It’s time for venture capital to look beyond equity.
In the past 18 months, the global COVID-19 pandemic has wildy accelerated a shift towards greater dependence on our digital economy. The US leapt ten years of digital transformation in just a single quarter last year and in January this year, UK online retail was up 74% from the year before.
(US e-commerce penetration, %)
It’s not just that we’re ordering more online, we’re actually doing almost everything now through an online platform of some kind. More and more of the companies meeting this huge surge in demand are startups - and many of these have extraordinary potential for growth. There are well over ten million eCommerce businesses globally now, as well as hundreds of new software and SaaS businesses born every day, able to operate easily at a low cost from anywhere in the world.
These types of businesses face big challenges though. Payment terms related to scaling inventory and the significant spend needed to grow marketing online (or drive acquisition) can be extremely restrictive.
Options to access capital as a springboard for the next stage of growth have been slim, and largely unsatisfactory. Growth capital on an equity basis can be lengthy, costly, dilutive and stressful to access. It’s right for certain types of businesses but for many it isn’t. And conventional bank loans or credit just aren’t fit for purpose. Banks appraise risk and underwrite loans based on six-month-old credit data, then require fixed payments that don’t account for monthly variations in revenue. On top of that, loans almost always require collateral or a personal guarantee, which is less than ideal for digital businesses that are light on assets.
It’s no surprise then, that new financing options for this vast audience of fast-growing digital businesses are the hottest new product in any startup ecosystem right now. Particularly revenue-based financing, or revenue ‘advances’, that offer businesses their future revenues upfront to fund inventory and marketing spend - alongside flexible repayment plans that adapt to sales volume.
At Forward Partners, we were inspired by this new model taking hold in the U.S. But the lightbulb moment for us was realising that early-stage VC firms would be better placed than anyone to create value for this market. We understand the challenges these businesses face, and we have the ability not just to give them capital, but to offer strategic advice and executional support too.
Our mission has always been to give more great founders their best shot at success, and in an age when capital has become a commodity, we have to innovate to thrive - making venture capital work harder for founders. This lightbulb moment highlighted a great opportunity for us, ultimately driving the creation of our very own startup - Forward Advances.
Future revenues, upfront.
Revenue advances are flexible, fast injections of capital – flexible because repayments are entirely based on each month’s real revenue. In return, founders pay a single, transparent, fixed fee with no penalties or late fees.
Forward Advances works with two key types of businesses. The first - eCommerce businesses (likely SMEs) with consistent or growing sales. The second - technology businesses (likely startups) with recurring revenue models, Saas or marketplaces, for instance. What ties these together is recurring or regular revenues, and plenty of room for growth.
Revenue-based financing has recently undergone the Stripe treatment to become one of the most hyped sectors to be in, think about, talk about – and make use of. It even has its own vocal proponents like Harry Hurst, whose promise that his company Pipe will “unlock revenue as an asset class” has led to a nearly-30-thousand-strong Twitter following, a Times Square billboard and the support of entrepreneurial legends like Marc Benioff.
It isn’t a new model. The peer-to-peer cohort of post-financial-crash fintech made inroads, matching lenders with borrowers, often using cash flow and monthly or annual contracts as the litmus for lending. And banks have been doing it for centuries. But it’s a sector that’s not just getting attention: it’s expanding fast. A recent report that valued the sector at $901 million pre-pandemic projected it to hit more than $42 billion by 2027.
While innovative funding routes are fresh air for our economy – Venture Capital still plays a key role. Those building software, in particular, are likely to be venture-backed, because of how much upfront capital they need to get a product to market. So offering revenue-based financing also means we can keep supporting companies we backed from the start, with financing that fits for a new stage in their growth.
Leveraging technology and data to manage risk.
Open banking has been powering a wave of innovative financial products. The boom in alternative funding has allowed P2P lending platforms like Funding Circle to offer $15.2 billion in loans. For financial providers, benefits of open banking include the ability to create a verifiable, detailed picture of a company by reconstructing cash flows; a ‘real time’ view of a customer’s financial situation; and overall, a far more detailed customer understanding and idea of risk.
However, the tech goes far deeper than open banking now. The digital-first nature of many startups makes it easier to use the data made available through numerous integrations.
These integrations come in different, but equally powerful, forms. Through data from eCommerce integrations like Shopify, we can understand the key financial characteristics of a business (such as margin), and we can also predict when a company may need additional support. For example, if a Kardashian features your lipstick on Instagram, you may want to double down on inventory and marketing spend to capitalise fully on the impact. It’s very difficult for a traditional financial advisor to see needs or opportunities of this kind.
Paid media integrations, like Google and Facebook ads, mean a provider can build an understanding of return on advertising spend (ROAS). While a fairly rudimentary measure, it enables a quick understanding of how well this type of advertising is working for a business. This is particularly useful because in digital marketing, we often see decreasing returns at scale, so it’s important to look at both headroom and performance as a company invests in paid media.
This level of detail allows funding providers, like us, to truly understand the businesses we support, their benchmarks and how to help them grow. It significantly reduces risk - but it’s also a crucial part of unlocking market potential. Traditional credit scoring, starved of data, led to unfavourable terms for many and actually locked huge numbers of businesses out of the market completely.
By pulling sophisticated analysis from the data provided, we can solve a problem for an underserved market and open up a new one too.
As a value-add VC we’re also able to go further than financing - we provide exclusive access to the specialised team of startup growth experts that make up our studio. So we can help make sure our companies are ready to take on the scale they’re capable of achieving. For Forward Advances, this has had a measurable impact across fast-growth tech companies like ChargedUp or eCommerce companies like Atterley, who were able to grow annual sales 121% with financial support from Forward Advances and guidance from Forward Studio.
If cash is air, how much you need depends on how fast you’re running. And an advance links repayments to sales, so if sales slow down – or simply change with the seasons – so do repayments. This offers the flexibility startups need .
Take Stripe and Stare, a Forward Advances company that boasts the most comfortable and sustainable knickers in the world. The founders raised seed funding, then later needed a fast injection for marketing and inventory – but preferred not to dilute through equity. We believe in the founders, the platform and the numbers, so Forward Advances gave them access to funding tied to their strong revenue. Stripe and Stare used the cash wisely and if they decide to raise equity in the future they’ll be doing it with better terms at the table.
This is just the start.
Revenue-based financing is a starting point for a new, more dynamic funding system that can sustain the digital future of the UK economy. It’s about empowering digital companies to be braver; to run fast and to grow with confidence.
Venture capital already funds and supports these businesses, often right from the outset. But it’s time to go further; to stand up as a new breed of investors – those that build alongside their companies, for their companies. We’d like to lead the way.