As venture capital funding dries up due to Covid, many startups have found themselves looking for alternative financing opportunities that don’t involve raising equity.

One option on the table is revenue-based financing (RBF), a type of revenue or profit-share investment structure that’s gained traction in the last several years.

Unlike equity financing, revenue-based financing is a fixed sum that’s repaid over time based on incoming revenue. Founders receive money from an investor to spend on marketing or inventory, and with every sale they make, they repay a percentage of that loan.

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A company might receive €100k, and would then repay 5-20% of every future sale back to the investor until the amount is repaid in full — with a fixed fee on top. Typically there are no equities, personal guarantees or hidden fees involved.

While founders can typically raise less money than they could from a VC, Ariyan Seyed Nassir, founder of German revenue-based finance company Uplift1, calls it a type of “rocket fuel capital” that gives qualifying founders immediate cash for growth without them needing to sacrifice ownership.

“Many startups just need working capital to scale — whether it’s for inventory, online marketing or operating expenses,” Seyed Nassir told Sifted. “They’re always in this dilemma of raising equity to enable faster growth. We enable them to do it, and they don’t need to give away shares.”

Already a growing trend (particularly for e-commerce companies), the buzz around RBF is increasing. That’s in part because the instant cash structure allows founders to act on immediate growth opportunities instead of waiting around for equity capital that may or may not come through.

But even if RBF is potentially viable for startups, is it really ripe to take off? And who can take advantage of it?

A niche option

Berlin’s Uplift1 has a simple investment process: founders fill out an online form and get invited to a first screening call for a discussion about metrics and requirements. If everything looks mutually beneficial, both sides sign an NDA and exchange further data. The decision-making process takes about a week.

This makes it especially beneficial for healthy startups who need cash quickly, particularly in the bootstrapping phase or in lieu of bridge financing.

“Maybe companies will raise rounds a little bit later because they use revenue-based funding to push until the next round, and go a little bit longer. It’s very applicable in a situation where a company wants to push innovation or reach a milestone, and they would usually raise a bridge financing or convertible,” Seyed Nassir of Uplift1 said.

Matteo Rizzi, Fintech investor and cofounder of FinTechStage, sees RBF as an interesting alternative that can cater to new ways in which startups are being founded and scaled.

“RBF is not only viable, but I believe that with the rise of the venture studio model, the opportunity for entrepreneurs to save equity in the bootstrapping phase is very attractive,” Rizzi said. 

But the nature of revenue-based financing also makes it limited.

Seyed Nassir said that startups can’t use it for expanding into ten new markets or building a company from the ground up. 

“If you’re doing €100k of monthly revenue, a VC can give you €10m. A revenue-based funding company can give you maybe €500k, and only if the company is healthy and on the path to scaling.”

Startups must also consider RBF’s impact on the fundraising journey as a whole, particularly when it comes to venture debt. Will Gibbs, principal at Octopus Ventures, thinks it’s important to model all possible scenarios.

“You should understand the broader impact on any other venture debt covenants and equity instruments. Much like when companies think about venture debt, sometimes there are surprising outcomes when you actually model the impact with all the fees. It’s critical to have a reliable finance director run a number of scenarios to understand the upside and downside,” Gibbs said.

Data-driven and digital

UK-based Uncapped is another revenue-based financing company that emphasises a tech-driven approach to financing. Startups can apply in 15 minutes, and once they receive the go-ahead, they are able to connect the sales accounts they use to run their business (sales, marketing, finance, etc.) With that information, Uncapped makes a data-driven decision. It takes 24 hours for a startup to get funding. 

Chief executive and cofounder of Uncapped, Piotr Pisarz, said the idea is to use available data to find deals in a new, unbiased way. 

“I think VCs want to be much more data-driven, less biased and able to look at companies in a more structured way, but it’s hard to do it without technology,” he said. “As an ex-VC, I can say that often the most sophisticated technology they use is a CRM. Our decisions are based purely on the metrics and data, without these built-in biases.”

That works out well for revenue-based financing in the wake of the Covid crisis. It’s the ideal model for capitalising on e-commerce opportunities, as startups get funds to increase inventory and reach more customers via online ads.

“In Covid times, what we see is a growing demand in e-commerce, and at the same time, a declining cost of acquisition in online marketing,” said Asher Ismail, cofounder of Uncapped. “We allow founders to very quickly unlock that growth potential with capital for inventory and advertising.”

Shifting VC attitudes

Uplift1‘s Seyed Nassir said that Covid has placed VCs in an even more favourable negotiation position.

“Some VCs are getting participation with low valuation, or favourable terms for them, liquidation preferences and so on,” he said. “And even if you’re a healthy business, you might not get funding because VCs need to pick the winner. They need to have 10x returns or know that you can go public in 10 years. So in this context, revenue-based funding makes a lot of sense.”

With more conservative outlooks, VCs are pulling out and waiting for the situation to stabilise further. This puts founders in a tough spot, through no fault of their own.

“Venture capitalists are now thinking in triage mode about how to save certain companies within their portfolio. So that means there’s less capital available to fund new deals,” Ismail said.

Now is the time

The cofounders of Uncapped both stress that in Covid times and beyond, revenue-based financing is both a fast and fair option for startups who can benefit from funding repeatable parts of their business.

If revenues slow, so do the repayments. The technology behind it also makes it possible for founders to get funding quickly, and without needing to step out for yet another pitch or meeting.

It also assures that founders stay in control during times of uncertainty. 

“Founders don’t need to risk their house, especially in a time when things are less certain. We’re really giving them an option to grow,” Ismail of Uncapped said.

But even if Covid weren’t in the picture, the tech landscape is finally ripe for something as data-driven as revenue-based finance. 

“Five years ago, we wouldn’t have had all the platforms available from which we could take the necessary data for our product, at least from a technical perspective,” Pisarz said. “Behaviours have changed and more people are buying online. There’s now a bigger demand for focusing on funding repeatable parts of a business.” 

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Fredo
Fredo

I’ve been trying to get in touch with Uncapped for weeks now. I appreciate all they say, but it would be nice if they could reply to one of my emails! Terrible experience…

Ricardo
Ricardo

Such is the norm with funding specialists across the world: they’re all pretty with words on the internet, but when it comes to responding to you, they’re nowhere to be found. If you don’t get a warm intro, you’re mostly SOL. Never bite into the “we’re different” bait.

Jonathan Holis
Jonathan Holis

Hi Fredo – happy to introduce you to them – I’m on [email protected]

Allan
Allan

The companies security against the loan? The IP. Did not see any thing in the article. It maybe unsecured in the traditional sensce, however failing to pay the debt will mean your IP goes to the finance company.