Revenue Royalties - More on Community-Based Revenue Sharing
In my last post, I hinted at a way to raise capital for the 80% to 90% of growing companies that don’t qualify for sophisticated angel financing or venture capital, or don’t want it. One good reason not to want to get capital from sophisticated angel investors or venture capital investors is the share of the company that sophisticated investors will typically require in exchange for their C&C (cash and coaching.) If your product is equally sophisticated (or esoterically technical) you may have no choice. But for products and services that can fire up the imagination of the non-sophisticated investing class, you have another choice. We call it “community-based revenue sharing.” or revenue royalties. It may be the best path for you.
In this post I’ll offer you a surprising extra benefit for your raising capital in this way, and then outline the process for raising the capital.
First the surprising benefit
Your investors can help promote your company! In other words, not only does this method reduce the many burdens of having to deal with investors and pay them back, it also reduces a major unknown in any business plan: the cost of promoting your product or service. This is because investors who are compensated as a share of revenue have an immediate and direct benefit for helping you create a buzz around your product or service. So with this method, you are killing two birds with one stone: obtaining investment capital and creating a buzz. More on this in a moment.
There’s another surprising and hidden benefit to you and your family: This whole process is local and very social, so you gain a lot from it socially in your community. This goes beyond professional networking, into more intimate and long lasting relationships. You create new friends, you build your prestige and standing in the community, and of course, you have a lot of fun. It’s interesting we’ve found that when couples do this together and it brings a whole new circle of friends together. How else can you win in business, increase your prestige, make new friends and have a lot of fun all at the same time?
What you need to know
Before you can create a plan for raising capital using community-based revenue sharing, you’ll need the following information:
- What is the size of the available market for your product or service?
- What is the demographics of the customer (age, gender, location, income, background)?
- What is your go-to-market plan?
- What are your revenue projections for the next 10 years?
- How much investment capital is needed in the coming year?
- How much is needed to reach break-even (if not there already)?
- How are you going to use the funds you raise?
- How can you leverage use of the funds you raise with other traditional sources of finance, such as bank finance?
- What is the demographics of your potential investor community group?
- Who do you know that is well-connected to your investor community, and is available to reach out to them?
Item 9 is an important point because 1) investors will want to know that their money is leveraged, and 2) if you have other sources of finance, you won’t have to raise as much in the current round. Let’s say for example you're raising money to add locations for your business. If this involves buying real estate or equipment, lease financing or fixed asset financing will cover most of the cost. You need only raise enough capital for the down payment and monthly payments until there is sufficient revenue to cover the monthly payments. Other sources of financing include Accounts Receivable financing, factoring of invoices, purchase order financing, and distributor financing (where your distributors pay you early or in advance) thus contributing to your success. Sale of distribution rights is also common. You may also have options for unsecured financing depending on your personal credit and that of your company.
Why do you need 10 years of revenue projections, knowing that 10 years of projections is complete guesswork? True it is guesswork, but so is a profit projection or any other projection. You need a revenue projection so that you can give investors a guestimate of how quickly they’ll be paid back and then when can they expect to double their investment.
What are you going to offer investors in return for their investment?
With revenue sharing, you offer your investors a capped share of the revenues of your company, or a particular product or service within your company. The formula to compute what the investors get can be as simple as say 5% of gross revenues until the investment is doubled. Slightly more complicated is probably better, with a smaller percentage in the first few years, then growing as revenues accelerate, then declining again. This is why you’ll need the 10-year revenue projection. The projection allows you to assign the right percentage of revenue to pay to investors each year.
No matter what the percentage scale you use, you should always cap the returns to investors. I think promising to double the original investment is an attractive workable plan.
You can also further complicate the plan by adjusting revenues for certain expenses that vary in a predictable way with revenue, such as cost of goods, outside royalties and outside sales commissions. You can call this “adjusted revenues.” This is not the same as returning to investors a percentage of profits, since profits are notoriously difficult to compute and include management salaries. Your investors will know that you have an incentive to minimize profits by increasing management salaries. So investors will be happier with a percentage of revenue (or adjusted revenue) rather than a percentage of profits.
Summary of the benefits of community-based revenue sharing
Here I’m going to summarize the benefits of this investment plan to you and your company, since they’ve been scattered throughout this post and the previous one:
- You need only pay investors when you have the cash to do so.
- You are not burdened by a fixed repayment schedule and fixed interest rate.
- Therefore, the likelihood of investor’s having a basis for legal action is reduced.
- You are not selling ownership in the company.
- This leaves the possibility of selling ownership (corporate shares or LLC membership) to a later time when the company is worth a lot more (and therefore investors are willing to pay a lot more for each share or membership point.)
- Your investors are strongly incented to help you by creating buzz for your product or service.
- This method can be done locally, thus (possibly) avoiding federal regulation. (Please check with an attorney.)
- You gain new close friends and new prestige in the community.
- You have a lot of fun.
How do you do it?
The method for raising capital through community-based revenue sharing is different than raising capital from sophisticated investors. It assumes that your investors are already familiar with your area of business. It then involves creating relationships with your investors based upon your common interests. You can begin to imagine that the process involves entertaining investors and letting them get to know you and your team personally. It also involves investors becoming enthusiastic about your business model, products and services based on their previous familiarity with your area of business.