What is Revenue based Financing?
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.
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.
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.