How does revenue-based financing work for growing companies?
Short answer
Revenue-based financing gives a company capital in exchange for a share of its sales until the investor is repaid. I mostly use a gross revenue royalty. The company pays a percentage off the top line, the investor can often get money back faster than with straight equity, and the investor's equity can step down afterward. It needs a company that already has revenue.
How the royalty gets paid back
The company already has sales. An investor puts in capital. The company then pays an agreed share of its revenue until an agreed amount has been repaid. Because the payment comes from the top line, it rises when sales rise and shrinks when they fall. In my deals the company does not need to show a profit first.
Terms are negotiated. The percentage, the repayment cap and the length of the deal can all differ. I use the gross revenue royalty version, which is paid off total revenue before expenses.
What this looks like in my own deals
We have done five gross revenue royalty deals, and I was negotiating the sixth when I recorded one of the clips below. We invest and take a royalty off the top-line revenue. Once we have our money back plus an agreed percentage, our equity stake or warrant gets reduced.
In my deals, we typically have 100% of our money off the table in three to five years. In my last two deals I used an equity warrant instead of straight equity. Once we receive 1.2 times the money back from gross revenue, our equity drops from 5% to 3%. It is almost like the company bought back some of that equity. We can then recycle the cash into the next deal.
In this panel clip I explain how the royalty and warrant combination works and ask other investors if they have seen it used.
Summary and key takeaways from this video
"Investors do like income, and knowing they're getting at least their money back off the table is highly appreciated and usually not offered to them."
Where it fits and where it does not
It only works if there is revenue. For a very early company with no sales, no royalty is possible. It also does not suit every investor. Someone chasing 20 times or 100 times returns on a high-growth tech company will not want it.
There is a financing risk too. We looked at a vertical farm company that had a contract to supply an airline. A structure with a priority payment could have worked early on. It would not have survived the next round, because new investors would not have accepted us getting paid ahead of their investment.
On the other side, I met a family that had just sold their portfolio for $100 million. They are growing their next chain of retail locations. With a royalty, their investors could get two times their money back in three years and go away. The family keeps all the equity, which goes from 5% to zero. A certain type of investor will want exactly that.
Keeping the other side happy
A royalty can be used to make a deal smart or dumb for either side. I want the company or seller to feel good about it. You do not want a founder who is resentful the day after closing.
In this demo I run a royalty-style buyout through an AI deal structuring tool to see what structures come back.
In that demo the example was an insurance business with $1.2 million a year in revenue. I offered seller financing and a gross revenue royalty for seven years, weighted toward the first three. The goal was a fair price under a good structure. Many sponsors talk to a securities attorney before putting anything on paper.
More from my talks
Since I recorded those clips, the count has grown. We have now closed at least 13 deals using gross revenue royalties, and we are structuring a few more. What investors like is that they get their money back off the top line whether the company produces a profit or not. Most people do not like crossing their fingers and waiting a decade, hoping they will get their money back out of the company. A royalty gives them a repayment path that does not depend on a big exit.
"We've done at least 13 deals now that we've closed using gross revenue royalties, and we're structuring a few more right now. Investors get their money back off the top-line revenue whether the company produces a profit or not. People do not like crossing their fingers and waiting a decade, hoping they'll get their money back out of the company."
Facts from this talk
- I have done five gross revenue royalty deals and was negotiating a sixth, taking the royalty off top-line revenue.
- In my recent deals, once we receive 1.2 times our money back from gross revenue, our equity goes from 5% to 3%.
- My demo example was an insurance business with $1.2 million in revenue and a seven-year gross revenue royalty weighted to the first three years.
Sources
From Richard C. Wilson's Centimillionaire Strategies YouTube channel: Ultra-Wealthy Investor Q&A Webinar, Investor Discussion Panel - Technology Investor Mandates - Feedback from Investors on Where Tech ..., Artificial Intelligence for Capital Raising | Top 7 AI Tools Live Demo + Q&A. Quotes come from the video captions, lightly edited for readability. Figures are the speakers' own estimates and experience.
General education only. Not legal, tax or investment advice.
Talk to a securities attorney to explore options around royalty agreement terms, warrant and equity documents and offering documents. Do not use AI to write your own legal agreements.
Where to start
- 1Confirm the company has real, trackable revenue before you consider a royalty.
- 2Decide the royalty percentage, the repayment cap and the term you can live with.
- 3Decide what happens to equity or warrants once the investor is repaid.
- 4Think ahead about how a royalty will sit with the next round of financing.
- 5Many sponsors have a securities attorney review the documents before approaching investors.
More questions on this
Do you need profits to use a gross revenue royalty?
In my deals the payment comes off the top line, so the company pays from revenue. That is why it suits companies that have sales but are not yet profitable.
Which investors like this structure?
Investors who want income and want their principal back sooner. It is a poor fit for investors looking for 20 times or 100 times returns on very early tech.
Can it be combined with equity?
In my recent deals I take a warrant, and my equity stake steps down once I reach 1.2 times my money back. Many sponsors ask a securities attorney how to document it.
Related questions
- What is the difference between a convertible note and a SAFE?A convertible note is commonly described as a loan that later converts into equity, often with interest and a maturity date.
- What is preferred equity and how does it work?Preferred equity sits in a deal's capital stack between the bank loan and the common equity.
- What is a promote and how is it calculated?A promote is the back end profit that goes to the sponsor or operating partner after the investors who put in the money have received their preferred return.
- What is a most favored nation clause for investors?A most favored nation clause, or MFN, says that if the sponsor gives another investor better terms, you can ask for those terms too.
Work through it with the pitch deck grader. See all deal structuring resources.