What are Revenue Participation Notes?
Revenue Participation Notes (“RPNs”) are debt instruments that entitle the holder (i.e.; lender) to receive a share of top line revenue from a company rather than a fixed periodic payment based on a percentage of the monies loaned to a company.
Key elements of Revenue Participation Notes are:
- There is no equity sale of membership interests, stock or shares.
- The percentage of revenue that is received by note holders is set by the entrepreneur as a fixed term of the note, but the size of payments each period (month or quarter), will be variable as it is tied to revenue for the period. (The payment stream can be very variable if the entrepreneur’s business is seasonal.)
- Revenue Participation Notes generally have a maturity date of seven years from issuance; however, they also have a payout cap that is set by the entrepreneur at 1.5 to 2.0 times the initial investment. The payment obligation of the note is fulfilled at the earlier date of when the payout cap is reached or the maturity date. The length of the investment will vary based on the performance of the company.
As an example, say a company issued $300,000 of Revenue Participation Notes with a 5% revenue share and a payout cap of 1.5 times the investment or $450,000. Given the following revenue projections, the RPN payment stream would be as follows:
|Year||Projected Revenue||RPN Payment (5% of Revenue)|
|5||$4,000,000||$90,000 (Payment Cap Reached)|
If revenue growth was stronger, the RPNs would be paid off sooner. If revenue growth was weaker, the RPNs may not be paid off until the maturity date.
For the investor, the RPN has distinct advantages:
- Liquidity is achieved much earlier than with equity as payments begin flowing back to investors when revenue starts flowing to the Company.
- An investor can have a direct effect on the return to the investment by working to increase Company revenue. It significantly reduces investor-management conflict that can arise when returns are tied to a Company’s bottom line.
- Due diligence is simpler than with an equity investment as there is no concern about the Company’s valuation or exit strategy.
For the Entrepreneur, the advantages of RPNs are:
- Investor payments are tied to Company revenue rather than an amortization schedule reducing cash flow concerns. The incentives for the investors and the Company are aligned with revenue growth. Investors have a direct incentive to promote the Company and increase its sales.
- Company stock is preserved for later funding rounds. – A capitalization table’s investors do not change with issuance of RPNs.
- Company valuation is not a concern.
- Voting rights should not change plus there is no dilution of management or board control.
- Your business doesn’t need an exit strategy and event to provide investors liquidity.