Revenue Based Financing: An Alternate Method to Fund SAAS Startups

This is a guest post by Siddhant Jain, the founder & CEO of Vdocipher, a SAAS startup looking to solve the problem of online video piracy and a Malpani Ventures portfolio company.

 

"I am writing this article to tell you about my experience with a relatively new and innovative method of financing startups. 

Methods of Financing - When looking to raise funds for scaling your startup , one mostly thinks of equity funding and standard debt as the options. Equity funding can come from rich individuals (angel investors) or VC companies.

Debt can be taken from banks or individuals or companies providing debt. Bank debts also require collateral and software startup companies rarely have a good asset which can be considered collateral by banks. Most debts are based on compound interest and thus apart from the principal, the interest to be paid back is also a considerable amount. 

B2C and B2B Startups - For startups who are going to have negative cash flows for quite a few years (e.g most of B2C startups in India) , debt is a difficult choice. 

On other hand Many B2B Startups, specially SaaS companies have a path to profitability after initial few years. 

When VCs did not fund us & ‘Revenue Based Financing’ for scaling- In end of 2019, when VdoCipher was growing in early stages and didn't have enough cash to keep scaling; we went to look out for a large seed round from various investors, primarily VC funds and some individual investors who do large seed rounds. We were not able to raise funds at that time.

That is when we were helped out by our lead angel investor Dr. Malpani with a debt in the model of‘ ‘Revenue Based Financing’. 

Am briefly listing the details of a general Revenue Based Financing (RBF) agreements below -

1. Without collateral in the form of Debenture.

2. Quarterly interest payment tied to quarterly revenue of the company. Minimum % of revenue to be paid back towards the interest + principal amount. The % to be in single digits and company can pay more than the minimum amount , in case they have good cash flows in a certain quarter.

3. Target Internal Rate of Return by the Financier for debenture to be closed. (Other financiers might do it based on interest rate).

A hypothetical agreement sample - INR 1 Cr ($130,000) of debt with IRR requirement of 25% and minimum quarterly payouts to be 5% of the revenue. Debt will be considered to be paid back when the sum total of payments make an IRR of 25% on the principal amount. Certain Maximum cap on the total return payable and/or Cap on the duration of full repayment. 

4. VdoCipher made good progress and became profitable in 2020, and was able to clear full debt by January 2021. If we had slower growth, then we would have been able to return it later in 2021. 

Why RBF proved to be a cheaper financing method than equity ?

VdoCipher was able to pay back the full debt raised in 2019 by early 2021 and thus became debt free. No equity dilution was needed. (Another method by which we could have returned the debt was using cash from a next VC round; we did not take that approach.)

On other hand VdoCipher still owns the responsibility to make returns for the equity funding in the company which were done earlier in 2016 & 2017.  

Note - The above positive example is a success primarily due to the reason that VdoCipher was able to grow at a good pace with positive cash flows. In case a company had constant or declining revenues, then the debt interest would have piled on over time. 

Final Thoughts

RBF for SaaS startups has been getting hotter since few years in the USA and now there are companies & investors doing it in India as well.

Many times, Startups do not explore all possible options for business development & fund raise; and consider only conventional routes. What mode of funding works best for a startup, is ultimately on a founder to understand and decide; but one must know what all options are available in the market."




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