It’s no secret, in just a few weeks the high flying tech valuations of 10-20X multiples are now a thing of the past. Due to a downturn in major tech stocks, turbulent financial markets, an increase in interest rates and chaotic geopolitical conditions, VC performance in recent quarters has been slow. While markets at the beginning of the pandemic were able to rebound quickly, the fiscal policy tools that made it happen — and the money behind them — has dried up.
“Plan for the worst,” VC giant Y Combinator told its portfolio companies in a recent letter. While YC advocates for cutting costs and extending runway, they point out that even top tier VC companies will have a harder time obtaining capital as investors tighten their belts. Existing portfolio companies with higher records of performance will be prioritized over new offerings, and new funding rounds will be smaller and fewer between. Funds will be prioritized to the highest performing portfolio companies leaving many strong and growing companies in the dark. What’s particularly heartbreaking is the impacts this will have on new businesses and their employees.
However, venture capitalists tightening their purse strings doesn’t necessarily mean the end of tech or even funding. Startups just need to find another avenue.
How Alternative Funding Models Fill the Gap
When venture capital budgets shrink and the economy itself starts to wobble, startups will be faced with a few options. Some businesses will choose to stay the course with the equity route, choosing to raise at a revised lower valuation, if this option even exists to some startups.
Traditional debt is often not ideal for many startups, as banks often view startups as risky investments and require 2-6 months of process, personal guarantees, security interest and can impact credit scores.
Alternative methods of funding (like non-traditional debt and revenue-based financing) often fill a gap for the startup community. In just a week, and without requiring personal guarantees, and personal credit hits, can fill the gap created by the Venture Capital firms.
Startups can choose to use their alternative funding in a variety of ways, including growing their teams, expanding product lines, stocking inventory, and more. In addition, the alternative funding round is not tied to the valuation like equity is and therefore can help companies raise or bridge their financing without a down round evaluation.
As many have noted, it will be a two year survival period for the startup community. Alternative funding can offer the ability to carry the business forward while setting the business up for success in the future.
One particularly new and growing alternative funding method that many startups are turning to is Revenue Based Financing.
How Does Revenue Based Financing Work?
Revenue based financing, which takes a percentage of a business’s monthly revenue in exchange for an initial outflow of cash, sits somewhere between equity and traditional debt. Businesses take out a loan for the amount they need, which is underwritten based on the company’s past performance and stability. They pay the principal back at the end of a set term, plus a portion of monthly sales for each month in between.
Revenue based financing gives lenders some stability and protects borrowers from the effects of a slow economy. With more predictable costs than VC and less risk for borrowers — no revenue means no payments —- RBF can be the answer on both sides of the table. In any case, if equity funding continues to dry up, it may end up being one of the only major financing options for tech companies looking to expand.
Companies such as Corl have created terms that are intended to help businesses survive the next 24 months with two year term loans. Businesses can get upfront capital and in return they pay 0.5%-10% of their monthly revenue (with many falling toward the lower end). At the end of the two year term, businesses repay their loan. The royalty payments allow businesses to have the security of rising and declining revenue as they head toward more uncertain times.
Although no one knows what the future will hold, the need for funding is here to stay. With alternatives popping up to fill the gaps equity financing left behind, there’s never been a better time for startups in the tech world to try something new.
