The 3 Big Deal-Killers That Scare Off Your Angel Investor(s)

A revenue-based financing instrument called a Revenue Royalty Certificate.

I'll gladly pay you Tuesday for a hamburger today. - Wimpy

The above quote sums up in one line what most first time capital seekers sound like to angel investors.  I say this because the number one concern of investors is the preservation of their capital which includes the ability to extricate it from the company within a reasonable amount of time.

When the investor asks what sort of liquidity event the entrepreneur plans to create for this purpose and when, the answer is invariably vague. "Oh well, if everything goes perfectly we will IPO in a few years or be acquired by a big company." That folks is as confidence inspiring as Wimpy's famous offer. Investors require a minimal level of certainty. Vague answers only scare them off. That is the first big deal-killer.

The second deal killer is an inability to agree on a valution. The entrepreneur needs $500K and is offering 20% of the company for it. That's only fair, right? The angel wants 51% because of the high level of perceived risk. The chasm between the two valuations is in most cases too wide to bridge.

The third big deal-killer is over how any potential profits may be split if they do occur. Since the startup will be a private company initially the founders will want to minimize taxable income via the standard ways. This usually means that nothing is left over to share with the passive investors. Considering that his money could be tied up for five or more years without any return, can you blame the investor for not being excited enough to write a check?

Is there a solution? Is there a way to eliminate these three deal-killers? The answer is yes. It's done by using a revenue-based financing instrument called a Revenue Royalty Certificate.

Find out more about this amazing yet still little know tool which was recently written up in the WSJ: An Alternative Financing Option for Start-ups: Entrepreneurs Going the Revenue Royalty Route Use a Share of Revenue to Pay Back Loans

Get the details here on how to successfully use Revenue-Based Financing.

Comments

[Garth Adams]

I think revenue financing is the wave of the future. It's being used here in SV more and more.

[Will Liang]

If the start-up already has a quickly rising revenue stream, what risk is there to the investor following the revenue-based approach? Is his "51%" still justifiable? Is his position in negotiating for a fair shareholding in the start up weakened?

[Peter]

Will,

With an Revenue Royalty Certificate, the investor doesn't get any equity up front. Think of it as a hybrid. A convertible hybrid. By convertible I mean that once the principal and interest have been paid off in full, there may be an "equity kicker" triggered which gives the capital supplier a 1 to 5% equity stake in the company.

RRC's are amazing flexible and you can do almost anything with them. It all comes down to what you and the capital provider agree to.

[Chris Kilcullen]

I would like to set a time to talk and get your opinion on funding. I have built a site designed to support the products and companies that support this economy to help put Americans back to work. I would like to learn more about your RRC model.

[Ken Steinberg]

It's an interesting concept for sure, but I think that calling it a startup funding strategy might be stretching it a bit as this tends to rely on existing revenue, not something most startups have. This is essentially a loan that is paid back by setting aside a percentage of revenue. One could also consider it a convertible note with trimmings (low ownership conversion, fix/sliding multiples, defaults etc). It will be interesting to see where this format settles out as anything is possible in financing. :^)

[ROBERT SLOOP]

As always Peter you are spot on.

Most start ups need to answer the big 4 investor questions:

How much
How long
what is my end
and how do I get out

And even after all this is addressed, CAN YOU PULL THIS OFF!!

I have presented a pre-negoiated MBO as an exit at one times sales with 70% equity to the investor with a 2 year payback and mothly distributions and a management team with 25 years of sector success, "AND STILL GOT TURNED DOWN"

Make sure your investors are focused and everyone is on the same page.

Welcome to startup heaven

[DT]

Debt financing sometimes is an opportunity for VCs to squeeze out/ wash out angels who do convertible loans to entrepreneurs. I've met a number of angel investors who are gun shy because they were squeezed out of companies that later did well, but the VCs in series A made sure to limit the equity available to angels and even threatened to pull their investment if they didn't get their way.

What safeguards are there for investors to avoid predatory VC practices around these and other loans, and how do VCs view royalty financing?

[Thomas]

great discussion. www.revenuebasedfinance.com has a lot more info on revenue/royalty based venture funding.

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