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Defining “Value Preserved” – A New, But Core Concept in Growth and Debt Financing

The technical explanation: 
At Bootstrapp, we view the “value preserved “”the retention and/or accretion of potential value from the alternative chosen, as compared to other alternatives.” This is typically measured as the amount of equity value, in dollars, that a company’s leadership is able to retain for themselves, employees, and other shareholders instead of needing to sell the equivalent amount of equity-value to equity investors. This value typically grows as one projects into the future, with a strong correlation to the growth in overall enterprise value. 

The Plain English Explanation
Think of value preserved as the of opportunity cost. Instead of missing out on something because you didn’t pursue an opportunity, you actually retain, gain, or preserve value within your company because you did not pursue an opportunity. Furthermore, opportunity cost is defined as “the loss of potential gain from other alternatives when one alternative is chosen.” Value Preserved, as we define it, is a type of opportunity benefit – i.e., “the retention and/or accretion of potential value from the alternative chosen, as compared to other alternatives.”

Let’s use an example: 
What if you sold 10% of your company today for $1M. That would mean that your company is currently worth $10M. Not bad. Now what if in five years, it’s worth $50M. That same 10% of your company is now worth $5M – and recall that in this scenario you sold it for $1M. Obviously that’s all fine and dandy – an investor took a risk on you and they should be rewarded for it. However, what if you – as a savvy founder – were able to obtain that same $1M that you had originally needed, but split it up and took out $500k in debt, and then only sold 5% of your company for $500k – so that you still ended up with the same capital that you would have had otherwise, but you sold only half of the equity. 
 
Later on, using the same scenario, the 5% of equity that you sold would be worth $2.5M – meaning that the 5% of the company that you DIDN’T sell would also be worth a cool $2.5M. You just preserved $2.5M in equity that you now own instead of the investors owning it. You get to keep that cash during a liquidation event instead of them.
 
Now obviously, in this scenario, you’ve also taken out debt – and so you’ll be paying interest on that debt as well. So it’s not a perfect comparison. But it’s easy to also calculate the interest payments you’ll be making on the proposed $500k of debt, especially if you have concrete offers from financiers with hard numbers so that you can simply run the math. 

And so the next step is easy: you take the $2.5M of equity that you preserved, subtract the interest payments that you’ll need to make as a result of the debt, and voila: You have your “Preserved Value”. Depending on a number of factors, the preserved value can sometimes be in the millions – and many founders simply sell that value to equity investors without giving it a second thought.  
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How much does revenue-based financing really cost?

There’s an incredibly counter-intuitive aspect of revenue-based financing, which is this: the more successful you are as a company, the higher the cost of capital associated with your RBF.

This is counter-intuitive for a few reasons:

  • It’s the opposite of how society typically views capital. If you walk into a bank and have a successful business, you’ll get a cheaper rate because you’re a less-risky borrower – not a more expensive one.
  • Most people – myself included – generally equate time with money. (You know, the old saying goes…). For example, if you take out a car loan and then pay it back earlier than expected, you’d pay less interest than if you took the full term to pay it back. This makes sense – the lender has their principal plus the pro rata interest, so now they can go lend it to the next person. And you, the borrower, just saved all of the interest that would have been accrued moving forward – had you kept the loan open.
  • It appears that RBF has a structure that punishes borrower for good behavior. In this case ‘good behavior’ meaning that they run a successful company. When someone is more successful than expected, are they expected to actually pay a higher cost of capital?

However, the kicker that will clarify it all is this: The amount of capital paid back in addition to the principal is set in stone, and time is the variable that can change, which is the inverse of the typical model. Compare this to the car loan example above in #2 – where the total amount of money paid back is flexible dependent on when its paid back, and the interest is fixed – based on a fixed period of time set by the lender. For example, many car loans may be structured for 60 months. Time is set in stone, and how much you pay back depends on your ability to pay that loan back faster (assuming no pre-payment penalties).

 

Let’s simplify and use some real numbers. Scenario A: If you were to take out a traditional car loan of $10,000 and pay it all back 1 day later. You’ll only have to pay interest on that 1 day when you had the capital. If you took out a relatively expensive loan and agreed to pay a 10% APR, that 1 day of borrowing would only cost you .027% in interest.

 

However, let’s run Scenario B, this time using the revenue-based financing model: You take out a loan of $10,000 with a fee of $1,000. Most RBF lenders operate on this fee-based model which gives the borrower flexibility as to when they pay back the loan (i.e. time is the variable that can change). Now, no matter when you pay it back, you have to pay back $11,000. If you were to follow the same payback timeline as scenario A, and pay back the $11,000 the next day – your APR would be 3,650%.

 

Obviously RBF loans aren’t built to be paid back the next day, but the math illustrates an incredibly important point: revenue-based financing can be tricky to leverage, as you may actually be leveraging incredibly expensive capital if you’re more successful than you originally projected. It’s a relatively new model where time is a major factor in the cost of capital you use to grow your business – and adds to the complexity of your decision: which instrument do you choose to finance that growth?

How does revenue based financing work?

Check out a quick video walk-through of the tradeoffs you’ll want to consider: