Revenue-based financing, a longstanding investment model in royalty intensive industries like entertainment, has been gaining traction as a vehicle for high-net-worth individuals to invest in small and midsize businesses—the economic engine of the U.S. It is also providing an opportunity for RIAs who are engaged in impact investing and want to diversify beyond ESG offerings in the public markets.
Private Debt Investment With Impact
A blend between bank debt and venture capital, revenue-based financing (RBF) is a non-dilutive capital investment vehicle through which investors lend money to companies in return for a percentage of revenues until the initial loan amount, plus a repayment cap are paid off. In the world of impact investing, RBF is hitting several marks including addressing inequities in access to growth capital among minority-owned businesses and those in low-to-moderate income communities, and providing loans to clean energy companies, renewables innovators, and more. Investors can use their money to drive positive change while benefiting from the fixed-income nature of quarterly returns from the loan repayments, typically in the range of 6% to 7%.
Earlier this year, UBS reported that in a nationwide survey nine out of 10 women investors said they believe money is a tool to achieve their purpose and they want to use their investments to drive positive change. Around the same time UBS released its survey, KKR came out with an analysis of the traditional 60/40 portfolio and recommended that 30% of portfolios should be in private assets, including private company debt as part of a fixed-income strategy to better position investors in times of global uncertainty. Targeted revenue-based financing is uniquely positioned to accomplish both goals – purpose-driven investing in private debt.
Addressing A Gap, Creating An Opportunity
Small and midsize businesses fuel the U.S. economic engine. According to the Small Business Administration, companies with 500 employees or fewer make up 99.9% of all U.S. businesses and create the majority of jobs. Growth opportunities abound when founders have access to capital, but while women and minority firms comprise an increasing share of U.S. companies, they are disproportionately challenged when trying to secure financing. In 2020, women-led companies received just 2.3% of all venture capital investment. Crunchbase reported in June that startups with at least one Black founder received just 1.9% of deals and 1.2% of overall venture dollars invested in the U.S. so far this year.
Within that gap lies opportunity. Funds focused on leveling the playing field for women and minority-owned businesses do more than fill a void. Like the venture capital model, they provide critical resources such as mentorship and access to business networks—resources that, coupled with growth capital, give them the added support and financial stability that power their ability to adapt to change and thrive.
Evidence of small businesses’ creativity and resilience were on full display during the pandemic, but that isn’t new. Adapting to change and pivoting to take advantage of an opportunity are hallmarks of small and midsize businesses because they tend to be more in touch with customers and are inherently more flexible than larger counterparts. Investors providing capital to these types of businesses through an RBF fund get to align themselves with those successes and receive the financial benefits alongside the portfolio companies because the quarterly payments are based on actual revenues.
An Innovative Asset Class
These types of impact investments are geared to provide reliable returns and can potentially serve as a replacement or complement to traditional fixed-income products. They are an innovative asset class offering diversification and liquidity. By deploying a range of alternatives to traditional venture capital, private equity and public markets, investors are backing real companies with real revenues and actively diversifying who gets funded—fueling job creation, better wages, community lift and a major step toward fixing the racial wealth divide.
During a time of intense market volatility, RIAs may be tempted to pull back on impact investing but doing so ignores the potential to bring innovative and sound investment approaches to clients. RIAs engaged in impact investing are looking to generate returns that meet clients’ financial goals, while also demonstrating that the investments are effecting positive change. Revenue-based financing is gaining more attention as an impact-investment vehicle because it can do both.
Kim Folsom is founder and CEO of Founders First Capital Partners, a firm providing revenue-based financing, term loans and business acceleration support to businesses led by women, people of color and military veterans, LGBTQIA+ and businesses located in low-to-moderate income areas as well as those dedicated to inclusive hiring practices.