If you need to cash to build your company but aren't keen on draining your personal savings or giving up equity to venture capitalists, there may be another possibility.
Looking to expand? There are the traditional sources: Digging into your own personal savings, loaning from a traditional bank, or finding an angel or VC investor who will fork over the cash for a share of equity.
But there are situations in which none of these is a good option–especially in tough financial times like these. Your personal savings may be skimpy or needed for, well, personal responsibilities. In the current environment banks aren't exactly rushing to help small businesses out and your company may not have the scale or size to attract a VC (or you may simply want to hold on to ownership). So are you out of luck?
No, says Lighter Capital, a Seattle-based company that offers a unique financing option to entrepreneurs: revenue-based financing. Founder and veteran entrepreneur Andy Sack explained how it works on the blog of New York VC Fred Wilson:
A revenue-based finance investment provides capital to a business by "selling" an ongoing percentage of a company's future revenues to the investor. For simplicity, you can think of it as a revenue share type of arrangement. Investor gives capital to company in exchange for a small percentage of gross revenues. RBF lives as a hybrid of bank debt and venture capital. This kind of financing has been around for a while in non-tech industries such as mining, film production and drug development, but it’s recently been gaining traction in the world of growth finance and early-stage technology funding….
Instead of a typical bank loan which requires a business to pay a fixed interest payment, a revenue-based loan receives a percentage of revenues over a specified amount of time, allowing "interest" payments to fluctuate when a growing company has inconsistent cash-flows or lumpy or seasonal revenues…. Another way of saying this is RBF turns loan repayment from a fixed expense to a variable expense.
Loans average $100,00-$250,000 and most are paid back within three years at a rate of 15% to 30% annual interest. Lighter Capital has lent around $2.5 million since opening its doors in November 2010, and stresses its model is particularly valuable to businesses with "lumpy" revenue, such as seasonal enterprises.
So what sort of business is a good fit for RBF, and what's the experience of financing your business this way really like? Inc.com called up an entrepreneur who has used the model to find out. Eric Estoos is the CEO of HarborCloud, a Bellevue, Washington, company that hosts small business applications in the cloud. He looked to Lighter Capital for funding when he wanted to grow his business but didn't want to give up any equity.
"This type of model is appropriate for a business that's getting some traction and is seeing some return on the resources that they've got and want to take the next step up before going to more traditional VC or angel funding," he says, adding that "for a business that has revenue, has their bases covered as far as their monthly net and is just looking to grow the business and needs some capital to do that, it'll make a lot of sense."
He has used the financing from Lighter Capital to hire for his growing company and pronounces himself satisfied, though as with every move in business, there are trade-offs.
"The money is a little more expensive than, say, traditional bank financing. However, for a business that's only been around two, three, or four years banks really just aren't lending, so it's really tough to try and get any leverage from a bank," he says.
And Fox News Small Business has reported another major downside to carefully consider: "if the borrower becomes delinquent on the loan after a set time period they stand to lose everything–their business, patents, domain names and trademarks– to Lighter Capital."
Estoos, however, feels that getting funding from the team at Lighter Capital, all of whom are experienced entrepreneurs themselves, has other subtler advantages that counter-balance the risks for him.
"The payback is tied to my success, so I feel like they have more of a reason to stand behind me and help promote my business, as well as provide a vehicle for a second round, which we have done. They've also provided a lot of other resources from the standpoint of just [being a] great group of guys to bounce ideas off and help steer the ship. And I felt comfortable that I'm getting solid advice from them because they have everything to gain from giving me good advice."
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