The revenue sharing deal structure is not new, but is was not used substantially until this decade. See Royalty/Revenue Share Deals for a background on the deal type. It remains a fringe deal structure, but it has some significant merits:

  • The invested company does not need to be committed to a particular exit strategy
  • The invested company does not need to offer a BOD seat or give up meaningful control of the company
  • They are quick, easy, and cheap to execute
  • The invested company does not need to pay $10k – $25k to a legal firm to close this type of deal
  • They begin to return capital within 12 months of signature and payout over the five successive years
  • They should not cause a problem for a company to raise additional capital or be acquired
  • Depending on how the company treats the Note from an accounting standpoint, they may be able to deduct the payments as interest payments. The company will have to confer with its own accountant on that issue. We do not get involved in their account other than to review their books periodically in our continuing diligence.

The concept of a royalty for some IP or financial contribution is not new. You see “Mr. Wonderful” offering this type of deal all the time on Shark Tank. It has been around as long a licensing deals have been in use. So, this is simply an extension to the royalty concept.

Essentially, the our standard agreement says the following:

  • For every $100,000 of committed funds, the company will agree to pay X% of their top line revenue to the investor
  • For every $100,000 of committed funds, the company will agree to a warrant package for the investor with a penny strike price for 7 years
  • In return, the company gets one year of “grace” to jumpstart its revenue stream
  • At the end of each year, a minimum of 25% of the original investment price must be returned to the investor
  • The lifetime value of the contract is 3.5x on the original investment, or a balloon payment at the 6th anniversary of execution if the returned capital does not exceed 3.5x
  • There is a one-time buyout of 3.5x in the event of an acquisition, for which no partial payments are accepted and this term applies only for the purpose of acquisition or change of control.
  • There are penalties if the revenue is not paid on the milestones.
  • The investor gets standard information rights

We have had success with this model and it allows us to work with companies that may, for whatever reason, not fit the traditional venture model.

When should you use the Revenue Sharing Agreement:

  • When you are dealing with a growth-oriented lifestyle business
  • When you are dealing with a service-based business
  • When you are dealing with a product-based company
  • When a company’s IP position is within six years of expiration
  • When you are dealing with a company that does not want to commit to an exit strategy

What you should know about revenue sharing:

  • It aligns all parties interest in getting to revenue and scaling quickly and effectively without regard for an exit strategy
  • This is still not a common deal structure and many entrepreneurs have never heard of them
  • When an entrepreneur does the math, they will initially push back citing the cost of the deal. In my experience, entrepreneurs look at equity returns from an exit as “found money.” But, the minute you ask for part of their revenue, they balk. This is because they see revenue going out to the investors as something they have earned. However, once they understand the agreement, most are amenable.
  • You can still make a 10x return on a revenue sharing deal, but it requires an exit with the Warrant package.  The general expectation should be 3.5 – 5x as a return, but in what could be viewed as a more predictable and lower risk model.
  • We believe that this is an apt vehicle for many “heartland” deals as a first round that can later be invested for more equity

For more information:

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