Continuous Security Offerings: Money on Tap from Tokenizing Your Revenue
Revenue-based financing (RBF) has been around and lets businesses raise capital from investors who receive a percentage of the ongoing gross revenues. Smart contracts bring this to a new level by continuously issuing tokens linked to revenue. We did some preliminary research.
How RBF Works
RBF is a way for revenue-generating business to raise capital without issuing debt or diluting equity.
With RBF, a portion of revenues will be paid to investors at a pre-established percentage until a certain multiple of the original investment has been repaid.
Here are some of the termsheets of established RBF providers we analyzed:
- Bigfoot Capital: https://docs.google.com/document/d/12CgdA4pX8Ex_jzqvsPV2LTvj4PHe2ULjyQE7RpVAitU/edit
- Founder First Capital Partners: https://drive.google.com/file/d/1Dw2XMSkbGudb8bqfZJwI9COr71qhTYKh/view
- Earnest Capital: https://earnestcapital.com/shared-earnings-agreement/ and https://docs.google.com/document/d/10KNj6HJpfF9EjssJzRaGIw2LBxEdawjWbtfLZCGLFl8/edit
The above termsheets show a high degree of communality:
- Periodic payments continue until a return cap for money invested is reached (usually 1.2x - 2.5x, sometimes 5x!);
- The reserve pool can fixed (e.g. 10% of all gross revenue) or variable;
- There is collateral, typically via a first security interest in all business assets;
- There may also be a "minimum runway requirement” i.e. the business has to have sufficient capital to cover its costs over a period of time.
- There is typically a warrant clause (a percentage of the outstanding shares as of a specified date, often with anti-dilution protection) or some other conversion mechanism similar to a Simple Agreement for Future Equity (SAFE)
- Occasionally there even is a personal loan guarantee and there several restrictions on how their capital can be used.
Neither VC nor Debt
RBF providers position themselves in the middle of a spectrum between VC and lenders, however RBF can co-exist with (typically earlier stage) VC and (later stage) pure debt.
It is an attractive option not only because it is anti-dilutive for founders, but the reporting requirements are typically minimal since a business only has to disclose its revenues, so founders can focus on its growth and pitch clients rather than investors.
It’s a tried and tested model and shows a high degree of similarity with accounts receivables-based financing, in which capital providers a business with working capital based on the discounted value of outstanding invoices it is owed.
It also shows similarity with royalty-based financing and RBF and royalty-based financing are often used interchangeably, even though the latter is more often used to obtain funding in return for a carry in musicians’ back catalogue or even future output.
A Dream Use Case for Smart Contracts
All of the above provide a dream use case for smart contracts especially for businesses that receive their revenue in crypto, including stablecoins.
In such a setup, a wallet would be earmaked to receive a fixed or variable reserve of revenue and investors would receive their periodic payouts directly in the wallets they used to send funds from.
The revenue reserve wallet would not be accessible to the business, which would only be able to set the % of its revenue it earmarks in line with the rise and fall of its revenue.
The smart contract in essence turns the offchain legal version of the termsheets above into committed code on blockchain, which helps guarantee contract fulfillment and cut costs.
Cue: A Token!
In the above, for the investors the economics would remain essentially the same: They likely do not care that much about the fancy pantsy of smart contracts as long as the terms of the deal are broadly in line with with deals they’ve done before.
It is important to keep this in mind when we introducing a token: many things can and have been tokenized however issuers often won’t find investor demand for their token if they dramatically reshuffle the underlying economics for investors.
Tokenizing a RBF offering would essentially involve the creation and issue of a token that represent a claim on the revenue reserve.
A simplified setup could be as follows:
1. A company commits to set aside a fixed percentage of its revenues in a cryptographic wallet, visible to all but accessible to none (except buyers who redeem — see below).
2. Investors can buy tokens to get exposure to the growth of this reserve.
3. Tokens are also tradeable in a secondary market (subject to securities laws).
4. A minting mechanism would automatically issue more tokens when there is investor demand to purchase tokens directly from the reserve. This would typically be when investors are bullish about the company’s growth prospects.
5. The price of the newly minted token is a function of the number of tokens already outstanding: the nth token will be more expensive than the n-1th token.
6. A predetermined portion, e.g 5% of the token proceeds could in turn be allocated to the revenue reserve, growing the reserve as more investors come in.
7. Token holders can buy or sell tokens (once they’re out of lockup) through a secondary market e.g. tokens could be listed on a exchange or more optimally bought and sold via a decentralized token swap.
8. Anybody who holds a token, either from buying it directly from the reserve or in the secondary market, can redeem it against the crypto currency pool held in te reserve. The redemption price would be continually recalculated as a function of the amount of funds in the reserve and the number of outstanding tokens at the time of redemption.
Money on Tap
The setup above is effectively a continuous offering of a token which, for all intents and purposes, is a security and therefore subject to securities laws and their safe harbors.
If, which is likely, an accredited investor safe harbor would be used, the offering would be conducted via white-listing and accreditation of each and every token buyer.
Once accredited, token buyers who buy from the reserve continually replenish the company with working capital. The secondary market meantime should offer a mechanism for investors to express their views on the company’s prospect by putting a multiple on a company’s revenues, in the same way traditional shares put a multiple on listed companies.
For the company, a token would provide a tool for a broader group of stakeholders, including its paying clients, to have a carry in the success of the business.
This is a very powerful tool to build community loyalty: for instance, tokens could be issued to paying customers who could be granted a set % of their purchase price in free tokens.
As a result, company and customer could become much closer aligned than ever before: think of it as Elon giving you some shares in Tesla for free after you bought that Tesla car!
Where does that leave me as an investor?
For investors who compare their position as a token holder with that of a traditional RBF deal however, the economics have been radically reshuffled and it remains to be seen if traditional investors will bite.
They’d be worse off in that the simple setup would not include any conversion rights, so maybe some sort of SAFE-type mechanisms would have to be added.
Also, in the above setup there are no preference rights on the assets in the reserve compared to terms of some of the traditional termsheets we looked at.
What token buyers would gain over BRF investors is liquidity. However, as we have seen with a number of tradeable tokens, front-running and price manipulations are still rife in cryptolandia, which makes liquidity a two-edged sword.
Finally, investors would have to have assurances that all revenue, also revenue received in fiat, ultimately gets deposited in the crypto wallet that holds the revenue reserve. Logistically, this would mean part of your fiat revenue needs conversion.
Accounting-wise, investors may insist on an audit of all revenue (and not only the crypto sales proceeds accruing to the company’s main treasury wallet which are visible on blockchain), which may add significantly to the reporting requirements of the issuing company compared to a traditional RBF deal.
CONCLUSION
A continuous issuance of a token that represents a claim on a company’s revenue is a use case cut out for smart contracts: it could radically transform the technological ease with which revenue-generating projects can access capital.
On its economic merits, such token issuance could be a mixed blessing for both investors and the issuing company, and we look forward to continued experimentation with offering terms that balances expectations from both.
At Otonomos we like to be part of this experimentation ourselves and are in dialogue with Fairmint, whose work in this area we learned a lot from and with whom we are in dialogue about a possible Continuous Security Offering for our company.
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