John Stewart knew his company needed a hefty cash infusion to transition from a cloud services provider to a software provider. But without physical assets to borrow against, a bank loan was out of the question; venture capital wasn’t an option, either. “We were too late for angel funding and too early for growth funding,” says Stewart, CEO of Charlotte, North Carolina-based MapAnything.
His solution: Borrow $1 million from Lighter Capital, a Seattle-based financing firm that specializes in revenue-based deals with small businesses poised for big growth. Rather than forfeit equity or repay a fixed monthly amount, MapAnything pays Lighter Capital 7 percent of its monthly revenue. The more the company makes in a given month, the faster it repays the debt.
Thanks to the money borrowed, which MapAnything sank into sales and marketing, the company turned its business model on its head. In 2012, MapAnything had revenue of $1.9 million, $600,000 of which was in software sales, Stewart says. In 2013, the company made $4 million, $3.6 million of that in software deals.
Lighter Capital is among a handful of U.S. firms offering five-, six-, and seven-figure revenue or royalty financing to young companies with high gross margins. “There are lots of great companies out there that could easily be $10 million to $30 million businesses, but not $1 billion businesses,” says BJ Lackland, CEO of Lighter Capital. “Thus, they have a hard time attracting venture capital. We fill that gap.”
If you want to pursue this type of financing, here’s what you need to do.
1. Demonstrate growth potential
Financiers want to see proof of your profit margins and growth potential; the same goes for healthy cash flow. Lighter Capital, for example, wants at least 12 to 24 months of solid financial documentation, with a minimum revenue of $15,000 a month. “We don’t require a company to be profitable,” Lackland says, “but we want to see where they have a path to profitability.”
2. Show how you’ll use the money
If you can’t specify how you’ll use the funds, you’re not ready for a revenue or royalty loan. These lenders want assurance that you’ll use their money for growth-oriented activities. “Marketing and sales are a good use of the funds,” Stewart says. The typical Lighter Capital customer uses funds to hire a vice president of sales, launch a marketing initiative, or finish and launch a product, according to Lackland.
Related: Acing Your Pitch to Investors
3. Make sure the numbers work
A revenue or royalty loan is worthless if repaying it completely hobbles your cash flow. For Tracey Noonan, co-owner of Wicked Good Cupcakes, a $75,000 royalty deal with a private investor in 2013 made sense: Sales were exponential, and she needed money to move to a bigger facility and buy packaging in bulk. The Boston-area entrepreneur paid off the royalty loan in 72 days and reduced the royalties paid on her signature $6.95 cupcake in a jar from $1 per unit to 45 cents, in perpetuity.
Although the permanence of such an arrangement may sound onerous, Noonan is thrilled: “What we pay back now is the equivalent of a 12 percent equity stake, a small cut that we never would have gotten from an investor as a new company.”
Related: Related: Landing Financing Without Taking on Debt or Giving Away Equity
4. Think about mentorship
It’s not just about who can cut you the best deal. “You’re going to want an investor who can help you grow your business,” says Alfredo Ramirez, president and CEO of Austin-based Vyopta, a cloud video customer engagement company that secured a $500,000 revenue loan in 2013. Executives at his lender, Austin-based Next Step Capital Partners, don’t have a seat on Vyopta’s board, he explains, but the financiers observe board meetings and offer advice as needed, “like a VC, but without buying equity.”