Executive Summary
A Revenue-Based Loan or Revenue Share Agreement (RSA) can offer a range of benefits to enterprises in their early or growth stages. The investor gives the company a loan in exchange for a share of the company’s future revenues. A Revenue-Based Loan acts both like debt and equity, but offers a lot more flexibility to both parties: the debt doesn’t accrue interest and has more flexible repayment terms. The company gives a percentage of its future revenues (much like equity) to the investor until the agreed upon amount is paid back, without having to give away company ownership. Payments for a Revenue-Based Loan are therefore not tied to a fixed amount or interest rate, but rather to the sales of the company at the time, allowing the investors to grow with the company. This incentivises both investors and founders to better align their interests.
When is a revenue-based loan a good financing option?
Revenue-based loans are a good option when an early-stage company needs to raise capital in order to grow and expand, but neither qualifies for a bank loan, nor wants to dilute its equity at such an early stage. Since the payments the enterprise gives to the loan holders are relative to the sales of the company, founders can be more relaxed knowing that if they go through a bad spell or have strong seasonal fluctuations in revenue, they won’t be faced with extortionate fixed interest payments that they can’t afford during that time. Put simple, holders of a Revenue-Based Loan will only do well if the company does well. This means you have to build trust of the loan holder in your business model and your ability to re-pay the agreed upon amount. Beyond trust, you need to be able to show a very solid revenue model and financial plan that can be backed by financial history that shows that you will be able repay the loan holder.
The following (non-comprehensive) characteristics and implications provide you with an overview to analyse the pros and cons for this investment instruments:
| Enterprise Lifecycle | Early-growth stage |
| Amount | Varies |
| Pay-back period (Maturity) | Flexible (can go up to 20 years) |
| Use of funds | Unrestricted |
Source: Based on (Roots of Impact, 2020)
The following table summarises some key characteristics of revenue-based loans and implications you should consider:
| Characteristics | What does this mean for your enterprise |
| Low financial burden for the company. | You are not obliged to make periodic fixed payments, nor is there a requirement for collateral. |
| The implementation of a Revenue-Based Loan is relatively simple and does not require a notary. | This will result in lower costs for you as the founder. At such an early stage in your business, you will need to find cheap ways of financing your activities, so a Revenue-Based Loan would be a straight-forward option. |
| The investor is largely dependent on the company’s future sales. | The relationship you have with your Revenue-Based Loan holder will be one of mutual interest and collaboration. Since the loan holder can only benefit if your company does well, it is in their interest to help you succeed. |
| No collateral and no equity dilution. | You preserve control over your company and there is no need to use assets as collateral. In some cases, you might give investors warrants as a substitute. |
| Early returns for investor. | Rather than waiting indefinitely for the exit event, the investor receives early returns. This is something you should play on to make your business case more attractive to investors. |
| As a result of the revenue-based payments, the company has to forgo crucial cash flow during the scaling phase. | This means that with a revenue-based loan, you will have less cash flow (amount of money being paid in and out of account). This will reduce the resources you will need for financial bookkeeping since there will be less movement of money. |
| The investor’s potential return might be limited by the multiple or cap defined ex ante. | A multiple or cap represents how many times the initial investment ("multiple") or the total amount ("cap") the enterprise should repay. This cap is a way for you as the founder to put a limit on the amount that the investor can profit from the Revenue-Based Loan. Negotiating a multiple that both you and the investor are happy with should be done with the help of a financial advisor. Depending on the risk associated with the investment and the type of investor (debt or equity), the multiple will vary. |
| Periodic repayments | Repayments are based on a fixed percentage of revenues, or alternatively profit, cashflow or other financial indicators. The frequency is usually annually or biannually. In order to keep track of these repayments you will need to have a good bookkeeping system in place. Staying consistent with your repayments is crucial for maintaining a healthy relationship with your Revenue-Based Loan holders. |
Key features
- A Revenue-Based Loan is a type of loan that a lender gives to a company in exchange for a share of the company’s future revenues.
- Unlike a traditional loan or a convertible note, it has no fixed interest rate and instead, the payments are tied to the revenues of the company.
- The lender receives a revenue share, which is the agreed percentage of the company revenue that will be paid to the lender. In the agreement, this is accompanied by a “multiple” or a “cap”, which states how many times the initial investment the lenders will be repaid (for example, the lender might receive 1.5X of their initial investment).
- The lenders are therefore conditioned by the success of the company but do not have the responsibility that comes with ownership that equity holders have. Having said that, since the company revenue growth is directly tied to the amount they receive, it is in the lender’s interest to help the company grow in the right direction to be paid back at an earlier stage.
- Although the founders preserve their control over the company trajectory, the working relationship between company and revenue-based-loan lenders is one of collaboration and mutual interest.
- If you meet the requirements, the instrument provides a quick and flexible financing solution and can be an attractive investment option for the investor, that can often prove to be very lucrative (if the company grows).
Tips to build your investment case as an early-stage water-related enterprise
Basic requirements
In order to qualify for a Revenue-Based Loan, your company should ideally be in its early-growth stage and have the potential to grow and increase revenues. You should have a solid business plan and an established product that will convince the investor of the company’s potential. Having a recurring revenue model always goes down well with investors.Although you don’t necessarily have to provide collateral, you should be able to demonstrate a high cash flow or satisfactory evidence of company traction which can act as proof of future success and increase investor’s willingness to invest. In order to make up for the volatile interest payments, the investor expects you to deliver significant revenues during peak season when sales are high. In order to qualify for a revenue-based loan, your company should also have high gross margins, understood as your net sales revenues minus its costs of goods sold (COGS). Your company also needs to show great potential for revenue growth since this will largely define whether investors will make money from their investment.
Revenue-Based Loans as a financing instrument for water, sanitation, hygiene and waste management early-stage enterprises
Let’s zoom into a couple of water sector example to make some key aspects of revenue-based loans more tangible.
Case study 1:
An interesting case of financing innovative water enterprises through revenue-based loans lies in the African drinking water organisation Jibu.
Jibu is a for profit company that has adapted a franchise-based business model to source, produce and retail safely treated drinking water through water kiosks. Franchises purify existing water sources in high-density urban and peri-urban communities and focus on the neighbourhood within walking distance of the storefront. Jibu provides the kiosk and treatment infrastructure and supports local franchisees to run local businesses. Over 80% of Jibu franchises generate enough profit to not only recover invested CapEx but to fuel expansive growth (JIBU, ny). To scale their business model and provide safe drinking water to more people, Jibu has raised revenue-based loans. The venture capitalist and private equity organisation Total Impact Capital (TIC) has issued several revenue-based loans to Jibu which are entirely secured (through assets owned by Jibu) and therefore offer investors a peace of mind when investing in what would otherwise be high-risk and potentially low-return markets. Total Impact Capital has partnered with Jibu based on validated pro forma assumptions in terms of pricing, volume of water sold, expenses and other key drivers, and the innovative business model, which minimises investor risks and unlocks private financing for franchises which have proven to be profitable. The strong evidence for Jibu’s impact across different scales and the prospects that revenue-based loans can accelerate the growth of existing franchises and the expansion of new ones have further contributed to the provision of this type of capital.
Case study 2:
Revenue-based loans have also been setup to offer financing that is tailored to specific needs in the water sector, where demand for water services may vary seasonally. During rainy periods, for example, utility operator’s pumps and pipes remain unused as households use rainwater free-of-charge instead. With regular bank loans, operators consequently face a number of challenges including: 1) interest rates that bear no relationship to the revenue generated by the capital deployed, 2) forecasted cash flows that are unattractive to banks due to long payback periods and strong seasonal variations in revenues, and 3) operators that do not have the collateral to raise sufficient capital for network extensions. For the capital requirements of smaller operators, the deal size is often too small for equity investments and grants focus on the development of new infrastructure and provide often only partial contributions, requiring complementary funding.
The Cambodia Revenue Finance Facility, set up by the Stone Family Foundation in partnership with the French NGO GRET/iSEA and the Bank for Investment and Development of Cambodia, provide revenue-based loans, where repayments are linked to revenues rather than determined by a fixed rate, allowing operators to service their debt despite seasonal variations. The initiative aims at expanding networks to cover 100% of accessible households, providing patient, flexible capital to support investment in capital expenditure including new water treatment plants, network extensions and network upgrades. Using a detailed business plan to guide the investment, a loan is provided to the operator and is repaid to the bank as a percentage of water sales (~13% to 25%) over a period of time (an estimated 9 to 15 years). Linking repayments to a percentage of the revenues makes the finance flexible, as the real value of repayments rises and falls with revenues. This is critical given the highly seasonal nature of operations, which can see a 50% variance in revenues between the wet and dry seasons. (THE STONE FAMILY FOUNDATION, 2019)
Interesting options and variants you should know about to establish a suitable agreement for a revenue-based loan
If you gage the interest of an investor to provide you with a revenue-based loan, you should understand (among others) the following options and variants that can help to shape this financing instrument
- A final repayment date for the remainder can be agreed upon. In this case the enterprise has to pay the investor the remainder (balloon payment) for reaching a pre-defined multiple (e.g., 1.5x) on this final repayment date.
- Honeymoon, also known as grace period. Useful to provide the enterprise with the needed time to reach efficient scale.
- Straight interest rate that is enhanced with a "royalty kicker", i.e., a percentage of revenues payable to the investor on top of the straight repayment (which dilutes some of the aforementioned advantages for the enterprise).
- Conversion to equity or participation rights in future rounds of funding (see also convertible note).
- The loan could be combined with business development services in order to prepare the entrepreneur ("the borrower") for loan monitoring, business growth, capital infusion, and help to reduce the risk of default.
- The investor could be provided with the option to convert the investment to a normal loan upon achievement of a specific revenue level. In that way, the enterprise will pay back as they would do with a traditional loan schedule, thereby providing the creditor with interest principal payments. This variant offers the possibility to put a cap on the amount of money the enterprise will have to pay to the investors, and it helps them to make more accurate future financial projections.
- The Revenue-Based Loan can be used in combination with subordination of the loan, thus allowing the impact enterprise to attract further funding and investors.
Linking financial rewards to the achievement of impact, for example reducing the multiple/cap or the revenue share.
