Investment Theme – Revenue Based Financing

At a time when the creation of unicorns and successful technology IPOs are becoming increasingly commonplace, we are beginning to see a revolution in another investment structure which equally deserves investor attention. This is ‘Revenue Based Financing’, an investment mechanism which allows for traditional growth start-ups to raise debt funding rather than rely on equity infusion from private capital.

What is Revenue Based Financing?

Revenue Based Financing is an alternative investment structure with different mechanics/ returns compared to both equity capital and traditional lending products. It is a debt instrument, that is paid back by pledging a portion of the company’s future revenue.

Target Companies for Revenue Based Financing?

As mentioned above, Revenue Based Financing investors look for traditional high growth start-ups which:

  1. Are not inclined to receiving equity capital to fund their expansion
  2. Do not have assets and meaningful profitability to procure traditional debt products

As such, these would involve bootstrapped SaaS companies or other Direct to Consumer (D2C) brands which acquire their revenues through digital means rather than a cash business. This further allows the revenue to be escrowed prior to distribution.

Requirement for Revenue Based Financing

From the investor perspective, Revenue Based Financing allows for investors to gain exposure to smaller scale start-ups which do not have a path to exit for large investors. Rather, these investors will now receive a royalty on future revenue while taking little to no risk in the form of equity in the business. It is, however, important to note that if the companies fail to generate sufficient revenue, the investors will be forced to take equity in the company to recover their investment.

From the company perspective, this investment structure allows for flexibility in raising capital as current cash flows are not stable enough to ensure consistent servicing of debt. Traditionally, there is a 3-to-6-month gap between investment and revenue as the company needs to spend time on building inventory (in the case of a D2C brand) or developing their product (in the case of SaaS companies). Further, as these start-ups don’t have visibility or invoices on future revenue, there is currently no scope for invoice discounting. As such, companies find this form of financing more attractive, providing the opportunity to build scale as they pay back their investors and reducing the time taken to reach term sheet stage.

How Does Revenue Based Financing Work?

As against traditional methods of raising debt capital, the risks involved with Revenue Based Financing requires a more involved underwriting criteria by investors who are well versed with these types of businesses. The criteria for underwriting these investments primarily revolve around the following:

  1. Existing Revenue traction and Customer stickiness
  2. Revenue growth – nominal growth of 20% to 30% will be adequate (lower than expectations from traditional VC investors)
  3. Quality of Operations – Ability to survive with 80% to 90% of revenue

Upon disbursal of the investment, the payback is structured around the multiple of revenue achieved as well as the period of payback. Therefore, unlike other forms of debt capital, Revenue Based Financing is dependant on the actual cash flows of the company in a certain period rather than prior agreed interest rate. Further, the actual IRR received by the investor can be a minimum of 12% to even as high as 50% depending on the company’s performance. To note, higher revenue growth will product higher IRR and vice versa.

In conjunction with the debt method of Revenue Based Financing, investors may also choose a hybrid debt/equity instrument for longer term capital. This allows for investment of 4 to 5 years where the remaining unpaid capital gets converted to equity when the company decides to raise a further round. 

Revenue Based Financial as an Investment Theme

There has been a structural shift in purchasing behaviour arising from the pandemic. This coupled with the regulatory push to decouple ecommerce platforms and sellers has created a large opportunity for D2C brands in India. Further, most D2C brand operate in a long tail market such as fashion, F&B, handicraft goods, kitchenware, lifestyle, etc, where both typical debt and venture growth capital are unsuitable.

On the software front, India continues its journey to becoming a SaaS hub given lower cost of economics and availability of talent pool. India currently has over 1000 SaaS companies, with more than a quarter of them being founded in the last two years. The majority of these companies don’t meet VC SaaS metrics but are strong businesses in terms of margins and cash flow.

Finally, we also note that the banking and NBFC industry has been unable to keep pace with evolving needs of these start-ups. Most banks still need hard collateral, which is a challenge for D2C start-ups who work on an asset light model. Moreover, these banks take anywhere from 6 to 15 months for loan disbursements as opposed to the 30 second terms sheets we can see in this segment.


The US now has 32 companies which are investing via revenue-based investing instruments and have a total estimated AUM of USD 6bn. India, is beginning to see a similar shift with over 250 companies being funded through Revenue Bases Financing, including companies such as Label 56 Life, Petsutra, TagZ Foods, Sanfe, Tjori, and Pipa Bella. However, there remain a few unanswered questions and challenges to ensure successful scaling of this investment structure.

  1. As a company outperforms with higher IRRs (40 to 50%) they become attractive for VC funding. Given this case, there exists potential that Revenue Based Financing investors may be stuck with the low yielding companies, while others move into the VC ecosystem.
  2. As the investors primarily follow an AIF or VC debt structure, there exists a challenge in attracting a similarly large quantum of capital for AIF II structures.

Notwithstanding the above challenges, given the unique requirements of these start-ups coupled with the inability of traditional VCs and banks to service the segment, we believe the Revenue Based Financing revolution has potential for significant growth in India.

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