Convertible Notes and Startup Funding
February 12, 2025
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The manner in which startup companies obtain their financing can have a very large impact on the future of their business. In the previous articles, we have already discussed how bootstrapping as well as investments by professional investors work. Both of these approaches have their own advantages and disadvantages. Up until recently, it was assumed that these are the only two alternatives for a startup firm to raise money. However, with the passage of time, we have realized that this is not necessarily the case.
It is possible for startup firms to obtain financing using a third method which is called revenue-based financing. In this article, we will have a closer look at what revenue-based financing is as well as how it affects investors as well as the founders.
Revenue-based financing is a method in which an entrepreneur can approach professional investors in order to raise funds but they can do so without giving up a portion of their equity. In traditional investments, investors obtain an equity stake when they invest in a company.
In revenue-based financing, investors are not provided with equity stakes. Instead, investors are entitled to receive a part of the revenue of the firm for a specified period of time. Hence, an investor can invest $10 million in a firm in return for 5% of the revenues of the firm. Additionally, the startup company may have to return a multiple of the original investment at the end of the period. For example, the company may have to pay 1.25× of the original investment in order to compensate the investor for undertaking the risk.
The concept of revenue-based financing is quite recent. However, it has been growing at a very rapid pace. This is because of certain advantages which are associated with revenue-based financing.
Professional investors have come up with different versions of revenue-based financing. Shared earnings agreement and point of sale capital are some versions that have become quite popular. There has been a considerable rise in the number of companies and investors using revenue-based financing and this is expected to continue in the near future.
Even though revenue-based financing has been growing by leaps and bounds because of the above-mentioned, there are several disadvantages of this model. Some of these have been discussed below:
The bottom line is that revenue-based financing is a relatively recent mechanism that is being used in order to raise funds. However, the effects of this arrangement are not fully known and hence its advantages and disadvantages cannot be fully known for sure.
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