Many early-stage companies looking to grow are faced with a difficult decision: continue to bootstrap or accept investment. Continuing to bootstrap means that growth can only be financed by cash flow, which frequently means that this growth will happen slowly. Accepting growth capital in the form of equity investment can help accelerate growth, but means that the ownership and control of the business will change.
Apart from equity’s higher cost of capital, which we’ve discussed previously, entrepreneurs should consider three other risks involved in accepting an equity investment in your company. Often, these risks are mitigated by ensuring you’re working with a trusted partner, however, the risks should not be ignored and represent the risks of accepting equity investment. Revenue-Based Financing (RBF) can help mitigate these risks, which we discuss below.
First, your incentives may not always be aligned with those of your equity investors. Equity investors are exit focused, in that they need your business to sell in order for them to recoup their investment. While there are certain scenarios (such as secondary markets) that allow for equity investors to cash in without a sale of your business, they are not frequent. It’s important to understand that by accepting equity investment, you will be expected to sell or IPO your business at some point in the future. Even when this is known and accepted, the tension may be timing – how can you be sure that you won’t be enjoying the growth and your investor will believe it’s time to sell?
Second, equity investment requires you to set and agree on a value for your company. Your interests are misaligned with equity investors here – for a given investment size, you want to give up as little of your business as possible, and your investor is trying to get as much of the business as possible. If you’re a seed-stage deal, often times your idea may need some additional proving and revenues may be low. This results in a much lower and frequently disappointing valuation for your business, requiring you to give up more for less. Later stage companies are often in a much better valuation position, as their company and market have proof of traction.
Finally, if things go off the rails, investors could take control of the business. Some less-scrupulous investors may include control provisions that require their approval of spending and budgets. While this isn’t normal, it does occur, especially in the Utah investor ecosystem. Also, depending on the size of the equity round, if the investor ends up owning more than 50% of the company, they effectively have the ability to take over operational control at any given time. This case is not extremely common either. However, a frequent control that investors can and do utilize is the potential for future investment – if the company isn’t performing and the investors want to leverage their control, they can choose not to make another investment, effectively harming your business and signaling to other investors that the company is not investment grade.
GSD’s Revenue-Based Financing opportunity provides an alternative financing option for entrepreneurs that mitigates these risks and helps prepare you for possible future equity rounds.
Because you’re making RBF payments based on revenue, we are incentivized to help grow your business, and are indifferent to an eventual sale or exit. RBF’s loan structure means that we don’t need to align on a value of your company – in fact, our capital can help grow your business to a larger valuation for a future equity fundraising event.
Finally, because we don’t own equity, our ability to control the business is extremely limited. We do ask for two key tools that help us monitor the health of the company, one is board observation rights, which means that we are non-voting member of your board of directors. Second is a commitment guarantee, which is a promise you make to commit to the company, even if things start to get rocky. We never request onerous control provisions and never require a personal guarantee of the loan. When things go bad, it’s in our best interest to help you fix the business, not take over.