Covid 19 is a lesson in why alternative investment structures are needed

This article and all the articles tagged Tactics or Ideas are opinion articles and therefore only reflect the view of the author. 

Covid-19 is teaching us many lessons that take the form of “that thing we used to do, or that idea we used to feel safe thinking, turned out to not be that good an idea after all.”  Covid 19 is teaching us the value of resilience and flexibility.   

Companies that need cash and wish to borrow to survive the crisis have no idea when their cash flows will once again become predictable.  Companies that thought they had predictable cash flows and have borrowed against those predictions are now stuck with fixed payments they can’t meet.  

The core problem with traditional debt for social enterprises is agreeing to fixed payments against variable revenue streams, negotiated early in a company’s life when revenue is most unpredictable.  Many enterprises in the countries where Covid-19 lockdown measures have been implemented are going to fail. It’s not true that “no one saw this coming.” Covid-19 specifically, yes; but unpredicted swings in revenue early in the life of a company?  Both foreseeable and foreseen.  

There is an alternative, but it’s been practiced only at the fringes.  This global crisis presents the opportunity to reconsider how we structure early stage investments.  For the many companies in trouble, Revenue-Based Finance (RBF) approaches are among the most promising ways to restructure debt to assure repayment in the long run.  Little has changed about the long-term prospects of most of these companies; yet many have total uncertainty about near-term revenues. A return to revenue growth is likely, but the timing is completely unknowable.  This type of situation is a perfect recipe for the use of RBF.

For new financings, the benefits of RBF have never been clearer.  If a crisis can quickly slow the economy once, it will happen again — why not design our financing structures for flexibility and resilience?  Revenue-Based Financings are investment structures that link the returns to the investor with a company’s revenue. This type of structure is in the interest of both the social enterprise and their investors.  There are many ways to structure RBF and you can learn more about structuring options at impactterms.org  

Because the payments due to investors from RBF structures vary with company performance, they are designed to handle exactly the kind of stress and uncertainty we are seeing in this crisis (and others like it in the future). A company that borrowed using an RBF structure, instead of traditional debt would not be forced to make payments that they can’t afford but if they miss put them in default. Its action also saves the investors in the company. Yes, the investors’ returns will likely decline as payments get pushed to the future, but that’s a much better problem than losing their whole investment.

One investor using RBF both for restructuring and new investing is Capacity Capital, a new fund investing financial and social capital into small revenue-generating growth businesses, especially the overlooked and underestimated.  For example Capacity Capital recently made an investment in RentSons, a company that helps people link up with “helping hands”. Rent Sons had a mix of existing debt obligations that, as is common in debt structures, did not offer the company the flexibility they needed to manage downturns in the business cycle.  They now have the flexibility they need thanks to Capacity Capital restructuring those old debts and providing new financing in a combined RBF financing.  

Through a new RBF investment they are providing RentSons additional growth capital and restructuring their old debn

For investors and companies that have used traditional debt and are facing likely default, this is a great time to consider restructuring the debt using an RBF structure.  When the timing of cash flows is uncertain but the company’s prospects are still strong, the traditional option is equity. However, the investor has to believe they will one day be able to sell that equity.  By restructuring into an RBF structure, the company can have the flexibility they need to recover, and the investor can have a realistic path to recovery and profit.  

It will take some time before we have enough perspective to look back and draw final conclusions from this experience, but one clear lesson we can learn today is the value of flexibility and we can put that lesson to work today by using Revenue-Based Financing and the other alternative investment structures featured on ImpactTerms.org 

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