Background
The purpose of this guide and the related articles, is to accelerate the ability for the global community of impact investors to use alternative investment structures. This guide is designed to help entrepreneurs and investors navigate the different legal frameworks that influence alternative investment structures available throughout the world.
Globally the traditional investment structures of debt and equity are well understood and low cost to utilize. The rise of impact investing, catalytic capital, and other innovations has motivated investors and enterprises to seek non-traditional investment structures that better align their financial and impact intentions. One of these emerging structures is Revenue Based Finance.
The growth of Revenue Based Finance (RBF) has been motivated by the desire for investment structures that provide greater flexibility to entrepreneurs with business models that are not as well suited for traditional debt and equity financing. For example, Revenue Based Finance is often used when companies don’t yet have predictable cash flows to service debt, and where equity investors cannot reasonably expect to be able to exit their investment.
Through this guide, you will be able to learn about some of the most common ways to structure Revenue Based Financing investments across multiple jurisdictions.
Methodology
Given the complexity of international legal frameworks, this guide initially includes eight countries, selected because of the nature of their impact investor communities and to include global representation. The initial countries are (each country title links to that country page)
For each country in this guide, there is a separate country guide that includes information on:
- For each legal structure explored
- The legal and tax category (is it considered equity or debt?)
- Governance rights
- Investor Qualification Requirements
- Currency Considerations
- Collateral Consideration (when relevant)
- Priority Payment Rights (when relevant)
- Distribution and Redemption Limitations
- Legal Limitations to Pricing or Total Return (eg Usary laws)
- Status in Insolvency Proceeding
- Limitations of Liability
- Transfer Restrictions
- Critical Tax Considerations
Revenue Based Finance Options By Country
- Singapore
- United States (New York)
- Germany
- Brazil
- Mexico
- South Africa
- England and Wales
- Netherlands
Summary Observations
Dependence on Existing Corporate Structures
In all of the countries in this guide, the proposed Revenue Based Finance structures are created using modification of existing debt or equity structures. We found no instance where a country’s laws specified a corporate structure specifically designed for Revenue Based Finance.
Common Legal Impediments
The primary restrictions on Revenue Based Finance are related to each country’s laws on the issuance of dividends, share repurchases, and usury.
For Equity Based structures, some countries limit the distribution of dividends either by requiring board authorization for the approval of each dividend, or by constraining the total payment of dividends to retained earnings or some other measure of excess capital.
The limitations on the amount of dividends have significant structuring implications. Early stage companies or companies with low, seasonal, or highly variable profits are likely to have periods where their legal ability to pay dividends is restricted, thus reducing investors’ potential returns.
- Singapore had no such restrictions.
- Germany: “Any payment of Guaranteed Dividends can therefore only be made from free capital, i.e., distributable profits and distributable reserves”.
- Brazil: “The Brazilian entity must have accrued profits in its financial statements sufficient to offset any losses from previous fiscal years, so that the positive difference may be distributed.”
- Mexico: “No distribution of dividends is allowed if there are no net profits or if 5% of the net income has not been separated for forming the statutory reserve.“
- South Africa: “ In order to declare a dividend, it must reasonably appear that the company will satisfy the solvency and liquidity test as set out in section 4 of the Companies Act.”
- England and Wales had no such restrictions.
- The Netherlands: “Permissible only if the company’s equity exceeds legal or statutory reserves.”
In the face of limitations on dividends, the primary structuring option for Equity Based RBF structures is redemption at a premium above par. This guide did not explore limitations on above par redemption in sufficient detail.
For Debt Based structures, the primary structuring consideration is usury laws. Because of the variability of revenues, it is easy for Revenue Based structures to have periods that deliver high returns and others with lower returns. Structuring RBF could be limited if a country’s usury laws limit the total return to the investor, or prohibit periods of high return.
- Singapore had no such restrictions.
- United States “In some states, predatory financing practices could lead to claims under state unfair and deceptive acts and practices, usury, predatory lending, fraud, good faith and fair dealing laws.“
- Germany: “It has been determined by German case law that a loan agreement by which a lender causes himself or a third party to be promised or granted pecuniary advantages which are clearly disproportionate to the performance (i) by wilfully exploiting the weaker position of the borrower or (ii) by gross negligently denying that the borrower only engages in the pressuring conditions due to its weak position, will be null and void”
- Brazil: “Our understanding is that the legal rate limit is not applicable to financial and capital markets transactions. However, interest limitations may apply to debentures and other securities subject to private placements that do not involve financial institutions and that are not registered in organized markets and, therefore, follow the same rationale as loan transactions (as opposed to debentures subject to public offerings, which are considered investments in the capital markets).”
- Mexico “There is no objective standard or percentage of what is considered usury being subject to court interpretation considering the court precedents […] it is not that this limitation would prohibit revenue based financing, as long as the interest is proportionate to gross revenues, irrespective of the fact that there could be periods with high payments.”
- South Africa: “If a transaction falls within the scope of the NCA, the interest will be subject to a cap.”
- England and Wales had no such restrictions.
- The Netherlands had no such restrictions.
Acknowledgment and Disclaimer
Toniic would like to thank TrustLaw, Thomson Reuters Foundation, for facilitating the connection with pro bono law firms that conducted the research underpinning this resource. This resource is offered for information purposes only. It is not legal advice. Readers are urged to seek advice from qualified legal counsel in relation to their specific circumstances. We intend the resource’s contents to be correct and up to date at the time of publication, however, we do not guarantee their accuracy or completeness, particularly as circumstances may change after publication. Toniic, the assisting pro bono law firms, and the Thomson Reuters Foundation, accept no liability or responsibility for actions taken or not taken or any losses arising from reliance on this resource or any inaccuracies herein.