The Emergence of Revenue-Based Venture Capital
For seven years, Christopher Columbus pitched wealthy rulers with an innovative idea: fund an expedition that would disrupt the spice trade. He eventually found a sponsor in the Spanish monarchs, and as history would have it, that trip led to the discovery of the Americas.
He didn’t know it then, but Christopher Columbus’ method of acquiring funding for his voyage was an early form of venture capital. Over the years venture capital has changed, shifting from being practiced within wealthy circles in the early 18th century, to publicly owned venture capital firms in the 20th century.
Presently, at the cusp of the 21st century, the face of venture capital is changing yet again. More and more startups with innovative ideas are being left out of funding rounds because of the inflexibility of venture capital firms. In a global analysis of venture funding, KPMG predicts that the current trend of a smaller number of late-stage deals will become problematic for high-quality early-stage companies to attract funding. This has led startups to seek alternative funding.
“The advent for start-ups to seek alternative investment from qualified investors is due to both the myopia of VC companies, which they believe fit in their portfolio and highly inflexible terms for founders,” explains Carolina Abenante, the founder of contract management platform NYIAX. This myopia is what has brought about the rise of new venture capital firms that are focused on more than just growing fast in hopes of raking in a big return when the company goes public.
These new firms have realized the many missed opportunities that stance causes. Innovative startups have had issues finding funding because they aren’t a fit, or the founders are too “diverse.”
“VC in 2019 is getting more diverse. Investors are seeing greater returns by investing in underestimated entrepreneurs. A lot of decisions in investment are made by gut. Investors are human too though, and when you don't have data backing up your decisions, bias seeps in. That means there's an opportunity to profit by working with underestimated founders,” says Keren Moynihan, CEO of Boss Insights, a company that provides real-time insights for start-up companies, accelerators and investors.
These new revenue-based venture capital firms have taken the VC-world by storm, creating more opportunities for founders than previously thought possible. Businesses that were once dismissed as “lifestyle businesses” because they prioritize profit, are now finding funding with revenue-based VC firms.
Revenue-Based Venture Capital: The New Face of Funding
Every company has challenges in growth. The difference between a startup and an established company like Google or Apple lies in their access to funding. Established companies typically have reserves to fall back on, while a few bad months can derail an innovative startup.
Revenue-based venture capital is one way that founders can retain control of their business while supplanting growth by successfully navigating the ups and downs of business. Instead of giving up equity-like in a traditional venture capital deal, companies agree to repay their investors a fixed percentage of revenue until they have provided said investors with the agreed-upon fixed return on their capital.
Instead of focusing on rocketship growth—typically 500 multiple and 100 percent IRR or more for the firm involved—new VC firms are focused on revenue instead of equity, diverse founders and other founder-favorable models that split equity and dividends.
Presently, there are a handful of revenue-based venture-capital firms pioneering this change.
Indie.VC: This twelve-month program requires at least an average revenue of $250,000 the year prior to applying for investment from them. Though the average investment per application is $285,000, checks from Indie.VC range from $100,000 to $1 million. During the twelve months, each firm receives support on its path to profitability.
Indie.VC isn’t hunting for unicorns that can achieve a billion-dollar IPO. Instead, they invest in “real businesses,” and are focused not on their exit. Rather, they want to help each business they invest in achieve sustainable profit.
The Riverside Company: Strictly for B2B SaaS companies, this firm invests in startups across all sectors with a proven business model, and at least $3 million average recurring revenue. The Riverside Company’s non-controlled investments are geared towards companies with diverse founders.
Lighter Capital: To get in with Lighter Capital, you need an annualized revenue run rate of between $3 million and $9 million, since they typically invest up to a ⅓ of that amount. Startups can expect to receive between $1 million and $3 million. This firm is geared towards companies in the tech industry, and guarantee investment without the need to give up equity, board seats or personal guarantees.
TIMIA Capital: Another revenue-based venture capital firm geared towards startups making at least $1 million in annual recurring revenue, with a view to helping them grow to $10 million. They typically invest between $1 million and $3 million. TIMIA Capital’s repayment terms are tied to monthly revenue—increasing in higher months, decreasing in lower months—the perfect situation of a business with fluctuating revenue.
SaaS Capital: This firm specializes in SaaS companies as the name suggests. They lend between $2 million and $12 million to companies with monthly recurring revenue of at least $250,000. They’ve been lending to SaaS companies without taking equity since 2007, making them one of the earlier adopters of the revenue-based model.
Bigfoot Capital: Though Bigfoot Capital is revenue-based, it’s unclear as to their desired run rate. They’re geared towards SaaS companies who have already found their first early customers. They believe in finding investment terms that are mutually beneficial for all involved, usually without taking equity.
Clearblanc: This firm invests in ecommerce and consumer SaaS startups with an average monthly revenue of at least $10,000 and at least six months of revenue history. Clearblanc lends up to $1 million per month. Startups can receive the money in as little as 24-hours if they satisfy all criteria.
Earnest Capital: Earnest Capital invests in companies with monthly recurring revenue of $25,000 or less, especially those with a remote-first policy. They are geared towards seed-stage investments, with the aim of helping startups grow enough without needed another stage of funding.
RevUp Capital: This firm invests in companies with between $500,000 and $3 million. While the average check size isn’t publicly available, RevUp Capital’s investment is geared towards growing companies, especially those whose revenue is tied directly to the amount that they spend.
These nine firms are currently revolutionizing the way companies acquire capital to start and keep their businesses running. Another revenue-based venture capital firm doing that is NextGen Venture Partners. NextGen Venture Partners is structured to do exactly what the revenue-based venture capital model does—connect with founders from all geographic locations and provide them with funding options that empower them.
The Future of Revenue-Based Venture Capital
The future of revenue-based venture capital is bright. “It’s about learning how to contribute to a startup’s success in a meaningful way while bridging the gap between entrepreneurs, and investors,” agrees Jessica David, Marketing Director of at SeventySix Capital, a sports tech venture capital fund.
Alternative funding may be the way for startups to grow sustainably, while still managing to make a big exit for the founding members. For example, mattress company Tuft and Needle did the opposite of what startups in their time were doing. Instead of hoarding venture capital, the founders opted to to take a $500,000 loan.
When the company started growing faster than they could fund it, they chose an alternative way to grow their business—merging with Serta Simmons, in a deal that is estimated to have net co-founders between $200 million and $800 million. Clearly, alternative funding can still lead startup founders to profitable exits, even if it doesn’t fit the popular model that the industry has grown accustomed to.
Over the next few years, we expect revenue-based venture capital firms to continue to make alternative funding available for startups who aren’t interested in giving up equity or find themselves snubbed because of their diversity. Without traditional venture capital, startups can still expect fast growth and since they don’t have to relinquish equity, more profitable exits.