Founders Bill Spruill and Charles Gaddywere careful not to give up too much of their company, Global Data Consortium, to the venture capitalists eager for a piece of the digital identity verification company.
When they needed growth capital in 2018, they worked with RevUp Capital to structure a revenue-based financing package that repaid the capital, up to a cap, with a small percentage of future recurring revenue, not equity participation. Instead, they shared that equity with employees.
When London Stock Exchange Group bought the Raleigh-based business four years ago for $300 million in cash, that early, non-dilutive bet meant the company’s founders kept most of what they’d built. More than two dozen employees became millionaires at the time of the transaction through an equity participation plan.
“In our model, our companies tend to be a little more capital efficient,” RevUp’s Melissa Withers. “When they do raise equity dollars, they do so in more modulated ways. And so the exits that we’ve had, disproportionately, the founders have actually walked away with liquid wealth.”
Equity investment can be expensive, especially with the terms that many investors impose: Board seats. Liquidation preferences that ensure investors get paid first. Anti-dilution clauses that punish founders if a later financing round comes at a lower valuation later. Those costs compound across rounds until the founders who built their companies find themselves last in line at the very exit they spent years working toward.
After the exit, Spruill and Gaddy did something even more unusual: They became the first RevUp founders to become limited partners in the Providence, Rhode Island-based firm’s revenue-based investment funds.
“I didn’t realize how uncommon the founders coming back as LPs was,” Withers tells ImpactAlpha. “We have now 10 new LPs that are all former RevUp founders who finally made some wealth and reinvested back into us,” says Withers. Spruill, a Black gay founder, also launched an investment fund shortly after the exit, investing in diverse tech founders in North Carolina’s “Research Triangle” in Raleigh, Durham and Chapel Hill (see, “Five promising pages in the playbook for shared prosperity”).
“In my venture fund, our best exit was garbage for the founders,” Withers says. “When the outcomes are really good for the investors, a lot of the times they’re bad for the founders, because by the time the dollars get to the common stockholders, there’s no cash left.”
Founder-friendly
Revenue-based financing functions more like a loan, and doesn’t ask a founder to give up a piece of the company to get the capital to grow it. A founder repays a fixed multiple of the financing as a set percentage of monthly or quarterly revenue until a multiple of the original note amount is paid off.
“You could do a seed round and end up giving away 30-40% of your company,” says Kim Folsom, a seven-time entrepreneur who now manages similar revenue-based funds at Founders First Capital Partners, “As you continue to grow, if you grow using equity, the more you give up, the less you have.”
https://impactalpha.com/investing-in-resilience-why-americas-overlooked-businesses-matter-more-than-ever
Founders First has built a wealth creation tracker that follows the firm’s portfolio companies from the point they first come in for financing through the growth that follows over time. Folsom says the tracker uses valuation models similar to a 409A valuation, the kind of appraisal companies use to price stock options. “We look at increased revenue, cash flows, profitability for the companies to see how that impacts the overall valuation of the company,” Folsom told ImpactAlpha.
Founders First says of the $20 million the firm has deployed to its serviced-based small businesses, it expects to create nearly $45 million in wealth for its portfolio companies and their communities. That’s wealth that would otherwise have gone to VCs under traditional equity models.
The next layer, Folsom says, is following that appreciation to where it actually lands, whether a founder is able to buy a home or build a retirement account, and whether the gains reach further to employees, through 401(k) plans, stock options or other wealth-creation programs of their own.
Revenue-based financing isn’t a one-size-fits-all replacement for venture. It doesn’t work, for example, for pre-revenue companies, or for the capital-intensive, loss-leading growth that only equity can absorb. But for the founders for which it is a fit, the real pitch isn’t cheaper capital, it’s the ability to avoid trading away ownership and governance in order to grow.
Folsom is careful to distinguish flexible, founder-aligned revenue-based capital from the extractive “Merchant Cash Advance” model that sometimes goes by the same name. In addition to RevUp and Founders First, she points to Decathlon Capital and Lighter Capital as practitioners of “this alternative equity-like growth capital model.”
Delaying dilution
In RevUp’s revenue-based contracts, which range from $350,000 to $500,000, founders typically return around 5% of cash collected on a trailing quarterly basis, over three to six years. There’s no penalty for early payoff, meaning a company can buy out of the remainder of its contract at any point.
And to avoid functioning like conventional debt, RevUp’s contracts aren’t securitized, and founders aren’t required to sign personal guarantees. “I have a very hard time looking a founder in the eye who doesn’t have a lot of personal wealth and suggesting that they should personally guarantee a loan for a company,” says Withers.
Withers launched RevUp in 2016 after growing frustrated with who VCs funded and who they didn’t. Venture capital’s one-size-fits-all term sheets forced companies into models that didn’t fit their businesses. The whole system created an illusion of what big exits actually meant for founders.
With her partner, Allan Tear, she was attracted to revenue-based financing as a founder-friendly alternative for gritty, overlooked entrepreneurs building revenue-driven businesses that could grow to become $30 million companies and create quality jobs and wealth for founders and communities, but were never going to be the next venture-scale outlier like Facebook or Uber.
“These were companies that were incredibly important to our country’s economic future. These were companies that produce wealth and jobs,” Withers tells ImpactAlpha.“Venture works really well in high-risk, high-reward categories like medicine, rockets and robots. There’s places where my model is terrible and doesn’t work at all.”
RevUp targets founders overlooked by traditional VC and are navigating the notoriously difficult climb from $1 million to $10 million in revenue. Withers describes two overlapping groups: companies that are, in her words, “too niche-y” for institutional venture to take seriously and founders who are skeptical of institutional venture on their own terms.
RevUp has deployed roughly $25 million in 70 companies since 2016. About $21 million of that total has been deployed through its revenue-based funds, including those backed by its previous founders. RevUp pays dividends to LPs twice a year; its funds have produced a net internal rate of returns of 19%.
“I just think we got a little obsessed with this coastal unicorn thing, even in impact,” she adds. “People built venture funds, and now they’re having the same problem venture’s having, which is they can’t produce any liquidity for anybody. And when they do, the founders get screwed. That’s that system.”
RevUp’s portfolio companies have gone on to raise $150 million in follow-on equity funding, which Withers sees as evidence that delaying dilution until a higher valuation, rather than avoiding equity altogether, is itself the ownership-preservation strategy. “We like to prove the point that this gap in the capital continuum is really about creating optionality to allow more of these companies to get larger,” she says.
RevUp has raised $10 million towards its latest $20 million target fund, which Withers expects to close by year’s end. Through the new fund, RevUp will make small equity investments in alumni companies nearing an exit, a move she says is intended to boost the fund’s multiple on invested capital, or MOIC.
Withers says she has no plans to raise a hundred-million-dollar fund. Instead, her ambition instead is to keep proving the model works, and to nurture entrepreneurship as a path to real economic mobility.
“I think entrepreneurship has never been more important than it is right now, today, in this moment,” Withers says. “It’s the only glimmer of hope that I have when I read the news.”
Small exits can have big impact, she says. Withers says two co-founders who sold their company for $8 million were able to walk away with $3 million each in cash because they had no equity holders on the cap table. “Fast forward, they now started a new company, and we just invested in that company,” she says. “And they’re LPs in our fund.”
Another team sold their company for $5 or $6 million. “They immediately invested $100,000 in our new fund, without thinking,” she says. “They were like, ‘Of course, we’re gonna.’ And not only because we helped them, but because they believe that this is the fly chain that they wanna be a part of.”
