Beyond Venture Capital, New Models for Startup Funding Emerge:Q&A With Angel Investor Jay Vasantharajah
Vasantharajah spoke with MarketCurrents WealthNet recently to describe innovative new funding models – including revenue-based and royalty-based – that are helping his portfolio companies fuel growth without parting with equity.
Could you describe your investment philosophy and portfolio for our readers, please?
I have a broad range of investment experience. My portfolio includes public equities, early-stage angel investments, private bonds and private real estate. My investment philosophy is split between tech and real estate. The future is tech, that’s where the growth is and as a result I am heavily investing in SaaS and other tech-based investment opportunities. Real estate has great terminal value, I invest here as I view it as a hedge.
You’ve mentioned that companies in your portfolio have used revenue-based financing in the past. Which companies are best suited to this form of fundraising and what are the pitfalls?
Any company that has seasonality in their revenues can benefit greatly from revenue-based financing. If they take the cash right before their slow season, the APR ends up being reasonable. Companies that don’t have access to traditional debt obviously benefit as well. In eCommerce, an inventory-based business, revenue based financing can smoothen out a long cash conversion cycle. Overall the APR can be high compared to traditional debt, but there are other benefits like no personal guarantees. The real pitfall is the high APR, and potential cash drain (they take anywhere between 5-30% of topline revenue). I recently wrote about Clearbanc, the leader in revenue-based financing, on my blog.
What is your outlook on royalty-based financing models?
Very bullish on royalty-based financing for online businesses (SaaS, eCommerce, etc). There are a few emerging companies in the space now, but I feel there’s plenty of room for expansion. I have started seeing HNWIs and FOs doing RBF deals directly with businesses. It’s a great way for founders to raise money without dilution. It also offers great incentive alignment as the investors start making a good ROI as the company grows (revenue increases). There is usually a buyout clause, something around 1.5-2x the original cash investment. The idea is, the founder executes this clause after several years (3-5 years), where 1.5-2x the amount is not much money to the company at that point, given they’ve been compounding their growth along the way.
From an investor’s perspective, what makes these alternative means of financing attractive?
Royalties are attractive because of the transparency they offer as well as the cash flows. Revenues are very easy to track with online businesses. Most companies use the same revenue platforms like Stripe or Shopify. Investors have an amazing view into a company’s revenues, and in turn their ROI. With the right buyout clause, investors can easily earn an equity-like IRR with predictable bond-like cash flows. Some instruments have an option to convert the royalty into equity as well, so it gives the investor and founder great optionality. Compare this with traditional equity instruments for early-stage investing, like the SAFE, where the valuation of the investment is quite opaque.
Do you have any other comments or advice for our readers?
Definitely pay attention to the RBF space. I think there will be some fantastic opportunities there. SaaS companies are well-suited to take on RBF, as they have recurring and predictable revenue. Doing deals directly with startups, or investing in a fund/syndicate are both great ways to get exposure. I am actively looking to add RBF investments to my portfolio, hoping to close a deal sooner than later. Feel free to reach out to me if you’re interested in chatting more about RBF and deals I have been looking at.