The Reconstruction | March 9, 2021

Impact investors turn to revenue-based financing to bridge capital gaps for founders of color

Dennis Price
ImpactAlpha Editor

Dennis Price

ImpactAlpha, Mar. 9 – As Kim Folsom likes to say, Founders First is majoring in the minors. 

Rather than produce a few tech unicorns at billion-dollar valuations, Folsom wants to help create hundreds, or thousands, of diverse-led operating businesses each valued in the millions or tens of millions.

Without the exponential growth prospects venture capitalists look for, nor the collateral required for commercial bank loans, such businesses have had a hard time accessing growth capital.

Folsom, a seven-time entrepreneur, founded San Diego-based Founders First in 2015 (see, “Agent of Impact: Kim Folsom”). The firm’s flexible form of revenue-based financing for solid, service-based businesses that are creators of both jobs in underserved communities and wealth for diverse founders requires portfolio companies to pay investors a percentage of their top-line sales, up to a predetermined cap.

Business founders like such revenue-based financing mechanisms because they avoid the dilution of standard equity investments and help entrepreneurs retain control of their businesses.

Investors increasingly find revenue-based financing appealing because, like a loan, they are able to recoup their capital without an exit. At the same time, the terms of repayment provide equity-like upside opportunities (the faster a company grows and repays, the larger the internal rate of return). 

 “Our goal is to make this a sustainable model with quantifiable impact in the communities we serve,” Folsom tells ImpactAlpha. “We want to be able to demonstrate a new capital asset class for investors.”

Revenue-based financing has long been used in sectors such as resource exploration, entertainment and pharmaceuticals. In the past five years or so, capital providers have adapted the tool to finance small and growing businesses, many led by underrepresented founders.

“We have seen a significant growth in both the number and volume of revenue-based providers that have emerged in the last five years,” says Jacob Haar of Community Investment Management, which provided a $100 million credit facility to Founders First in 2019. “As a category revenue-based financing is here to stay, and is growing.”

Shifting risk

Firms like Decathlon Capital in Park City, Utah, and Lighter Capital, based in Seattle, have attracted institutional capital to deploy revenue-based finance to larger companies.

Folsom’s model takes revenue-based finance down market, with smaller businesses in second and third-tier cities and led by founders who have largely been shut out of capital access. That boosts the risk – and the opportunity. 

The potential to close a massive capital gap for founders of color with a scalable but underutilized financial product has captured the attention of investors and foundations looking to catalyze solutions for economic opportunity in the U.S.

In Chicago alone, Black and Latino entrepreneurs face a gap of at least $146 million in venture capital backing, the consulting group Next Street reported last year. ‘Equity-like’ capital products that meet the needs of moderate-growth businesses could fill part of that gap, found the think tank. 

Founders First itself this month raised $9 million in equity financing from the Rockefeller, Surdna and Kauffman foundations, Spring Point Partners, and others. 

The Rockefeller Foundation has long been bullish on revenue-based finance as a tool to create economic opportunity, says Thomas Belazis, who led the foundation’s investment in Founders First. Rockefeller backed Founders First with a program-related investment from its “Zero-Gap” portfolio, which also includes investments in student lending platform Sixup and Leapfrog Investments’ $700 million fund for healthcare and financial services in Africa and Asia.

“If you can prove this out, you have a lot of potential to catalyze some large scale institutional dollars into this space,” says Belazis. “Layer on the impact angle, and we think that there’s a lot of opportunity here to demonstrate this and make this a full fledged, scalable institutional asset class.”

To prove the case to commercial investors, the investment in Founders First itself was structured as a standard Series A financing, with a structured exit and coupon payment. The investment will help Founders First deploy the $100 credit facility it raised in 2019 and expand from San Diego, Dallas, Austin and Chicago to Miami, Denver and Philadelphia. Surdna’s Shuaib Siddiqui said the innovative underwriting model meant investors were taking on additional risk to help Founders First create a track record.

“This is where our capital is important,” says Siddiqui, “We are willing to take risks to go in and help prove models, help prove thesis, but will be attentive as other investors come in.” 

Siddiqui led Surdna’s limited partner investment in Melissa Bradley’s 1863 Fund, which also provides revenue-based financing to entrepreneurs of color. Surdna is also an investor in Community Investment Management, the provider of debt financing to Founders First, Lighter Capital and other revenue-based lenders. 

Revenue-based tools could be a breakthrough for marginalized and underinvested in communities, Siddiqui says. Standard-issue debt, even from foundations and other community financiers, “places all the burden and all the risks on that community,” he says. “Using equity-like finance shifts the risk,” he says.

Right fit

To be sure, revenue-based finance isn’t for every founder. The structure often works better in the context of later stage businesses, says Aner Ben-Ami of Candide Group, which has used revenue-based finance in a number of investments. 

“At some point, the growth trajectory required to repay investors starts to look a lot like the kind of ‘hockey stick’ projections that the venture capitalists are looking for,” Ben-Ami writes in Don’t go chasing unicorns. “And if investors are buying into the venture-style growth, they should probably pause and wonder why they’re targeting a 2x return instead of the 10x outcome venture investors are chasing.”

That perhaps explains the shuttering last week of, after institutional investors accustomed to VC business-as-usual declined to participate. The strategy, launched six years ago as part of O’Reilly AlphaTech Ventures, offered a profit-sharing structure that promised to help profitable tech companies grow while letting founders retain ownership. 

“As we’ve sought to lean more aggressively into scaling our investments and ideas behind an ‘Indie Economy,’ we’ve not found that same level of enthusiasm from the institutional LP market,” explained founder Bryce Roberts.

Revenue-based finance “sits on the risk-return spectrum between equity and debt,” says Haar of Community Investment Management. “There is an uncomfortable positioning where investors don’t know how to think about it. It’s an alternative to venture and an alternative to credit.”

Haar says the challenge of investing equity in small business is that investors become deeply enmeshed in the balance sheet of the company. Credit, on the other hand, requires a fixed payment every month. “Revenue-based financing combines a payoff that is aligned with the underlying business, but is not changed by the expense structure.”

“Now we’ve seen a track record and the significant impact,” Haar says. “There are clearly companies succeeding in doing this kind of financing.”

Investors have to understand where they’re part of the problem, says Margot Kane of Spring Point Partners, the Philadelphia-based social investment firm of the Berwind family, another Founders First investor. 

Asset owners and allocators, “have to recognize where their requirements are such that a whole swath of the market is left out because the capital they need is just fundamentally missing in the market,” she says. To bridge that gap, she adds, “you have to shift perception throughout the supply chain of capital.”

David Bank contributed reporting.