Revenue Loans

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Revenue loans are another relatively new financial innovation in the early-stage company space.

A revenue loan is a loan that has a monthly or periodic repayment amount that is a percentage of the company’s gross or net revenue in the period with respect to which the payment is going to be made (for example, the preceding month or quarter). The payment amount is typically somewhere between 5-10% of the preceding period’s gross or net revenue. In other words, the payment amount is not set and fixed like in a traditional loan. It goes up and down based on the performance of the business. A revenue loan may have a four-, five-, seven-, or ten-year term, and is considered repaid when the lender has received the negotiated multiple of the loan amount (anywhere from 1.5X-3X) and any other costs of the loan.

Revenue loans may or may not be secured by the company’s assets and may or may not be guaranteed by the company’s founders. They may or may not have any financial operating covenants. They may or may not have any equity component (for example, they could come with warrant coverage. They may also come with a “success fee,” meaning a payment of some additional amount to the lender on the sale of the company.

Revenue loans fill a gap between typical commercial loans and traditional equity-based financing instruments. They are often used by companies that have cash flow and are looking for expansion capital but do not want to give up any equity in the business. For example, if a new coffee shop is doing really well and the owners want to open three more locations, they may not have the working capital required for that expansion. A traditional bank may not see enough operating history or might want personal guarantees from the owners along with constraining financial covenants. With a revenue loan, once those new venues start generating cash the owners can use margin on that new revenue to pay off the loan over time. The other advantage of the revenue loan structure is that if it took several months for those new locations to ramp up sales, the company would not be burdened with a high fixed monthly loan payment from a traditional loan. The revenue loan payments would start low and ramp directly with the sales.

For a revenue loan to work, it is important that the company have a high-margin product since they will be using a percentage of revenue to pay off the loan. For example, a company sells a product for $100 and the direct costs of producing and delivering that product are $50. They have a 50% product margin, (revenue-cost)/revenue. They will also have operating costs. Let’s say the cost of product support and the sales team and marketing average 30% of the revenue. The company now has $100 - $50 - $30 = $20 from each product, which they can use to cover their overhead and provide a profit. For our purposes, let’s call that the operating margin: 20%. It would be very risky for this company to take a revenue loan that takes 15% or even 10% of revenue, as it would leave them almost no cash (5% or 10% of revenue) to cover overhead and other needs. Software and SaaS (software as a service) companies are the canonical example of the high-margin products, with typically 80% or higher margins. For that reason, revenue loans have come to tech companies as well. Lighter Capital, for example, a revenue loan business based in Seattle, is an active lender to SaaS and technology services companies.

​danger​One legal issue you will need to watch out for in the revenue loan context is usury. Some state usury laws specifically exclude from the definition of interest a share of the revenue of the business. Other states do not have usury laws at all in the context of commercial loans. But some state usury laws apply to revenue loans and prohibit effective interest rates above a certain amount. This is an issue that needs to be thought through when making revenue loans.

Startups’ Perspective on Revenue Loans

Assuming that the company has a high-margin product or service, a revenue loan has advantages over a bank loan, including:

• Flexible payments, which go up only when the revenue is flowing, as opposed to the fixed payments of a bank loan, which can be especially helpful if there is a lead time to develop revenue from the investment.

• Typically fewer financial covenants, so more flexibility to run the business.

• Potentially no personal guarantees for the founders.

• Potentially no equity in the business has to be given up.

The cost of a revenue loan in terms of the effective interest rate paid by the company is typically significantly higher than for a bank loan. That can still be very attractive to founders compared with equity financing due to the following factors:

• Potentially no ownership dilution.

• Potentially not much in the way of lender control provisions or operating covenants (no investors on board seats, for example).

• Usually much faster and cheaper access to capital than traditional equity financings.

• No need for an exit strategy, meaning it’s fine if the business turns out to be a lifestyle business for the founders.

The downside of a revenue loan to the company of course is that loans can drain cash from the company. If a company wants to continue to expand beyond where its initial revenue loan took it, then they have to find the cash within existing operations for the next product development effort or business initiative. If a business suffers pricing pressure, cost increases, or other margin erosion, a revenue loan can be challenging.

Investors’ Perspective on Revenue Loans

Revenue loans can be great for investors because they allow investors to get a return on their investment without having to wait years for a company to be sold or go public. In equity financings, many angel investors run into the following problem: They are investing in stock and convertible debt in startups and early-stage companies. They are making a number of investments per year. Years roll by. They keep making investments. But none of the companies are getting sold or going public. “I’ve got plenty of deals on the conveyor belt,” Joe heard an angel investor once cry. “But I’ve got nothing coming off the conveyor belt.”

​important​ When you invest in a private company, you are signing up for the long haul. The lack of liquidity in angel investing can be challenging. For this reason, revenue loans can be a complementary part of your startup investing portfolio. You are not going to get the big win, but you are much more likely to get the 2X-3X return on your investment; and as the loan is paid off, you will have additional capital to deploy.

The other advantage of revenue loans to the investor is that the loan is debt and it can be secured. Debt is senior to equity—meaning that if the company fails, debt gets paid back first, before equity.