementally as the company generates sales, and repayment is typically 1.5 to 2.5 times the principal loan. Entrepreneurs benefit from a flexible payment structure – payments to investors are directly proportional to how well the company performs. If the company’s revenue growth is faster than expected, investors are repaid over a shorter period of time. If growth occurs more slowly, investors achieve ROI over a longer timeframe.
For investors, rev share has a narrower focus – on revenue growth instead of future acquisition or IPO – which means focus is concentrated on the company’s financials regarding future revenue. Investors may not sit on the board or advise on business practices like they would for an equity stake, but they are incentivized to see the company succeed.
For startups, rev share provides access to capital for companies with variable sales or for companies with an established market but without the size to attract VCs. It also allows management to maintain control of the company instead of answering to investors who hold equity shares or the need to risk personal assets as collateral for a loan.
Finding the right structure for any startup capital raise can be a challenge. Rev share is still a loan, and repayment is a must. This means not only due diligence on the investor side but also the need to demonstrate strong growth potential on behalf of the startup. But with rev share, both the startup and investors can contribute to the goal of sustainable revenue and ultimately drive a positive outcome for the business and investors through a simple, manageable investment structure.
Through First Democracy VC, our partnership with Indiegogo, we successfully raised $300,000 in a rev share offering with Republic Restoratives, a craft distillery in Washington, D.C. Two of our current offerings – Texas Zebo and The Field Guide To Evil – also now offer rev share opportunities.
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