How to get more capital to small businesses?
By John Hamilton
Royalty financing works well for second-stage companies that are introducing a new product or experiencing a merger or acquisition, not for startups.
Instead of set monthly payments, loan repayment would be based on a percentage of revenues, similar to daily merchant cash advance repayments.
"In the new model I am proposing, because the lender is assured of a piece of the entrepreneur's future earnings regardless of whether the current business succeeds, the lender should be willing to be more flexible with terms and rates," Ami writes.
I certainly agree with Ami that we need more "out of the box" lending and investing approaches in order to get capital to companies on whose success our economy depends. His proposed solution is similar to what Vested for Growth has done in New Hampshire since 2002.
However, I do not see this type of lending as being the role of bankers, whose "least-cost debt" business model only works when they are repaid 98-99%. Alternative lenders can take higher risks with subordinate debt as long as the borrower has steady cash flow and a strong management team.
Then there are companies that are primed for growth, but considered too risky for bank-type loans. That's where royalty financing comes in. Similar to what Ami describes, the investor's return is based on the company's performance and cash flow.
Royalty financing works well for second-stage companies that are introducing a new product or experiencing a merger or acquisition. It does not work well for startups, whose revenue is still speculative.
Evolving businesses often travel a wide spectrum of risk. Entrepreneurs are better off when all of the choices along the risk spectrum are available and when they understand the tradeoffs of each.
John Hamilton is the Community Loan Fund's Vice President of Economic Opportunity and Vested for Growth's Managing Director.