Revenue sharing notes: Investing in debt instruments

What is revenue sharing?

Revenue sharing is a loan arrangement where borrowers tie their repayments to the revenue that their business generates over time. When a borrower brings in high revenue, the timeline of repayment decreases. If revenue takes a dip, the repayment timeline increases.  

This can offer flexibility to high growth or seasonal businesses where revenue projections can be harder to predict. It also has the potential to provide attractive rates of return to investors.

What is a revenue sharing note?

Revenue sharing notes involve an agreement between two parties: lenders and borrowers. Investors (lenders) invest funds into small businesses (borrowers) that are looking to launch or scale their companies. The borrowers agree to pay the lenders a percentage of their revenue (for a particular period of time) until the total amount borrowed is repaid. 

Payments, if any, may vary monthly. Unlike a term note, revenue sharing notes aren’t tied to an interest rate. Instead, they are based on something called an “investment multiple.”

Key terms to know about revenue sharing notes

Maturity date: The date by which all funds are paid back to investors. Sometimes this happens before the Maturity Date, in which case no amount would be due. However, if any amount is still due by the Maturity Date, investors would be owed repayment of the remainder due.

Investment multiple:  From the investor standpoint, it is the total amount the company will owe you, including principal and interest.

Revenue sharing percentage: How much the business agrees to pay investors each month from its gross revenues. (This is not in addition to the investment multiple—this is how a business reaches the investment multiple).

 Securities are not guaranteed or insured, and investors may lose some or all of the principal invested if an issuer cannot make its payments.

How do revenue sharing notes work?

Use this hypothetical investment to understand how these notes work.

Example: You invested $1,000 in a revenue sharing offering on Republic.

• Investment Multiple: 2X
• Revenue Sharing Percentage: 5%
• Maturity: 48 months

How are payments calculated?

Your payment depends on how much of the total offering amount you took with your principal investment.

Suppose that the total amount a business raised was $100,000 and you invested $1,000.

Your $1,000 investment was 1% of the total $100,000 raised:

 You receive 1% of the total payment a business makes to all investors each month as long as the business can make payments.

How much does a business pay to its investors each month?

Each month, the payment a business owes to its investors depends on its gross revenues. This means that payments to investors are calculated first before costs are deducted.

Let’s say the business has the following hypothetical revenues:

What is my monthly payment?

Your monthly payment is your share of the total payment, if any, made to investors.

When do my payments start?

After closing a successful campaign, payments generally start after a business has generated revenue for one full calendar month. This is different from term notes, which commence in accordance with the terms of the note purchase agreement. Usually, businesses begin receiving revenues after they’ve opened to the public. If a company does not have revenues, then no payment is due.

There is a chance that payments will not commence at all if the company does not generate revenue. What’s more, not all loans come in the form of secured debt.

When do my payments end?

Payments end when the business pays you back your total payment amount.

The investment multiple determines the total amount a business must pay you. In this case:

So, if the investment’s maturity date is in 48 months, but the business pays you $2,000 in 40 months, then payments stop at 40 months. If it’s been 48 months and the business has only paid you $1,500, then the business would be required to pay the remaining $500 at the maturity date.

What are the advantages of revenue sharing notes?

• Unlike an equity crowdfunding investment, revenue sharing notes can become liquid much earlier. 

  • Payments flow to investors when revenue starts flowing to the company.

• Can offer a potentially attractive rate of return with some upside.

  • If a company exceeds growth expectations, their monthly repayments will increase, and the term length will lessen, thus increasing investors’ yield.

• Investors can play an active role in the success of the business.

  • Because investors receive a percentage of revenue, they can benefit from promoting the business in their community to help the business grow. 

• Due diligence is more straightforward than with an equity crowdfunding investment. 

  • There is no concern about the company’s valuation or exit strategy.

What are the disadvantages of revenue sharing notes?

• Securities are not guaranteed or insured, and investors may lose some or all of the principal invested if an issuer cannot make its payments.

• Potentially inconsistent returns.

  • Investors may not be attracted to a revenue sharing agreement if they are not generating consistent income. 

• No opportunities to exit or resell.

  • No secondary market exists for revenue sharing notes. What this means is, once you’ve invested in a company, you are at the mercy of the terms of the agreement until you are either paid in full, or the contract matures. 

So far, we have covered two of the three types of debt instruments in this series. If you missed the first post, read up on convertible notes. Our last post in this series (coming soon) will explain term notes for investors.