Alternative Startup Financing with No Exit Required

A new investment firm in Chicago is offering a unique funding option to entrepreneurs who are tired of bootstrapping, don’t want to give chunks of equity to angels and VCs, and whose companies are not a good fit for crowd funding.

It’s called ‘royalty-based financing’ ― an investment model which does not depend on an ‘exit’ strategy that traditional private equity investors expect of companies which they fund. Karan Arora, CEO and co-founder of Aristo Partners, says they will invest in exchange for a percentage of revenue earned each month. So, on a bad month, if a company makes nothing, the investors get nothing. Arora says that, currently, Aristo Partners is the only finance company in Chicago operating on a royalty-based model.

Asked why royalty-based financing is not widely-used in Chicago, Arora gives three reasons:

  1. Most entrepreneurs are not aware that the model exists, and have gotten used to the idea that they need to give up equity in order to get funding;
  2. The capital to fund a company is based on companies’ yearly revenues. Hence, Arora says the model is not ideal for pre-revenue start-ups needing huge investments; ideal, however, for those with yearly revenues >$100K and gross margins of >30%
  3. Most VCs don’t use the model because returns average 2X-3X (2-3 times the amount of investment) instead of 10X and the exit that many angels and VCs expect from the companies that they fund.

And, for entrepreneurs who prefer to keep their companies, and not sell them, it’s ideal. Royalty-based financing has been used to fund many industries, including entertainment, mining and farming. Many startups, in other parts of the country, got their start from royalty-based investments. In 2010, Andy Sack, then of TechStars, joined forced with FoundersCoop, of Seattle, to launch RevenueLoan (now LighterCapital) to fund startups using the royalty-based model.

The idea is not new. Royalty-based financing harks back to agrarian times when farmers borrowed money from investors to finance their crops.

“In the late-1800s, farmers used to get money based on what was called ‘royalty-based financing’ and with that capital they could do farming. When the harvest came out, and if they made money, they would return a small percentage of that money back to the investor,” says Arora. “That’s how it started and, now, it’s evolved into this foray of entrepreneurial funding.”

Arora and his two partners, George Gjermano (CFO), and Gary Schafer (COO) ― who all met as graduate students at Kellogg School of Management at Northwestern University, and all former McKinsey consultants ― are looking to invest an initial portfolio of more than $600-thousand into early-stage companies focusing on healthcare, consumer products, and technology.

“The three of us are experts in those sectors, so we know what to look for, and we can offer better advisory to the companies that we bring in,” says Arora. “But we are agnostic and we do look at other sectors.”

Aristo Partners is based at TechNexus in the South Loop. ❒

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