The future of RBF as we see it…
According to Sifted, "Revenue Based Finance startups" have raised a record €+670M in 2021 alone. The same article questions how "Revenue Based Finance" will evolve now that interest rates are rising and the global economy is entering a recession.
I have been working in RBF for the past two years, so I wanted to show that some of the supposed negative aspects of RBF mentioned in the article could be positive. Let me elaborate:
It's important to remember that €670M is a lot of money, but +80% of this money wasn't raised to grow RBF startups. Most of the funds were meant to be used as raw materials to lend out to clients. This means that only €135M has gone into building this industry from scratch, which is relatively low compared with other nascent industries. As an example, according to Crunchbase, just in the past 60 days, AI companies in Europe have raised +400M in Seed and Serie A rounds.
Could the source of the capital being lent out have already been better? The VC business model and returns generated by RBF don't match up. LP's investing in VC expect at least +25% IRR, which is not possible with financial assets created by RBF. All of this extra capital might have done more harm than good because expectations for return were so different between them.
"Sifted" suggests that lending to startups is about to become riskier. E-commerce and SaaS have grown during recessions, so these industries will likely continue growing.
However, the risk lies in the volatility of equity valuations for these companies. Valuation multiples can fluctuate based on the larger economy and interest rates. RBF provides a way to invest in "tech" without being subject to changes in valuation multiples. For this equation to work and be less dilutive for founders and early-stage companies, it should reduce the risk for financiers.
When markets peak, "funkier" lending becomes more common, likely harming RBF players. Can you imagine being a couple of months old startup and suddenly receiving 10's or even 100's millions of cash in your bank account with a note telling you to test out your offer and see how it goes? They probably would have needed more time to think about proper underwriting techniques.
The most significant innovation in the RBF area should have been defined by its name: revenue-based financing. Most players in this space have overlooked that original concept and turned RBF into unsecured lending of last resort. However, getting back to the principle behind carving out future cash flows and selling them to investors looking for steady yield and periodic coupons creates a lot of opportunity—especially during uncertain times like these.
The reason why Shopify was able to lend out 500 million dollars in Q3/2022 (The Information) is that default rates are 100% correlated with the quality of the data used in the risk assessments. Any company trying to develop a RBF should focus on making data models. Hence, they can handle an increase in underwriting process requests and fulfil the promise of 24-hour financing decisions.
To end its article, Sifted asks whether revenue-based financing startups need to pivot. Like every fledgling industry, RBF needs to wean itself off the unlimited supply of VC cash and prove it can weather an economic recession.
In my opinion, Revenue Based Financing has the potential to significantly assist the tech startup industry through the tough times ahead. It should focus on building upon the inherent strengths that suit this task well.
RBF startups should focus on building the infrastructure for revenue-based financing. This means analysing data, creating a tradable asset, and marketing those to organisations with balance sheets who want exposure to a short-term, monthly coupon-paying financial instrument.
- The popularity of RBF financing has led to many companies connecting their internal data sources to RBF platforms. This valuable data can be used to improve the accuracy of underwriting models, which will help reduce defaults and eventually become the most valuable piece of tech developed by RBF companies.
- To turn the provided financing into an asset that any investor can buy, RBF startups need to invest time into understanding and cracking the legal code these newly created assets are constrained.
- Investors will search for stability in uncertain markets in the next few months, making fixed-income assets more popular. If RBF startups want to take advantage of this wave and market their asset class to a broader audience, this is the right moment.
RBF startups need to focus on longer runways and profitability like any other startup. The difference is that RBF startups have the product to help the industry do just that. Their financing enables companies to lengthen their runway, making them an integral part of moving forward.
Starting up Levenue , I've been amazed by how much money our competitors have raised and frustrated by how long it took us to warm up organisations with the right balance sheets to start buying the assets we were creating. But we've cracked the code now, and we invite all our colleagues to follow us and help us put RBF on the map for longevity.
If you're attending Slush next week, look for the founders we've helped over the past couple of months and us! We would love to catch up with you over a cup of coffee.