Most people view debt as a rigid financing option best suited for investments in mature companies with predictable cashflow. Most debt instruments offer fixed annual returns that are commensurate with their inherently lower levels of risk relative to equity investments. To make debt a more flexible option better-suited to early-stage impact transactions, pioneers have introduced three innovations.
Repayment amounts are linked to an agreed-upon measure of the company’s financial performance, such as revenue or EBITDA.
Initial payment deferral
The repayment of principal and interest is deferred for a specified period of time.
Higher return profile
This variable payment structure provides for a risk-adjusted return if company performance meets or exceeds expectations. We have seen investors targeting 2-4x returns in 5-7 year periods using these instruments.
The parties to a variable payment debt transaction will first need to determine how the repayment amounts will be calculated. Learn more about variable payment debt repayment amounts.
Initial repayment timing
Based on the company’s stage of development, the parties may agree in advance to defer initial repayment for a predetermined period of time (e.g. one or two years). Learn more about variable payment debt and initial repayment timing.
Accrual rules during deferral periods
If the parties choose to defer initial repayment, they will need to decide whether interest or other obligations will be assessed or “accrue” during the deferral period or if repayment of those amounts will be waived (no accrual). Learn more about variable payment debt and accrual rules during deferral periods.
Caps on variable payment amounts
If the total repayment amount under the loan will vary based on the company’s financial performance, the parties may choose to cap the total return to the lender. Learn more about variable payment debt and caps on variable payment amounts.
The parties may agree to allow the company to prepay the loan at the company’s option but with a prepayment premium, or the parties could require the lender’s consent for prepayment. Learn more about variable payment debt and prepayment options.