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Understanding Revenue-based Finance

An Interview with Janice St. Onge

Janice St. Onge is President of The Flexible Capital Fund, L3C (the “Flex Fund”). The Flexible Capital Fund is the only licensed lender and Community Development Financial Institution (CDFI) in Vermont to provide royalty financing, also known as revenue-based financing (RBF).

MG: Why revenue-based financing? What is one solving for using RBFs?

JSO: We launched the Flex Fund in 2010, just after the financial market had crashed. In Vermont, we had a lot of innovative businesses in the food system, forestry, and clean technology sectors that couldn’t get growth financing — neither debt nor equity. The financial crisis had pretty much cut them off from growth capital. Some of those companies didn’t have hard assets, so they weren’t ever going to be bankable, at least not in the short term. So, at the time, we saw an opportunity to help fund the growth of these interesting companies that were core to Vermont’s economy but didn’t have access to growth capital.

We saw an opportunity to help fund the growth of these interesting companies that were core to Vermont’s economy but didn’t have access to growth capital.

Grow Compost Founders

The speed and scale of their early-stage composting business posed challenges for Lisa Ransom and Scott Baughman, co-founders of Grow Compost, so they turned to the Flexible Capital Fund for assistance. The Flex Fund’s flexible loan supported the company’s expansion into food scraps hauling in support of Vermont’s Act 148. The first-of-its-kind in the nation, Act 148 requires that all organic waste produced in Vermont — including food waste and yard debris — be diverted from landfill disposal, essentially making composting mandatory for all Vermonters. Photo by Erica Houskeeper courtesy of the Flexible Capital Fund.

We knew these companies needed flexible, patient risk capital to grow, so we looked around for investment structures that would be collaborative with other kinds of capital, not in competition. But we also wanted to ensure entrepreneurs and founders were able to avoid diluting ownership in their business and maintain decision-making control. It was important to us that our capital enabled them to stay and grow in the state of Vermont. In fact, oftentimes, that was one of the biggest factors.

And revenue-based financing, as a structure, looked really interesting. It can function like equity in some ways without diluting ownership, without an entrepreneur losing control. And it was a better fit for most of the growing companies at a Vermont scale. These are companies that have a good management team and market opportunity but may never scale large enough for an equity investor, and who often don’t have enough operating history or profitability for a traditional lender. I call this the “missing middle”.

These are companies that have a good management team and market opportunity but may never scale large enough for an equity investor. I call this the “missing middle”.

It is a debt instrument, but it can function like equity, right?

Yes, it’s a debt instrument. However, some of the RBF intermediaries and investors are structuring it as an equity instrument. We structure it as debt, but by nature of being repaid based on a percentage of revenue, payments are flexible — they can be deferred initially so that the money can be put to work without cutting into cash flow, and it doesn’t necessarily require that a company have collateral (hard assets) that a lender would typically use for security. Although we use RBF as a debt instrument, we don’t underwrite our loans as a lender would. We conduct due diligence, more like an equity investor would.

Encore Renewable Energy

Chad Farrell, second from left, meets with employees Sonia Johnson, left, Amber Lessard, second from right, and Kate Desrochers, at a solar project in Jericho, VT. Encore has 19 employees, just under half of whom are women, and includes individuals who identify as BIPOC and non-binary. The Flexible Capital Fund (Flex Fund) provided Encore permanent working capital via a revenue-based financing note to help Encore hire new staff for business development, engineering, and project management at a critical growth juncture. Since the first Flex Fund’s first financing, Encore has grown revenues almost sixfold. Photo by Erica Houskeeper courtesy of the Flexible Capital Fund.

Can you speak to your due diligence process?

When we do due diligence, I want to make sure a company has sufficient cash flows to repay our note. And I’ll look at a company’s leverage on the balance sheet. But most importantly, I look at the management team and their competencies. I’m really looking at it as an investor. We are in this for the long-term relationship with our entrepreneurs.

We have, as a CDFI, the amazing benefit of grant dollars to support business and CEO coaching for our companies. To me, RBF is high-touch lending. And we work with our companies like an equity investor might. We’re actively engaged with them. So, it’s about more than the money. It’s how the money is structured, but also what comes with it. We’re bringing a combination of wraparound services and the money to help these companies be successful.

Revenue-based financing is high-touch lending.

Can you speak a little to the growing number of funders in the RBF space, and the need for the entrepreneur to be educated?

So, right, part of my job is to educate, and to build awareness of this as one more tool that an entrepreneur can use in his or her financing toolkit. When we’re talking to an entrepreneur about RBF, and what the pros and cons are, we look at it in the context of, where do they personally want to be and where do they want their business to be in three to five years?

It also means that I’m educating bankers and investors and lawyers and accountants on where RBF fits in the capital continuum. I’m still doing that to this day.

Farmers to You Founder Farmers To You. Greg Georgaklis

Greg Georgaklis, founder of Farmers To You, founded the company in 2009. The mission was to create a regional food system — something in between hyper-local and large-scale industrial — that would allow families and farmers to feed and support each other. In 2013, The Flexible Capital Fund provided $305,000 of royalty financing to Farmers To You and brought in an additional $45,000 from patient impact investors to support the company’s first expansion from a barn in Georgaklis’ back yard to a distribution facility in central Vermont. Photo by Erica Houskeeper courtesy of the Flexible Capital Fund.

What’s so interesting is when we started doing this 10 years ago, things were pretty cut and dried.  Your choice as an entrepreneur was either to borrow money via debt or give up ownership via equity.  That was that.  RBF was just coming into play as an alternative structure.

And now you can pretty much say, OK, Ms. Entrepreneur, here’s how I think we should structure your financing. What do you think? Does this make sense for your growth plan?

Now anything goes if two parties agree.

Northern-Reliability-Jay-Bellows-04_EH

Northern Reliability is headquartered in Waterbury, Vermont. Jay Bellows, president and CEO of Northern Reliability, said that after the company experienced some growing pains, the Flexible Capital Fund came in with a $400,000 revenue-based financing note, which allowed Northern Reliability to ramp up sales and marketing efforts, hire new employees, and invest in product development. Photo by Erica Houskeeper courtesy of The Flexible Capital Fund.

Which is the good thing. If everybody is up to speed and sitting on the same side of the table. Yes?

Exactly. Yes. Is there anything else one should be sensitive to in the RBF landscape? Yes. I’ve found, oftentimes, a company needs more than one kind of capital to make up the financing package. So, no matter who is doing the financing, all the pieces need to “play well together”. Often, we will be a bridge to equity for some companies, or we will be one of several kinds of money coming in. It might be bank debt and community loan fund debt and equity investment.

If you’re an entrepreneur looking for capital and trying to figure out what’s the right match, consider that you might need more than one kind of capital.

If you’re an entrepreneur looking for capital and trying to figure out what’s the right match, consider that you might need more than one kind of capital. An entrepreneur should really understand how the different kinds of capital work together, as we show in our capital continuum (see graphic below). What is the capital stack for growing their business? I will always ask, OK, you’re looking for X amount right now, when’s your next round and how much will you be looking for? How does that play into this capital today? Because if you want to grow, you’re going to need more capital and you need to plan now for that, so you don’t mess yourself up down the road.

Flex Fund Capital Continuum

I am a passionate financial innovator committed to social enterprise and impact investment. I consult through my social enterprise, Good Capital Projects where I coach entrepreneurs and educate values-driven investors. I have a background in finance. I previously served as Slow Money SoCal Director of Investment Programs as well as ... Read more

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