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Rethinking Startup Funding: The Case for Revenue-Based Financing for (Impact) Startups

Yazarın fotoğrafı: Can AtacikCan Atacik

Güncelleme tarihi: 26 Oca

That’s the provocative question Luni Libes explores in his little eye-opening book, The Next Step for Investors: Revenue-based Financing. Libes, an experienced entrepreneur and investor, takes a hard look at the venture capital (VC) industry, showing how it has been designed to serve only a tiny fraction of startups and investors while leaving the rest struggling for resources. This is even truer outside of the US, in most emerging markets. His book identifies the flaws and offers practical alternatives, one that we advocate the most: Revenue-Based Financing.


Inspired by Libes’ arguments, I took a closer look at the history of venture capital and its inherent flaws. Below, I’ve summarized my key takeaways from the book and why I advocate for revenue-based financing.



The Historical Evolution of Venture Capital


The modern venture capital system owes its structure to legislative changes in the United States. In 1974, the Employee Retirement Income Security Act (ERISA) allowed pension funds to invest in privately held companies, and in 1978, amendments made it clear that these funds could also invest in early-stage private equity. This policy shift opened the floodgates of capital into the sector, which grew from hundreds of millions of dollars annually to tens of billions by the late 1990s during the dot-com bubble.


It was during the 1970s, 1980s, and 1990s that the structure of modern VC investments took shape, particularly the use of preferred equity. Under this model, investors provide capital in exchange for equity, with additional preferences that prioritize their returns over those of founders and employees. The model depends on high-growth startups achieving liquidity events, such as acquisitions or initial public offerings (IPOs), to deliver returns. While this structure works exceptionally well for a handful of top-tier funds like Sequoia, Kleiner Perkins, Andreessen Horowitz, and Union Square Ventures, it is fundamentally flawed for the vast majority of startups.


The Flaws in the Venture Capital Model


The venture capital model is built on the assumption that most startups can achieve exponential growth and a liquidity event, but this simply isn’t realistic for the majority of businesses. One significant flaw is the intense pressure it places on entrepreneurs to prioritize short-term growth metrics over long-term sustainability. Founders are forced to align their strategies with investors’ demands for rapid returns, often leading to mission drift, especially in impact-driven businesses and social enterprises.


Moreover, the VC model disproportionately favors high-growth, technology-driven startups, leaving out businesses in traditional sectors or those with steady but modest revenue streams. Social enterprises, which aim to create social or environmental impact alongside financial returns, often struggle to attract venture capital because they cannot promise the rapid scaling and exit opportunities that VCs require. This misalignment not only excludes a large number of promising businesses but also perpetuates a funding gap for enterprises that could deliver meaningful economic and social value.


The Case for Revenue-Based Financing


Revenue-based financing (RBF) offers a viable and tested alternative for impact startups and social enterprises. Unlike traditional equity financing, RBF aligns with the financial realities and goals of businesses that may not pursue exponential growth but can still deliver steady, market-rate returns to investors. Under RBF, investors provide capital in exchange for a percentage of the company’s future revenues until a pre-agreed multiple of the initial investment is repaid.


How Revenue-Based Financing (RBF) Works


Revenue-Based Financing (RBF) is a flexible funding model where investors provide capital to a business in exchange for a percentage of the company’s future revenues. Instead of fixed repayments or equity dilution, businesses repay the investment through revenue-sharing, typically until a pre-agreed multiple of the original capital is reached (e.g., 1.5x or 2x the investment). Repayments adjust to the company’s revenue performance, meaning that during periods of lower revenue, repayments decrease, and during high-revenue periods, they increase. This structure aligns the interests of investors and entrepreneurs by reducing financial strain and encouraging sustainable growth. Unlike traditional venture capital, RBF doesn’t require the business to achieve a liquidity event such as an acquisition or IPO, making it particularly suited for businesses with steady but modest growth, including impact startups and social enterprises.


This model has several advantages for impact-driven businesses:

1. Preserving Mission: RBF allows social enterprises to grow without diluting ownership or compromising their mission. Founders retain full control over their vision, avoiding the mission drift often associated with VC funding.

2. Flexibility: Repayments are tied to the company’s revenue, providing flexibility during slower periods and reducing financial stress on the business.

3. Inclusivity: RBF is particularly well-suited to businesses with steady revenue streams but limited access to traditional capital, including social enterprises, women-led businesses, and early-stage ventures in underserved sectors.


Organizations like Viwala and Deetken Impact in Latin America have successfully used revenue-based financing to support small and medium-sized enterprises (SMEs) and social enterprises. These funds prioritize sustainable growth and align investor returns with the companies’ financial performance, proving that RBF can work across diverse markets and sectors.


Impact Startups in Emerging Markets


For emerging markets like Turkey, where many social enterprises operate under non-profit legal structures and struggle to attract investment, RBF presents an untapped opportunity. By adapting regulations to allow social enterprises to use RBF and incentivizing its adoption through tax benefits or blended finance structures, policymakers can create a more inclusive entrepreneurial ecosystem. Additionally, financial institutions, including participation banks, can tailor RBF products to align with faith-based financing principles, further broadening access to capital.


In summary


The silicon valley styled venture capital model has been the dominant paradigm for startup financing for decades, but it is increasingly evident that it is ill-suited for most businesses, and even more so for those focused on social and environmental impact. Revenue-based financing provides a flexible, sustainable, and mission-aligned alternative that empowers impact startups and social enterprises to grow without compromising their purpose.


As more investors and policymakers recognize the limitations of traditional VC and the potential of RBF, there is an opportunity to reshape the future of entrepreneurship. By embracing innovative financing models like RBF, we can ensure that businesses driving social change have the resources they need to thrive while delivering meaningful returns to investors. It’s time to rewrite the rules of startup financing—for the better.

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