Not Equity. Not Debt. Revenue Structured Investments.
Revenue-based, royalty capital investments are spreading into angel and new venture investing. Several new funds have started over the last year, helped along by tight capital markets. Revenue structure investments aren’t equity, the ownership is of a percentage of revenues rather than of residual value, and they typically have fewer control rights – but face not risk of dilution and no need for a liquidity event. They also are not debt – payments are only made when cash arrives and the total repayment isn’t necessarily known.
There are two ways this deal can work but most important, the company needs to be very close to positive cash flow (has sales and break-even is less than a year away). The first way to work the deal would be with a royalty with a cash cap. Example 5% royalty of cash in (after reaching break-even) to a cash cap of 5X the amount provided to the company. So if the angels put in $200,000, the company would pay the angels 5% of gross revenue until they had been paid back a total of $1,000,000.
The second way to work the deal would be with a royalty with a temporal cap. Example: 5% of cash in (after reaching break-even) for a certain number of years (usually 10 – 15 years).
Typically both deals would include Board seats, monthly financial reporting requirements and inspection rights. If the company choses not to pay then the investors can take the security. Key issues are around change of control in the company and ensuring that spin-off companies are covered by the agreement.
This method of structuring investments may be used in a blend with equity investment and may be useful in bridging large gaps in valuation. In the first example above it could be a blend of $100,000 in equity and 5% royalty payments to a cap of $500,000. Revenue structure investments are not for start-ups.
First Angel Network may, in the right situation, consider this type of investment.