3 questions to smart minds

What is Revenue based Financing?

For this 3 questions to Dr. Christian Czernich

Round2 Capi­tal Partners
Photo: Dr. Chris­tian Czernich
23. Febru­ary 2021

The spec­trum of finan­cing for young compa­nies has broa­dened steadily in recent years. In addi­tion to VC, there are now a whole range of provi­ders of venture debt (risk-based loan finan­cing). Reve­­nue-based finan­cing is still little known. There is an inno­va­tive invest­ment fund in Austria that invests in seeded start­ups looking for growth capi­tal. In exch­ange for an invest­ment, the fund does not take company shares; instead, the company gives inves­tors a share of sales.

For this 3 ques­ti­ons to Chris­tian Czer­nich, CEO and co-foun­der of Round2 Capi­tal Part­ners in Vienna

1. Can you please explain how reve­nue-based finance works exactly? What returns can be expec­ted? How long are you usually invested?

Most of the busi­ness models of digi­tal compa­nies are built on a high propor­tion of recur­ring reve­nues. Reve­nue-based finance uses these recur­ring reve­nues to provide growth finan­cing to young compa­nies without diluting shares and without leng­thy nego­tia­ti­ons over company valua­tion. Tech­ni­cally, it works in such a way that the company recei­ves a subor­di­na­ted loan, the repay­ment of which is linked to sales. The reve­nue share typi­cally ranges from 2–6%, depen­ding on the amount finan­ced and the company’s sales, and consists of both a repay­ment and an inte­rest compo­nent called royalty. The reve­nue share is paid until a certain multi­ple of the finan­cing amount, which is between 1.35x — 2.15x, has been paid. When the multi­ple is reached after 4–6 years, the finan­cing auto­ma­ti­cally expires.

If the company is sold before the multi­ple has been reached orga­ni­cally, the outstan­ding amount plus a varia­ble exit fee is paid upon exit. The reve­nue-based finance instru­ment can in certain cases replace an equity invest­ment but can also be combi­ned very well with an equity invest­ment. Round2 also selec­tively offers young compa­nies a combi­na­tion with equity.

Reve­nue-based finance is a very simple and comple­tely trans­pa­rent finan­cing tool that allows digi­tal compa­nies in parti­cu­lar to mone­tize recur­ring reve­nues without giving up shares. By linking it to sales, the repay­ment auto­ma­ti­cally adjusts to the company’s cash flow and thus cannot put compa­nies in a bad posi­tion. — This flexi­bi­lity is a key diffe­rence from tradi­tio­nal venture debt finan­cing. The return on the finan­cings depends in parti­cu­lar on the sales growth of the compa­nies and is 12–15% on average in the port­fo­lio. The return of the fund can again increase signi­fi­cantly due to exit fees and selec­tive equity investment.

2. Why is now a good time for reve­nue-based finance? How is reve­nue-based finance accepted in the market? How did you get star­ted and who are your investors?

When we star­ted deve­lo­ping reve­nue-based finance for the Euro­pean market in 2016, digi­tiza­tion was still in its infancy and the finan­cing market for young digi­tal compa­nies was not very well deve­lo­ped. At the time, we saw a big gap in the finan­cing market, as the share of digi­tal compa­nies would steadily increase, but at the same time, banks did not have the neces­sary struc­tures or the right finan­cing instru­ments to finance digi­tal compa­nies based on intan­gi­ble assets. That was the first gap in the market. Venture capi­tal was then, and for the most part still is today, the only exter­nal form of finan­cing that company foun­ders can fall back on. When I was a student at Stan­ford, I had studied venture capi­tal in detail very early on. Even then, I came to the conclu­sion that venture capi­tal is a very powerful finan­cing instru­ment, but it is far from being suita­ble for all company foun­ders and busi­ness models. Due to a lack of alter­na­ti­ves, venture capi­tal is often used with compa­nies or in situa­tions where it does­n’t actually fit. That was the second gap in the market. We saw Reve­nue-based Fianance as a very good tool to close these market gaps between banks and venture capital.

Our assess­ment of the market and the poten­tial of reve­nue-based finance has since proven accu­rate. Due in no small part to the Corona crisis, digi­tiza­tion has acce­le­ra­ted signi­fi­cantly and digi­tal compa­nies are part of the main­stream. The market poten­tial is corre­spon­din­gly large and growing stron­gly. In the begin­ning, company foun­ders were under­stan­d­a­bly still some­what reluc­tant. In the mean­time, this form of finan­cing is also much better known in Europe, and our track record shows that it simply works very well. We are in the midst of an uphe­aval in the finan­cing market and reve­nue-based finance will take on an incre­asingly important role as an alter­na­tive form of finan­cing. Accor­din­gly, Round2 is on a strong expan­sion course. Today, Round2 EUR mana­ges around EUR 30 million. Mainly from entre­pre­neurs and family offices from Sweden, Germany, and Austria. As a next step, we will now open the fund to insti­tu­tio­nal inves­tors and signi­fi­cantly increase the capi­tal under management.

3. You have alre­ady made 18 invest­ments since 2017. Which compa­nies does Round2 Capi­tal focus on? What is this funding prima­rily used for by the young companies?

Round2 focu­ses on young compa­nies that are in an advan­ced stage of deve­lo­p­ment, have approx. 20 — 100 employees and have usually alre­ady reached opera­tio­nal break-even. The majo­rity of our port­fo­lio compa­nies mana­ged to get to this level before Round2 finan­cing comple­tely without exter­nal finan­cing. These boot­strap­ped compa­nies pursue a growth stra­tegy that enables growth without high burn rates. We call this “sustainable busi­ness buil­ding”. In our port­fo­lio there are many compa­nies like the German cyber­se­cu­rity company Myra Secu­rity, the Swiss EduTech scale-up Aval­lain, the Finnish multi­ple award-winning scale-up Vainu or the rapidly growing e‑commerce fulfill­ment provi­der Logsta from Austria, all of which have mana­ged to grow to a reve­nue volume between 5- 15 million Euro without exter­nal equity finan­cing. For the foun­ders of these compa­nies, reve­nue-based finance is an ideal way to acce­le­rate the growth of their compa­nies without having to relin­quish control.

Reve­nue-based finance is used almost exclu­si­vely for the expan­sion of sales, marke­ting and inter­na­tio­na­liza­tion. All measu­res that lead very quickly to sales growth. The typi­cal finan­cing volume is initi­ally EUR 500k — 2 million and can then be gradu­ally increased to EUR 10 million and more also by supple­men­ting it with equity.

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