Latest / The Series A Show with Fexingo: Early-Stage Funding, Pitch Decks, and Startup Milestones / Why Startups Are Offering Revenue Share Agreements Instead of Equity
Transcript
- Lucas: So I was looking at the data from PitchBook this morning, and one number jumped out at me. In Q2 of this year, revenue share agreements — where investors get a percentage of a startup's top-line revenue instead of equity — accounted for roughly 12 percent of all early-stage deals under $5 million. That's up from about 3 percent two years ago. Luna: That's a quadruple. And it's not just a niche for e-commerce or SaaS companies that have predictable recurring revenue anymore, right? Lucas: Exactly. It used to be that if you had a hardware startup or something with lumpy cash flows, revenue share was a non-starter. But now we're seeing it in biotech tools, climate tech, even some deep tech. The structure has gotten more flexible. Luna: How does a typical deal look today? Say I'm a founder raising $500,000. What do I give up? Lucas: Generally, you agree to pay back a multiple — usually between 1.5x and 3x the principal — as a fixed percentage of monthly revenue. That percentage is typically 2 to 8 percent. So if you raise half a million at 2x with a 5 percent revenue share, you'd pay back $1 million total, but only when your revenue is flowing. No fixed monthly payment. The cap is usually 5 to 7 years, but if you hit the cap early, you're done. Luna: So it's not debt in the traditional sense. But it's also not equity. It sits right in the middle. Lucas: Right. And that's what founders are finding attractive right now. With public markets shaky — look at ARKK down more than 2 percent in just the last five days, or Coinbase down almost 9 percent — the IPO window is basically shut for most startups. Which means VCs are holding onto their dry powder longer, and Series A rounds are taking 6 to 9 months to close. Revenue share lets you keep building without giving away 20 percent of your company. Luna: But there's a catch. If your revenue grows fast, the cost of capital can be higher than equity. A 2x return on a $500,000 investment in two years is a 100 percent internal rate of return for the investor. That's steep. Lucas: It is. But founders are making that trade-off consciously. They're saying, 'I'd rather pay a high price for capital that doesn't dilute me, because I believe my equity will be worth far more in five years.' And investors like it because they get paid back before the exit, so their downside risk is lower. Luna: Who are the big players in this space right now? I know Pipe kind of popularized the model, but they focused on recurring revenue streams. Lucas: Pipe is still around, but they've pivoted more toward a marketplace model. Then you have companies like Uncapped, which does revenue-based advances for e-commerce and SaaS. There's also Lighter Capital, which has been doing this for over a decade. And newer entrants like Wayflyer and Outfund are using revenue share for digital marketing spend. Luna: So what's the typical profile of a founder who chooses this route? Is it someone who's been burned by VCs, or someone who just wants to maintain control? Lucas: Both, honestly. I talked to a founder last week who had raised a small seed round at a $10 million valuation. She was about to raise a Series A when one of her VCs pushed for a full board seat and veto rights. She walked away and raised $2 million through a revenue share agreement instead. She now owns 90 percent of her company, and her revenue grew 150 percent year over year. Luna: That's a powerful story. But I imagine there are downsides. If your revenue dips, you still owe the share. And if you're growing really fast, you're paying out a huge chunk of your top line. Lucas: That's the tension. Revenue share is counter-cyclical in a bad way — when times are tough, you're still paying. That's why some deals include a floor or a grace period. But it's not as flexible as equity, where investors only get paid at exit. So founders need to model their cash flow carefully. Luna: Let me ask something I think a lot of listeners are wondering. How do investors evaluate these deals? What metrics do they look at? Lucas: Gross margin is huge. If you're a SaaS company with 80 percent gross margins, you can afford to give up 5 percent of revenue. If you're a low-margin hardware company, even 2 percent might crush you. They also look at revenue growth rate, customer concentration, and churn. Basically, they're underwriting the predictability of your top line. Luna: So it's almost like a loan, but underwritten on revenue quality rather than assets or personal guarantees. Lucas: Exactly. And that's why it's expanding beyond software. If you're a biotech tools company selling reagents to pharma labs, your revenue might be lumpy but your customers are blue-chip. That's attractive to revenue share investors. Luna: I'm curious about the legal side. Are these agreements standardized now, or is every deal bespoke? Lucas: They're becoming more standardized. There's a model form from the National Venture Capital Association that came out last year. But a lot of deals still have custom terms around the payment percentage, the cap, and the term. And there's a big question mark around how these agreements interact with future equity rounds — some VCs hate them because they create a senior claim on revenue. Luna: Right, because if you take a revenue share, you're essentially giving a slice of your top line to someone before operating expenses. That can make your P&L look weaker to a later-stage investor. Lucas: Exactly. So a lot of founders treat revenue share as a bridge to a specific milestone — getting to $2 million in ARR, for example — and then they raise equity after that. The key is to not let the revenue share payments eat into your growth budget. If you're paying out 5 percent of revenue but growing 20 percent month over month, it's probably fine. But if growth slows, it's a problem. Luna: So what does the data say about exit outcomes for companies that use revenue share? Are they more likely to succeed, or just different? Lucas: It's still early, but a study from the University of Chicago looked at 200 revenue share backed companies and found they had a slightly higher survival rate than equity-backed startups in the same stage. But they also had lower median valuations at exit. So it's a trade-off: you survive longer but you might not hit the same home run. Luna: That makes sense. You're optimizing for control and runway, not for the VC home run. Lucas: Right. And I think that's why we'll see revenue share continue to grow as an option, especially if interest rates stay elevated. The cost of debt is high, and equity is expensive in terms of dilution. Revenue share sits in this sweet spot where both sides have aligned incentives: the investor gets paid back faster, and the founder keeps control. Luna: I want to zoom out a bit. Do you think this is a cyclical trend or a permanent new asset class? Lucas: I think it's permanent. The infrastructure is being built — there are now funds dedicated solely to revenue share investing. And the next generation of founders is much more capital structure savvy. They know that a standard Series A isn't the only path. So we're seeing a fragmentation of early-stage funding, with revenue share, SAFEs with valuation caps, rolling closes, and even revenue-based lines of credit. The days of 'one-size-fits-all equity' are over. Luna: That reminds me of something you said earlier about how you'd rather pay a high price for capital that doesn't dilute you. I think a lot of founders feel that way, especially if they've seen their peers get pushed out by VCs. Lucas: Yeah. And it's not just about control — it's about optionality. If you have a revenue share agreement, you can still raise equity later, but on your terms. You're not forced to sell because you need cash to survive. That's a powerful position. Luna: So if you're a founder listening right now, what's the one thing you should consider before signing a revenue share agreement? Lucas: Model your worst-case scenario. If your revenue drops 30 percent for three months in a row, can you still cover the payment? If not, negotiate a floor — a minimum revenue threshold below which payments pause. And make sure you understand how the agreement interacts with any future equity rounds. Some revenue share agreements have a conversion option that can muddy the cap table. Luna: That's great advice. I want to mention something that I think ties back to what we were just saying about modeling and being thoughtful. If you're finding these conversations useful for what you're building or running, and you want to help keep this show ad-free, you can support us at buy me a coffee dot com slash fexingo. It's a small gesture that helps us keep bringing you these deep dives without sponsors. Lucas: Absolutely. And we appreciate every bit of support. Now, Luna, you mentioned the conversion feature — I want to dig into that a bit more because some revenue share agreements actually convert into equity at a future round, which changes the entire dynamic. Luna: Right. So there are hybrid structures where the investor gets a percentage of revenue until a certain return, and then they have the option to convert the remaining balance into equity at a discount. That's essentially a SAFE with a revenue kicker. Lucas: Exactly. And that can be attractive for both sides. The investor gets downside protection through the revenue payments, but also upside if the company explodes. For the founder, it's a way to raise capital at a higher valuation cap than a pure SAFE, because the investor is getting some cash flow along the way. Luna: But it also adds complexity. The cap table gets a weird instrument that's part debt, part equity. Some later-stage investors hate that. Lucas: They do. So if you're planning to raise a Series A from a traditional VC, you might want to avoid these hybrids. But if you're planning to stay bootstrapped or raise from non-traditional sources, they can be great. Luna: Let's look at a real example. You mentioned a biotech tools company earlier. How would a revenue share deal work for them? Lucas: Sure. Say a company sells lab equipment to pharmaceutical companies. Their revenue is concentrated in a few large contracts per year. A revenue share investor might agree to a 3 percent share of revenue, but with a floor: payments only kick in when quarterly revenue exceeds $1 million. That protects the company during dry spells. And the multiple might be 2.5x because of the lumpy cash flows. Luna: That makes sense. So the key is that the structure has to match the business model. One size doesn't fit all. Lucas: Exactly. And that's why we're seeing more specialization. Some funds only do SaaS, some only do e-commerce, some only do biotech. They've built underwriting models that understand the specific revenue dynamics of each vertical. Luna: So what's the next frontier? Where do you see revenue share going in the next few years? Lucas: I think we'll see revenue share agreements used in later stages too — growth-stage companies that don't want to dilute but need capital to scale. And we might see public companies start using them as a form of corporate venture capital. Imagine Apple offering revenue share to a startup that builds apps for its ecosystem. That could be a huge market. Luna: That's an interesting thought. It would align incentives — Apple only gets paid if the startup succeeds. Lucas: Exactly. And it avoids the antitrust scrutiny that comes with taking equity. So I think revenue share is going to become a standard tool in the capital structure toolkit, not just a niche alternative. Luna: I think you're right. And for founders listening, the takeaway is clear: don't default to equity just because that's what everyone does. Look at your revenue model, your growth plans, and your desire for control, and then decide what instrument fits best. Lucas: Well said. And as always, we'll keep tracking the data. Thanks for listening, everyone.