BJ Lackland is the CEO of Lighter Capital, a Seattle based company that provides revenue based financing to tech start-ups. Lighter Capital typically invests $50,000 to $2mm of growth capital into businesses without taking an equity stake in the company or a board seat.
Geoff Roberts (GR): Thanks for taking the time to chat with us BJ. The funding model that Lighter Capital uses is really interesting and might be a great alternative for our audience of early stage SaaS companies. Why don’t you start by walking us through how revenue based financing works?
BJ Lackland (BJ): Revenue based funding is an alternative to the typical model of angel or venture capital funding that’s so common in tech. This funding model allows companies to raise growth capital without giving up equity or a board seat, so entrepreneurs maintain control of their businesses. Companies agree to pay a percentage of their revenue on a monthly basis until they repay their loan, and the amount that they repay is capped. What this means in practice is if your company has a good month, you repay a little bit more. If your company has a bad month, the payment is less. Typically monthly payments are 2%-8% of monthly recurring revenue, and repayments are capped at 1.35x-2x of the amount invested in the business. Repayment typically occurs over a 3-5 year period.
GR: When I first heard of revenue based financing, an analogy was made to how funding is raised in Hollywood when it comes to making movies. How did the idea come about to leverage this model in the tech sector?
BJ: There a huge need in the tech sector for alternative funding sources. Traditionally, the only growth capital available is equity investments from angels and VCs. But raising VC money is incredibly time-consuming and it’s like strapping a rocket to your back - you’ll either shoot to the moon trying to make investors a 10x return or you’ll blow up halfway.
The vast majority blow up.
That just doesn’t fit a lot of companies and entrepreneurs. Lots are great business people who want to build companies to last. Or they want to put off an equity round until later. Or they don’t have 6 months to spend raising VC money. Either way, there’s a huge opportunity to provide capital that is non-dilutive and yet still aligned with the entrepreneur toward growth.
GR: What problems does this model solve when you consider the typical model of VC/Angel investment that’s been so prevalent in the tech sector?
BJ: This model solves several important problems. To start, the non-dilutive nature of the model means entrepreneurs don’t need to give up an equity stake in their business, or a board seat. The second is we allow companies to spend substantially less time on the fundraising process - this can become a huge distraction to early stage start-ups whose time is better spent building their business. I heard a statistic that it typically take a start-up something like 60 meetings and 40 pitches to raise $500,000 from angels or VC firms. We offer companies seeking funding an easy online application, and the funding process typically takes 3-4 weeks. Last but not least, with this model entrepreneurs don’t need to hit a “home run” or have some sort of liquidity event in order for the investment to be seen as a success. This model works much better for entrepreneurs who are looking to build a sustainable business.
GR: What do you look for in potential investments? What’s the profile of your typical investment?
BJ: There’s really three criteria that we look for in potential investments. The first is a monthly recurring revenue stream of at least $15,000 per month. We’re typically investing in businesses that have anywhere from $200,000 to $10mm in annual revenue. The second is high gross margins - at least above 50%, but more often than not above 80% which is fairly normal in SaaS businesses. Last but not least, we’re looking for an indication of stickiness - products that are providing sustainable value which is evident through low customer churn rates.
GR: My understanding is your decision to invest in any particular company is based more on an algorithm and the financial performance/unit economics of the business than qualitative factors like strength of team, market opportunity, etc. Can you speak to the process you use in deciding whether or not to fund a business?
BJ: You’re completely correct. We’re really looking more at the financial performance of the company, the unit economics, and you know - is the company offering a basic, durable offering for the market? And certainly the management team is a piece - we want to be working with good people and good people are what drive good returns no matter what business you’re in. It’s not nearly as important to have an MBA from Stanford or Harvard; you don’t have to be fraternity brothers with a VC to get funding at all. We do background checks, we want to make sure the entrepreneurs understand their business well, that they can speak articulately about their business, that they have a good financial understanding of what’s going on when operating their business. What’s least important is are they going to go on to be the next Uber? I mean, we just don’t really care. We’re really focused on funding businesses that are solid, that are durable and are going to be around. And they’re able to scale up - one of the reasons we want to see high gross margins is we want to see that if they land a bunch of new customers they can scale this thing up from $2mm to $10mm in the next 4-5 years. If they do, this model makes a lot of sense for the entrepreneur.
GR: What have been some of Lighter’s most successful investments?
BJ: It’s interesting because when you think of successful investments for a VC fund it’s all about what was the multiple and what was the exit and was it a brand name? And we have a couple of those but by our very nature our upside is capped. For us as investors, sometimes the companies that do best with us aren’t exactly household names. The biggest brand name company that we’ve funded is probably Steelbrick. We funded them when it was 5 people, a virtual organization, and they were totally bootstrapped. The original entrepreneur brought in a new and highly experienced CEO, they raised a ton of money, and they ended up selling to Salesforce for $360mm. An incredibly great outcome for them. That’s probably the biggest name we’ve funded because of the big exit. MapAnything is another - they do geolocation on Salesforce and ServiceNow’s platforms and are growing like a weed. They also went on and raised a lot of VC money. But most of the companies we fund are small businesses that are well known in their niche industries.
GR: What involvement does Lighter Capital have with their portfolio companies post investment?
BJ: It really depends on the entrepreneur and what they want. The only thing they need to do is provide us with financial data and handle the payment. We try to make that light as possible, so we have software that attaches to their accounting software package so they can login to our portal and hit a button and do all the reporting. A lot of the businesses have a bookkeeper or a controller do that work. Aside from the reporting, where we are most helpful is planning out their financing, frankly. As opposed to a VC we don’t necessarily need to know the best VP of Sales candidate in healthcare tech in South Carolina. What we know is if you’re doing X million in revenue and have this kind of burn rate and this kind of growth rate, what kind of capital is available to you from which different sources? Whether it’s angels, VCs, banks, and probably how to introduce you to any of those sources. So we can help with strategy, mostly on the capital side. We’re also coming out with some BI tools for entrepreneurs - we’re learning more and more and more about what drives growth. For example, we can say what an acceptable churn rate is for a company with an ASP of $1,000 per year and we can share that information back with the companies so they can benchmark themselves and learn how to grow their businesses.
GR: This all sounds great, and I love the non-dilutive aspect of this model. But what are the disadvantages or downsides of this funding model? What happens with your investments that don’t do well? Who does this model not work well for?
BJ: We’re a creditor, we’re not equity so we get paid first. We’ll take a second position behind a bank, but we’re not equity so we get paid first if the business goes down and is not successful. That’s the legal side but we try to work with the entrepreneurs. The businesses we’re funding don’t have any hard assets so it never makes sense for us to go and try to force a liquidity event - there’s nothing to liquidate. Their real core assets are the fact that they have sticky, high margin revenue streams. And if things don’t go well hopefully they can cut their expenses and survive with a sticky high margin revenue stream and have enough money to keep the business alive and pay us back our principal. If we don’t get the full amount that we’re owed, we have to work with the companies to figure that out and we’re not always going to win. That’s the reason we have a large and diversified portfolio. We fund something like 10-12 business per month and funded 101 businesses last year. Our goal is instead of having what a VC might have - 10-20 highly concentrated positions - we’ve funded 160 businesses and accept the fact that with some portion of those we’re not going to get repaid.
GR: You spend much of your time with founders of early stage SaaS businesses… what technology related challenges do you see most frequently within these organizations?
BJ: I think the number one thing is finding good developers. That’s a key, and it’s hard in this market and you need to have the capital to do that. One thing that’s cool that you’re doing at Outseta is you’re simplifying a lot of the software offerings that SaaS start-ups need, and that’s going to save them a lot of money. Another thing is getting their product offering good enough to sustain customers. I’m sure you’re familiar with the lean start-up and the notion of minimum viable products, but the majority of our customers are B2B and they just need to get their products to a good enough place where they can not only attract but sustain customers without under serving their needs and having them go elsewhere.
BJ Lackland can be found on Linkedin, or on Twitter @bjlackland.