Entrepreneurs who build businesses in small towns and low-income communities often do not have the personal credit profile or assets to access the capital needed from banks and investment firms to grow their companies.
Revenue-based financing—where investors provide capital in exchange for a percentage of revenue—has become a solution advocated by foundations and social impact investment firms as an affordable option for underserved business owners in the United States. A business that gets funding and its investors, because both do well when the company does well.
Revenue-linked investing is also more favorable by giving entrepreneurs “the opportunity to finance without giving up ownership,” which can happen with private-equity or venture financing, says Chat Renders, CEO of Renders, McVeigh Capital Management, a Boston-based asset management firm.
About four years ago, Randers McVeigh began advising Founders First Capital Partners — a revenue-based financing lender and advisory firm — on a fund that would allow individual investors, family offices and foundations to provide revenue-based financing in exchange for an annual return. 7%.
Founders First’s financing arm (it also runs the nonprofit Small Business Growth Accelerator) has already proven the concept in a fund it launched in 2016 with some small foundations and family offices, says San Diego-based founder, president and CEO Kim Folsom. firm and an entrepreneur himself who started seven companies.
Folsom’s goal at Founders First, she told Renders, “is to be Goldman Sachs for different companies by supporting different entrepreneurs. [to] Grow successful middle-market businesses that create jobs and wealth in communities often left behind.” At the same time, Folsom said, the firm can provide “compelling returns for mission-aligned investors.”
Penta Recently spoke with Renders and Folsom about revenue-based financing as a long-standing yet revolutionary approach to investment and how it can create social and economic equity.
Revenue-based financing was attractive to Randers — who manage nearly $100 million in impact investments for clients — as a mechanism to get money into “funding deserts” across the country “where there are BIPOC and women owners who don’t have access to capital, and they have no real leverage.” No,” says Renders.
For entrepreneurs who don’t work in New York or San Francisco, access to venture funding can be very difficult, for example. “We felt it was important to find ways to fund and fuel some of these businesses in a way that worked for them,” he says.
Revenue-based financing offers entrepreneurs more flexibility than standard bank loans, and it beats equity financing from venture capital—if it’s possible to get it—because the venture or private-equity investor expects the owner to sell the company or eventually take it public, a An event that takes local capital out of towns and cities that need it, says Renders.
For investors, revenue-based financing “allows you to be a funding partner with these businesses because it takes into account the reality of the market,” he says. “There will be quarters with strong revenue, and there will be quarters with weak revenue, and if you can ride with the entrepreneur you’re working with, if they understand what they’re investing in, it creates a better solution for your customers, and it creates A great opportunity for the suddenly unwired entrepreneur.
Change Catalyst Fund
Businesses Folsom underwrites for funding are “asset-light” with at least five years of revenue and a gross profit margin of at least 40%. Companies in the fund must be “geographically challenged” (meaning not in New York or San Francisco), run by diverse owners and succeed with “a small amount of capital,” she says.
Many of the businesses the fund invests in provide solutions for large companies. Examples include Chicago’s Ownshore Technology Group, a black women-owned business that provides compliance services to large pharmaceutical companies such as Pfizer and Moderna. Another, 3PO in Jersey City, NJ, offers treasury management services.
Renders says the firm worked with Folsom to design a funding mechanism that would allow individuals, family offices and foundations to receive fair returns for the risks they take, while leaving little room for entrepreneurs to deliver “real social value.” for capital.
The seven-year fund, which will eventually total US$30 million, today includes about US$5 million of investors who are Randers McVeigh clients, and each has invested about US$250,000. Investors have the opportunity to deposit capital into the fund quarterly for the first three years. They pay no management fees to invest and get an annual return of 7%. In the latter part of the fund’s existence, the internal rate of return can be higher as the principal is also repaid, says Renders.
The firm’s investors prefer stable yields in investments that are a little riskier than typical bonds, he says. A seven-year U.S. Treasury note, for example, currently pays about 3.1%.
Change catalyst funds can provide stable returns because the founders are first taking the risk of diverging revenue streams from the underlying companies. The fund manages it by pulling together a diverse portfolio of about 35 businesses, some of which have contracted revenues, Folsom says. This allows for more consistent revenue and therefore, consistent returns.
Founders First currently operates in five regions (California, Illinois, Texas, New Jersey and Pennsylvania), but plans to expand to 10 over the next five years.
It will also create more transformational catalyst funds that will target larger pools of assets to investors. The second fund, which will be between US$50 million and US$75 million, will be targeted at institutional investors, including impact investment funds and registered investment advisers.
A third fund of at least US$100 million will target major corporations and pension funds looking to invest for social impact.
The social impact this fund could achieve would be significant, argues Folsom. A generation ago, Main Street retailers and hotel chains and other non-tech businesses that were fundamental to the economy became America’s largest companies and substantial contributors to the American economy.
“The amount of money we’re providing to these diversified businesses in the form of six- and seven-figure capital infusions puts them on the path to becoming the next high street businesses that are US$20 million to US$50 million to US$100 million in a generation. Businesses that can support that level of growth,” she says. .