legal guide to revenue loans presentation

MLCE Revenue Loans © COPYRIGHT 2016

Revenue Loans:The Legal

Fundamentals

Joe [email protected]


Overview› What is a revenue loan? › How does it differ from other loans or sources of capital?› What kinds of companies can borrow via a revenue loan?› Key terms of revenue loan agreements

MLCE Revenue Loans © COPYRIGHT 2016 3

Revenue Loan Overview


What is a Revenue Loan?› A form of revenue-based financing› Lender loans funds to a business and receives payments

based on a percentage of their ongoing gross revenue› Loan proceeds are used for long-term growth capital › Borrower’s payment amounts vary over time, increasing

or decreasing according to business revenue


How do Revenue Loans differ from other loans or

sources of capital?


Revenue Loan vs. Bank LoanRevenue Loan Bank Loan

Credit More focused on business than personal credit

Requires borrowers to have good credit ratings

Assets Intended for asset-light companies. Typically secured only against company assets. Borrower does not need to have hard assets or physical inventory (a benefit for tech companies).

Typically requires hard assets as collateral

Guarantees No personal guarantees May require personal guarantees, so the founder’s own assets are on the line

Interest Full repayment amount set up front

Uses fixed interest rate and may impose prepayment penalty

Repayment Monthly payments adjust to revenue cycles

Typically requires fixed monthly payments that don’t adjust for the borrower’s ability to pay


Revenue Loan vs. Equity FinancingRevenue Loan Equity Financing

Founder Ownership

No dilution of founder ownership Angel investment or venture capital investors buy equity in the company, which dilutes company ownership

Control Lender does not take a board seat or control company decisions

Investors may require a seat on the board of directorsInvestors control some business decisions

Valuation Not required Requires a valuation of the company

Exit No pressure to sell the company—lender does not depend on sale or IPO to receive return

Exit required

Legal Cost Small legal cost for the loan administration

May require substantial legal fees

Level of Effort & Time

Funding can occur in as little as one month

Usually a 3-6 month process


Recap: Advantages of Revenue Loans › Interests of borrower and lender are aligned› Monthly payments adjust to revenue cycles› Typically secured only against company assets

› No personal guarantees

› Borrower does not need to have hard assets or physical inventory (a benefit for tech companies)

› Does not dilute founder ownership› Lender does not take board seat or control business decisions› Quicker source of funding› Can repay loan early as revenue growth allows—if the borrower

grows quickly, the loan will be paid back more quickly› No pressure to sell the company—the lender does not depend on

the sale or IPO of the company to receive return


Borrower Information


Borrower Eligibility Requirements› To obtain a revenue loan, the business must generate

revenue› Recurring revenue streams from subscriptions and

contracts are a plus› Must have strong gross margins to not overly tax the cash

flows of a company› Profitability is not required, but a path to profitability is› Ideally suited to technology companies, SaaS and

software


Revenue Loan Agreements


Revenue Loan Agreements

› Description of the

amount of the loan› Closing Conditions› Repayment Terms› Maturity Date› Grant of a Security Interest

› Representations & Warranties› Covenants (positive and

negative)› Events of Default› Remedies› Venue/Jurisdiction/Dispute

Resolution terms

Revenue Loan agreements include many of the same terms as traditional loan agreements.


Terms Unique to Revenue Loan › Repayment terms are different from typical bank loans

› Monthly payment amounts are a percentage of the prior month’s “Net Revenue” until a “Return Cap” is reached

› The “Return Cap” is usually a multiple of the amount loaned (e.g., 1.5x)

› Thus, the definition of “Net Revenue” is important in a revenue loan

› Because monthly payments vary, interest is also calculated differently

› Sometimes there is a success fee if the company is sold within a certain period of time

› Terms may include an early buyout option (voluntary)


How Monthly Payments Are Determined

› Monthly repayment amount is determined by reference to the borrower’s revenues › Usually revenues in the month immediately preceding the month in which

payment is due

› Similar to royalty-based financing because the repayment schedule is similar to how a royalty payment would be calculated› For example, the term sheet might describe loan repayment terms as:

“___ % of the borrower’s preceding month’s net revenue, due and payable on the 5th day of each month.”

› Percentage of revenue might vary throughout the year› For example, initially at 8% until the lender has received a certain amount of

repayment that year, then decline to a lower percentage for the remainder of the year


How to Define Net Revenue› Typically akin to gross revenue

› Think about how a royalty would be calculated

› When you move from gross to net, you are not typically netting a lot of items› For example, you might net out the following items:

› Customer returns

› Shipping charges

› Net revenue is the cash that shows up in the bank (vs. anything accrued)

› This can vary based on the deal


What is the Return Cap?› Revenue Loans have a return cap or a repayment amount› It is a multiple of the amount borrowed—typically 1.3-2.2x

the amount borrowed› For example, the loan amount is $200,000, and the loan

will not be paid in full until the borrower has paid the lender 2x the loan amount


Maturity Date› A revenue loan will have a maturity date› The loan term is usually 3-5 years

› It may be earlier if the lender has received the return cap

› If the company has not paid back all amounts borrowed before the maturity date, the remaining amounts will become due and will be owed on that date via a balloon payment


How Does Interest Work?› No predetermined interest rate or payment › Each payment is allocated between principal and interest› The amortization is generally like a traditional loan, but is

adjusted based on how much principal has been repaid to date


Usury Limitations› Some states have usury limitations › Interest rate can’t exceed maximum rate allowed under

state law› The interest rate calculation can only be done at the end

of the term vs. at origination› Some states have case law precedence for this

› Some states exclude a profit share from the definition of interest (see, e.g., Texas)

› Choice of law and the physical location of the lender and borrower also impact whether usury restrictions apply


Success Fee› A revenue loan may include a success fee› What is a success fee?

› A success fee is a payment due to the lender on the sale of the company

› Success fees can live beyond the term of the loan

› For example, they might continue until the later of (i) two years past the loan termination date or (ii) the fifth anniversary of the making of the loan


Early Buy-Out Option› Sometimes a borrower can pay off a revenue loan early,

for less than the return cap› A typical formulation might look like:

“In the event the borrower consummates a Qualified Equity Financing within 24 months of the closing date, the borrower may repay the loan by exercising the early buy-out option.”

› Define a Qualified Equity Financing › Ex: $1 million new money

› The borrower pays the lender an amount of cash and/or equity issued on same terms as in Qualified Equity Financing


Security & Subordination› The revenue loan lender will take security interest in all of

the company’s assets› But, the lender may subordinate to bank loans, and

security interests relating to equipment and other hard assets

› Revenue loan agreement may only allow certain “permitted liens” on the company or its assets


Revenue Audits› Lenders will want the right to check on a borrower’s level

of revenues› Lender reviews financial statements› Lender may obtain the right to view the borrower’s bank

accounts in real time


Restrictive Covenants› The lender may impose some restrictions intended to

protect the revenue stream› For example, the borrower may not take on additional

debt or liens, loan its own capital, or dispose of material assets without the lender’s consent


Questions?


Questions?Contact:

Joe [email protected]

legal guide to revenue loans presentation

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