Revenue Loan Offers Alternative to VC

Serial entrepreneur and seed stage investor Andy Sack last month unveiled his latest venture, Revenue Loan, which he hopes will transform the way that tech startups are funded.

Rather than invest for equity, Seattle-based Revenue Loan aims to give startups capital in exchange for a percentage of their future revenue. All a company need do, once it starts making money, is pay off Revenue Loan until the firm has made between 3x and 5x of its invested capital. There is no fixed time schedule. Depending on the deal and its upside potential, Revenue Loan might also ask for warrants for between 1% and 3% of the company it has backed.

Revenue Loan expects to attract entrepreneurs who need growth capital, but who don’t want to give up ownership or a board seat to a VC in exchange for financing. Sack says that Revenue Loan can invest in a much wider array of companies than what might make sense for traditional venture firms, whose overarching objective is to identify and back runaway success stories.

The founder of four companies, including local search social site Judy’s Book, Sack previously nourished Seattle’s investing landscape two years ago with Founder’s Co-op. The $2 million, angel-backed fund focuses on seed deals in software and Web-based services. It invests between $100,000 and $300,000 in each company, and has backed 11 startups so far, including Bonanzle and BigDoor Media.

Sack says he launched revenue Loan because he decided he could do more to help young companies after he read about a revenue-based finance model in a Harvard Business Review article last year. Written by Harvard Prof. Clay Christensen, the article discussed how to disrupt the venture capital business. As a test, Sack tried two revenue-financed deals with Founder’s Co-op portfolio companies Nearlyweds and BigDoor Media.

“The article got me familiar with the model, and with the different mindset required with a revenue-based finance kind of situation,” Sack says.

It also worked. Sack turned to his friend who’d sent him the HBR article—Erik Benson, managing director of Seattle-based Voyager Capital—and outlined the opportunity he envisioned. Voyager, along with Seattle-based Summit Capital and Founder’s Co-op, have invested a combined $6 million in Revenue Loan, which is looking to put between $100,000 and $500,000 in companies that have between $500,000 and $5 million in annual revenue.

To help with the effort, Randall Lucas has stepped down as an associate from Voyager Capital to join Revenue Loan as a vice president and credit officer.

Boston-based investor Arthur Fox, a self-described “godfather” of revenue-based financing who has employed a similar funding model for nearly 20 years, calls Revenue Loan’s approach a win-win for everyone involved—except for adrenaline-addicted VCs.

“It’s great for entrepreneurs,” says Fox, who has managed several pools of angel-backed capital and is currently working with Dallas-based Cypress Growth Capital to raise another. “It’s like someone who gives you money and says, ‘It’s OK to pay me when you have it. And when you don’t, don’t worry about it.’”

Revenue-based finance, which has so far been embraced by just a handful of investment firms nationwide, is probably closer to an equity investment than a bank loan in terms of risk, Fox says. But it’s also a much safer way to invest money, he adds.

“I don’t care if a portfolio company gets to be big or they stay small, if they address an explosive market or an obscure niche,” he says. “As long as they stay in business, I get paid.”

Asked why more investors haven’t embraced revenue-based finance, Fox says that investors and LPs are looking for a more reliable way to produce returns.

“Up until a few years ago, the equity model seemed to be working,” he says. “I have a lot of friends who do VC, and they can’t stand that I’m capped out. They can’t stand not having a runaway success as their goal. They’re addicted to the big hit, even though my returns are, in many cases, better than theirs.” —Constance Loizos