Revenue-Based Financing (RBF) as a Climate Finance Tool for Startups
By Dimitry Gershenson
Startup and SMB entrepreneurs solving the climate crisis face a massive barrier toward their success: capital (or the lack thereof). The Climate Policy Initiative estimated that an average $632B were invested into “climate” per year in 2019/2020. Of that, about ⅓ was balance sheet capital (i.e. equity or corporate debt) – that number has to grow 8X to $1.8T (every year) to meet predicted demand. 🤯
While equity rounds dominate the news, VC alone cannot fill this gap for many reasons (LP capital availability, cost, structure, demand, etc). We at Enduring Planet believe that 50%+ of the need defined above (~$900B+) has to come in the form of corporate debt/credit.
The emergence of alternative credit for the New Climate Economy
As the urgency of addressing climate change grows, there is an increasing spectrum of credit options available to entrepreneurs, allowing founders to retain more ownership, access a lower cost of capital, and better align fundraising with operations.
This guest piece focuses on revenue based financing (RBF), but climate entrepreneurs should know they have many options beside VC: grants, crowd-funding, corporate and off-balance sheet debt, advance purchase commitments, etc. For an overview of the Climate Capital stack, read the excellent overview published here by the Climate Tech VC team and our weekly Tuesday Insights at the intersection of capital, climate, and entrepreneurship.
What is RBF?
RBF is a corporate finance instrument (as opposed to project finance) used by startups and small businesses to support growth. With RBF, a lender provides capital to a business in return for a share of revenue for (a) a fixed term or (b) until a cap has been met. Borrowers generally pay back monthly based on a percentage of gross cash receipts (less commonly on a % of net income or other predetermined portion of income).
With most other debt, the borrower is required to provide collateral or a personal guarantee. This can present a significant limitation to early stage companies; they either need to have a large asset base to meet collateral requirements or the founders need to leverage personal wealth to secure the loan. RBF generally doesn’t have such requirements.
With venture capital, VCs invest capital in exchange for a % ownership stake in the company. Sometimes the investments come with other rights, like board seats. In general, early-stage VCs look for investments that they expect to generate a significant return (i.e. 30%+ IRR blended across their portfolio, 50X+ return for individual investments), making VC capital one of the most expensive options for entrepreneurs.
VC also has an inclusivity problem. Despite the fact that women now represent over 40% of all entrepreneurs, the percentage of venture capital dollars going to women-founded companies has barely budged since 2012 (about 13%). The numbers are even worse for Black and Latinx founders — <1% of VC-backed founders are Black, <2% are Latinx.
RBF sits somewhere in between VC and traditional corporate debt, in terms of the structure and pricing. Like VC, there are few protections for the lender if a company goes bust. Like most debt, there is no equity exchanged for the investment, and returns much lower than VC. In some cases, RBF lenders will also take a more active role in supporting the business (like VCs), however this varies significantly across lenders.
Other pros/cons of RBF?
Pros:
Speed - fintech tools dramatically accelerate the funding process, with founders getting term sheets in 1-7 days and funding in <30 days.
Simplicity - legal documents and underwriting are simpler. This means lower legal fees, a cleaner/faster process, and an overall more entrepreneur-friendly experience.
Alignment of payments & revenue - unlike traditional term loans, payments are directly proportional to revenue. This means if a company has a bad month, they pay less, enabling better management of cash flow.
Follow-on financing - because RBF requires active visibility into financials, RBF lenders are able to provide follow-on financing, or refinancing, at a much faster pace than traditional investors.
Inclusivity - RBF can be more inclusive when compared to other financial products because of how investments are sourced and underwritten. Many RBF lenders tout much higher ratios of underrepresented founders in their portfolios than the VC community.
Cons
Limited to post-revenue companies - pre-revenue and early-revenue companies typically can’t access RBF because lenders need to see a track record of consistent and growing revenue.
Doesn’t work for low-margin companies (typically) - RBF requires healthy gross margins (35%+).Variable cost of capital - RBF, by design, has a variable repayment model. This can make it more difficult to model cash flow when future revenue is less certain. You can mitigate this uncertainty by having a clear understanding of your unit economics and return on marketing/growth spend.
When is the right time to raise RBF?
You’re looking towards your next raise and want to pour extra fuel on your growth fire to get that higher valuation
You’re actively raising now and looking to minimize dilution and blended cost of capital
You’re not thinking about VC at all and are looking for extra capital to satisfy unmet demand and fuel growth
RBF with Enduring Planet
Enduring Planet is the first and only alternative lender focused 100% on climate.
If you are a post-revenue climate startup or small business operating in the US, check out our funding criteria and apply for our RBF here – it takes <10 minutes. For everything else, please shoot us a note via our Contact page.
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