landscape. “It’s a pretty interesting tool for startups,” says Jeff Schrock, a venture capitalist with Intel Capital. He adds, “It offers growth capital to companies that can’t participate in debt or equity [financing]…What I like about it is, compared to classic debt, it’s success-oriented. An entrepreneur doesn’t have to put all his chips on the table.”
Schrock thinks the model makes sense for certain software, gaming, and IT companies (hardware, not so much). Or even as a growth-capital tool for life sciences companies—especially those on the verge of gaining FDA approval of their product. It also could work for venture-backed companies whose prospects no longer merit further equity investment. There might be hundreds of those companies in a given year, Schrock says.
Nevertheless, some investors caution that it’s too early to know how successful the royalty-based model will be. “It’s exotic at this point compared to venture or debt. It’ll take some time to prove it out,” Schrock says. And he adds, “This is not a panacea. This does not solve all problems in venture. I don’t know if it’s going to solve the startup funding issue.”
Which, in fact, is precisely why others think it could eventually become huge. Thurston, a Portland-based consultant and researcher who has been testing “disruptive innovation” theory across different industries, says royalty-based financing for healthcare companies was already a $3.3 billion market in 2008. Yet few people have really studied it, and it doesn’t compete head-to-head with the venture industry. (For comparison, VCs invested about $28 billion in 2008—$8 billion of it in biotech and medical devices—according to the National Venture Capital Association.)
“Royalty-based financing has the potential to be very disruptive to traditional venture investing,” says Thurston, who has studied the new model with author Clay Christensen of Harvard Business School. “I don’t think it’ll ever replace equity, but it may end up creating such a big market that it’ll look a lot bigger than equity market investing. It’s like angioplasty. It didn’t replace heart surgery, but it created a much larger market for preventative heart care. Royalty-based financing in the next decade or two will be a much bigger market in terms of dollars invested over time.”
The proof will be in the proverbial pudding, of course. In the meantime, Sack is putting the finishing touches on his new fund’s structure and operations. Joining him on the management team at RevenueLoan will be vice president Randall Lucas, who was formerly a senior associate at Voyager Capital.
It will take some time and effort to explain the revenue-based model to entrepreneurs, Sack acknowledges. But he figures entrepreneurs will see the appeal pretty quickly when they realize they won’t have to sign a personal guarantee, or have a discussion about their company valuation, or give up
