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Private Debt Investing, A Diversification Opportunity: The Revenue Lending Model

AGEFI Luxembourg

Press release, AGEFI Luxembourg, December 2023

Written by Jose Kabana

When it comes to investing, diversification is key. Private debt returns offer a unique opportunity for investors looking to diversify their portfolios and maximize their returns.

Private debt has emerged as a valuable investment avenue, offering attractive risk-adjusted returns and diversification benefits to investors. In this article, we will explore the world of private debt returns, and its role in diversified investment portfolio, and its response to economic cycles.

Revenue lending is one such form of private debt that has gained popularity in recent years.

Private debt investments typically offer stable cash flows and consistent returns. Lenders provide capital to privately held companies, real estate projects, or infrastructure initiatives. Compared to public equity markets, private debt can offer more predictable returns due to its contractual nature and the security of underlying assets.

One example of corporate private debt is a bond issued by a company. A bond is a type of loan where an investor lends money to the company for a fixed period at a predetermined interest rate.

The company then makes regular interest payments to the investor and repays the principal amount at maturity. Bonds can be secured or unsecure, with secured bonds having collateral backing them.

Private debt presents an opportunity to diversify investment portfolios and reduce exposure to traditional asset classes. Its low correlation with public equity and fixed income markets can enhance portfolio resilience, potentially mitigating risk during periods of market volatility.

Like any investment, private debt returns are influenced by economic cycles. During economic expansions, private debt returns tend to be robust, with borrowers generating steady cash flows to service their obligations. However, during economic downturns, default rates may increase, impacting returns. It is crucial for investors to conduct thorough due diligence and assess the creditworthiness of potential borrowers to manage risk effectively. Private debt offers a distinct investment opportunity compared to other asset classes. Unlike publicly traded bonds or stocks, private debt provides investors with access to a broader range of borrowers and industries that may not be available in public markets. This allows investors to tailor their portfolios to specific risk appetites and yield requirements.

In recent years, successful private debt investments have generated attractive risk-adjusted returns across various sectors, including technology, healthcare, and real estate. These investments have allowed investors to benefit from consistent cash flows and capital preservation.

Furthermore, data reveals that many institutional and sophisticated investors include private debt in their portfolios. According to a recent survey, approximately 70% of investors allocate a portion of their portfolios to private debt, recognizing its potential to enhance returns and diversify risk.


Revenue Lending: A Promising Private Debt Segment

Revenue lending, also known as royalty-based lending, represents a unique form of private debt.

It involves investors providing capital to businesses in return for a percentage of their future recurring revenues until a predetermined minimum amount is reached. Sometimes there is also an exit fee or warrant on top. This model of financing is particularly attractive for businesses with high gross margins and predictable revenue streams. The repayments are tied to the company’s revenue, offering flexibility as they adjust with the business’s performance. Consequently, during periods of lower revenues, the repayment amounts decrease, providing some relief to borrowers. This form of private debt investing allows investors to directly tap into the success of the business they are funding, potentially creating a steady stream of income. Furthermore, it provides a way for investors to diversify their portfolios, mitigating risk while aiming for consistent returns.

Revenue lending distinguishes itself from traditional private debt lending in several significant ways. Traditional private debt lending typically involves loan provisions bound by fixed repayment terms and interest rates, often secured against assets, with the risk of foreclosure if the borrower defaults.


This distinction makes revenue lending particularly attractive for businesses with high revenue volatility, such as startups and growth-stage companies. They benefit from the flexibility that revenue- based loans provide, ensuring that repayment aligns with their ability to pay. For investors, revenue lending offers a potential hedge against market volatility, as returns are more directly linked to the performance of the individual company rather than wider market trends. This type of funding works well for investors as recurring revenues translate in stable and predictable cash-flows based on long-term customer contracts; and digital business models feature a high cash conversion due to high gross profit margin, low working capital and low capex needs.

The process of obtaining revenue-based financing begins with a detailed analysis of a company’s financials. Lenders scrutinize historical revenue streams, gross margins, customer retention rates, and other key financial indicators. Once the company is deemed viable for the revenue-based financing model, terms of the agreement are negotiated. These terms might include the percentage of monthly revenues to be paid, the total repayment cap, and any exit fees or warrants. After the agreement is signed, the investment capital is disbursed to the business.

As the company begins to generate revenue, repayments are made to the lender in accordance with the agreed-upon percentage of revenues. Thus, the lender recoups the initial investment, plus an additional return, directly from the success of the business.

Revenue lending offers several advantages to businesses seeking funding. Firstly, it allows companies to secure investment without giving up equity, thus retaining full ownership and control. Secondly, repayments are typically linked to company revenues, providing flexibility during periods of lower income. Thirdly, it is often faster to secure than traditional loans, with less emphasis placed on a business’s credit history. Lastly, revenue lending usually involves less administrative burden and complexity than equity fundraising, making it a more straightforward option for many businesses. One of the most notable examples of successful revenue lending is in the software sector. A private debt fund lent capital to a burgeoning software company, which specialized in cloud-based solutions, against a direct debit on a percentage of its monthly revenues. The company needed immediate funding to expand its operations but was unable to secure loans from traditional banks due to a lack of collateral. Through the private debt fund, the company was able to obtain the necessary capital, allowing it to rapidly expand and subsequently increase its cash flow. The debt fund was repaid on schedule, generating a substantial return on investment.

Jan Hillered, managing partner at revenue lending fund Round2 believes that “Revenue-based lending has become the standard non-dilutive method for financing software companies during the growth phase. It enables founders to monetize recurring cash flows from Software-as-a-Service (SaaS) contracts they sign with their customers. At Round2 we are convinced that revenue-based financing will play the role that bank financing used to play during the industrial era. In the digital era, an era based on immaterial assets, revenue-based or royalty financing is the product needed to support the growth of the digital economy.” Currently the software sector and, in particular, the SaaS subsector, offers very compelling economics as a revenue lending investment destination. In conclusion, private debt offers investors the opportunity to achieve attractive risk-adjusted returns and diversify their investment portfolios. By understanding the risk-return profile, navigating economic cycles, and conducting thorough due diligence, investors can capitalize on this promising asset class. More concretely, the revenue lending segment, applied to the SaaS market, presents a compelling investment opportunity for those seeking steady and reliable returns. Revenue lending has become increasingly popular in recent years, gaining attention from both investors and businesses alike. This alternative form of financing offers numerous benefits for all parties involved, making it an enticing option that could deliver superior risk-adjusted returns in the current economic scenario.