Interactive resources for incubators and accelerators
Interactive resources for incubators and accelerators
Interactive resources for incubators and accelerators

How to Invest Without Exits

a.k.a. Raising Funds and Non-Exit Capital

 

Investing in your own entrepreneur cohort can have a significant impact on the way you run your program. Participation is no longer just a case of charging your cohort to participate, or not charging them and covering their costs with donor funds.

 

This section looks at how the process of selecting companies for your accelerator changes once you start investing in them. It provides some useful questions to ask yourselves before taking the plunge into investment, and outlines some of the key criteria for making an investment in your own entrepreneurs worthwhile, for you and for the entrepreneur.

  • 0

    startups form per year in the US

  • 0

    of these are funded by venture capitalists

  • 0

    of those have made exits

VCs call the other 492,000 companies “unfundable” because they do not see the potential of getting 10x return on their investments.

  • Every company is “investable”. It just depends on how much risk you are willing to take and how long do you want to be paid back.

    Luni Libes, Fledge

There are three ways to invest in a company:

1. Debt financing

2. Equity financing

3. Revenue-based financing

Debt Financing

Debt financing occurs when a firm sells fixed income products, such as bonds, bills, or notes to investors to obtain the capital needed to grow and expand its operations. When a company issues a bond, the investors that purchase the bond are lenders who are either retail or institutional investors that provide the company with debt financing. The amount of the investment loan referred to as the principal must be paid back at some agreed date in the future. If the company goes bankrupt, lenders have a higher claim on any liquidated assets than shareholders.

When a company issues debt, not only does it promise to repay the principal amount, it also promises to compensate its bondholders by making interest payments, known as coupon payments, to them annually. The interest rate paid on these debt instruments represents the cost of borrowing to the issuer. Source: Investopedia

However, there will always be a risk where companies will be unable to pay investors for the first few years and so investors will not be able to make their 15% or more return.

 

Equity Financing

Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or they might have a long-term goal and require funds to invest in their growth. By selling shares, they sell ownership in their company in return for cash.

A startup that grows into a successful company will have several rounds of equity financing as it evolves. Since a startup typically attracts different types of investors at various stages of its evolution. Source: Investopedia

Revenue-Based Financing (Most Advisable)

Revenue-based financing, also known as royalty-based financing, is a method of raising capital for a business from investors who receive a percentage of the enterprise’s ongoing gross revenues in exchange for the money they invested. In a revenue-based financing investment, investors receive a regular share of the business’s income until a predetermined amount has been paid. Typically this predetermined amount is a multiple of the principal investment and usually ranges between three to five times the original amount invested. Source: Investopedia

EXAMPLES

  • 1.

    Revenue-based loan example

     

    $100,000 investment

    Payments of 5% of future monthly revenues (single digit topline revenue)

    Totaling $200,000 (predetermined amount)

    Providing a 2x return

  • 2.

    Revenue-based equity example

     

    $100,000 investment buys 10% ownership

    Company repurchases half those shares for $200,000

    Using 5% of future quarterly (less paperwork) revenues

    Providing a 2x+ return

Key Variables

% of revenues

Single-digit percentage

 

X cash-on-cash returns

  • Typically 2x-4x for seed stage
  • Commonly 2x for growth stage

 

 

Reflection

Key things to consider:

Debt or equity?
% of revenue
What ROI/IRR is fair?
X return?
How patient are you?
What else is important to you?

RESOURCES

  • The Next Step for Investors: Revenue-based Financing

    A book by Luni Libes on revenue-based financing

    Read

Next:

Mentors

How to find, recruit, and set up your mentors (and entrepreneurs) for success