RevenueLoan Blog

May 9, 2011

Send Me An Angel: Royalty-Based Financing for Angel Investors

Filed under: Angel,Movies — rsbelcher @ 4:55 pm

Rad

Yes, the above clip is rad. But it is also from “Rad”, the 1986 cult classic BMX film, starring Bill Allen as Cru Jones, and Lori Laughlin as Christian Hollings. As opposed to just dancing at the Formal like normal high school students (the two guys in matching Star Trek uniforms are ‘normal’?), Cru and Christian do sweet tricks on their BMX bikes to Real Life’s “Send Me An Angel”.

Lori Laughlin is certainly an angel, but Cru desperately needs an angel of a different kind – he needs a sponsor for the upcoming BMX competition because Mongoose Cycles (“Big Corporate”) is constantly changing the entry rules to keep Cru (“Little Guy / Scrappy Entrepreneur”) out of the race so that their sponsee, Bart Taylor (played by 1984 Olympic gymnastic gold medalist and husband of Nadia Comaneci, Bart Connor) will win with relatively little challenge.

Corporate Sponsorship of Athletes: The Venture Capital Model

Corporate sponsorship is ubiquitous in professional sports, but in individual sports like BMX racing, tennis and golf, the number of corporate sponsored athletes is actually quite small compared to the total pool. These athletes wear branded apparel, use the company’s gear and get paid to appear in television advertisements. These players usually come from a family of professionals , have built a unique brand and market following or hail from a prestigious high school or college program.  Occasionally someone with truly unique talent, strength and competitive advantage comes out of nowhere and dominates the field. Fitting into one or more of these categories doesn’t insure sponsorship, however, and the calls from corporate sponsors only come AFTER the athlete has achieved some success and displayed a capacity for more.

Similarly, only a very small percentage of start-ups and small companies receive top tier venture funding and the access to networks, branding and capital that comes with it. These companies are usually characterized by having founders from previous successful exits, having a unique brand with strong following or already having good connections from college or business school. Occasionally a category killer erupts to dominate a space. Like in the golf example above, fitting into one of these buckets certainly aids your company’s chance of attaining venture funding, but regardless, the vulture – ahem – venture capitalists don’t start calling until after you’ve achieved some success and demonstrated the capacity for the “hockey stick” growth curve.

Like the corporate sponsors, venture investors are only interested in opportunities that are worthy of and headed toward “prime time”.

The Gap

Tiger Woods and Facebook are the obvious standouts. But what about the rest of the field?

There are about 225 golfers on the PGA tour. Also, there are about 200 on the Nationwide Tour and another 2,000 on the mini-tours (Canadian Tours, New England Tour and Gateway Tour) and even more on the international tours. How many are on TV each weekend? How many are in car commercials? How many can you name?

In 2008 there were approximately 29.7 million companies in the U.S. almost all of which were sole-proprietorships. Of that 29.7 million only 6.0 million were small-businesses with more than one employee and only 18,000 had more than 500 employees[1].

In all of history (or at least since 1995) there have only ever been 61,427 venture financings[2].

As an aside, my inner spreadsheet-jockey can’t resist – here they are on a quarterly basis by stage:

As our analogy between professional golf and small business continues, it is clear in both examples that only a small number of both reach the upper echelons and receive the lime light, money, awards and PR to become pop culture icons.

The other 90% make nice, profitable businesses for themselves, but a big corporate sponsorship / venture capital is not available to them.

Credit cards or bank debt my work for some, but not all. For some the lack of collateral will be a non-starter and the lumpiness of cash flows can make paying amortizing loans difficult.

In sports, angels have addressed this gap in start-up funding for budding pro athletes by adopting a royalty-based financing model. In exchange for cash up front to pay for travel, meals, entry fees, equipment, health insurance and the like, an angel investor would receive a significant portion of the player’s winnings until he was made whole, and which point the percentage might step down over time.

Almost all angel investments in companies remain equity-based, and I posit that there is a need and an opportunity for royalty-based angel investing.

Angel Investing and the Royalty-Based Finance Model

Investor-sponsors in sports are usually enthusiasts of that sport themselves, and therefore enjoy sponsoring a young kid trying to make a go of it (and what 19th hole stories would he have if his investee really hit it big!). They enjoy having a horse in the race for what is a relatively small part of their portfolio. They also get paid back throughout the year, starting with the very first tournament. Lastly, the overall return on this investment is of less importance to the investor-sponsor than is the return on invested capital to the corporate development group at an equipment manufacturer looking to sponsor and promote an athlete for the season.

Angel business investors are very similar – they are typically successful businesspeople who now are afforded the opportunity to make investments for the return, of course, but almost more for the philanthropic component. They are eager to support growing companies in their hometown even if the investment returns flat or at a loss.

But typical angel investing is equity-based and tends to have very long investment horizons. Because she is investing in equity, the angel only gets paid back upon a liquidity event, and therefore the investments tend to be digital: they are either a success, or a donation. And unfortunately, as these things go, you’ll know much sooner if you’re donating than if it’s a success. In the event of success, Angel’s may not see returns (or even the principal!) for up to 10 years after the investment. In other cases the companies being invested in have no clear exit opportunity at all.

We here at RevenueLoan are offering an alternative to bank debt and venture equity for companies needing growth capital. We offer revenue-based loans from $50k to $500k to fund expansions.

I argue that revenue-based funding makes a lot of sense at the seed stage, and should be considered more carefully prior to an angel investment. Revenue-based debt provides:

–          on-going cash flows

–          solution to the “no clear exit opportunity” problem

–          opportunity to partake in the upside along the way, not just at exit

–          some risk protection: receive repayment immediately, not 10 years from now.

Angel investing is great for all those involved, and helps to fund and drive an innovative start-up industry in a community.

The next time you look to make an angel investment, or the next time you look to take angel funding, think through some of the criteria and situations raised in this post and consider if a  revenue-based model isn’t a better fit for your opportunity than classic equity.


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