Among the companies listed on the Inc. 5000, a small percentage – just 6.5% – secured funding through venture capital firms, while 7.7% obtained capital from angel investors. This raises the question: what alternative funding sources are available to rapidly expanding businesses?

An increasing number of startups are exploring revenue-based financing, but this approach isn't suitable for all situations. Consequently, a novel type of investor has appeared, providing a middle ground between traditional venture capital and revenue-based investment, a model we refer to as “flexible VC.”

Flexible VCs adopt the principle from revenue-based investment of achieving substantial returns without requiring founders to prioritize building a company solely for a sale or IPO. Simultaneously, they retain the characteristic of traditional equity venture capital – the potential to benefit from and capitalize on a significantly successful exit event. Each flexible VC arrangement enables founders to obtain crucial early-stage funding while maintaining control over their company’s future, growth plans, and ownership structure.

It’s important to note that our classification isn’t based on strict technical definitions. Instead, we aim to encompass the diverse range of investment instruments currently offered by flexible VC investors, which are outlined below. As fund managers who utilize flexible VC strategies, we believe this approach represents a positive development for the investment landscape and will generate more consistent and reliable returns for investors.

Flexible VC 101: Equity meets revenue share

Currently, the most frequently utilized investment model involves a flexible VC investor acquiring either equity in the company, or a right to convert into equity at a later date, alongside the right to receive periodic payments calculated as a percentage of the company’s revenues.

Linking these payments directly to revenue figures ensures that both the company’s founders and its investors share a common focus on the business’s current performance, whether positive or negative.

Samira Salman, an investor and advisor specializing in family offices, explains: “Traditional investment structures frequently compel management teams to choose between pursuing growth initiatives and maximizing returns, creating conflicting priorities. This approach establishes alignment from the outset and provides adaptability based on actual performance data.”

These payments typically begin after an initial deferral period of 12 to 36 months. John Berger, Director of Operations and Impact Solutions at Toniic, has noted that this delay offers advantages to investors: “The deferral period gained prominence because it provides benefits to investors in areas like the U.S., where tax regulations differentiate between short-term and long-term capital gains. It has evolved beyond its initial tax-related purpose and is now often seen as a positive aspect for founders as well.” Following this period, the return payments commence, generally continuing until a predetermined return cap is achieved, often ranging from 2 to 5 times the initial investment amount.

The investor’s equity stake (or the right to convert to equity) is reduced proportionally to these revenue share payments. Upon reaching the return cap, the investor generally retains a remaining ownership percentage – a portion of their original equity position. Should the founder decide to seek a conventional equity VC funding round or pursue an acquisition, the revenue share arrangement is suspended, and the investor’s current ownership stake is converted to align with the terms of a standard equity VC investment.

Flexible VC 102: Variations

Adaptable VCs have developed frameworks utilizing performance indicators beyond just revenue, including metrics like profitability or the founder’s income. These alternative measures of company success introduce subtle differences in the arrangement between the investor and the company’s leader. As an illustration, arrangements based on profit-sharing guarantee that payouts commence only when the company achieves profitability, potentially postponing investor returns and adding complexity to the payment process.

Likewise, when flexible VC deals are linked to the founder’s personal earnings—typically through salary or dividends—investors are directly connecting their financial gains to the founder’s financial well-being. This approach doesn’t necessarily correlate as closely with overall company performance as revenue or profit sharing, but it fosters a distinct and individual level of commitment. These differences in how founders’ interests are aligned enable flexible VCs to focus on specific types of businesses with which they collaborate.

The state of flexible VC

In these scenarios, funding is supplied to support anticipated expansion without imposing stipulations regarding future funding stages, exit strategies, or rapid scaling. The founder maintains complete authority to prioritize either accelerated growth – often at the cost of profitability – or sustainable, profitable development. Flexible VC introduces a novel source of risk capital for self-funded startups, underrepresented founders, family businesses, and numerous other founder groups often overlooked by conventional funding models.

Currently, a number of smaller venture capital firms are utilizing flexible VC structures, but the total assets under management employing this approach is estimated to be less than $50 million. Similar to the growth of seed funds over the last ten years, we – along with some of our investors – anticipate that these Flexible VCs represent the leading edge of a significant trend within the venture capital landscape.

The following details the primary types of venture capital:

Flexible VC Compared to Other Venture Capital Approaches

Flexible VC investors provide founders with several of the same benefits found in traditional equity venture capital:

• Shared Success. Both in the event of significant achievement and in the case of complete capital loss, investors share in the company’s journey. When challenges arise, flexible VC investors generally avoid drastic measures like replacing management or restructuring the company, instead focusing on collaborative problem-solving.
• Operational Freedom. Founders retain the ability to allocate funds as they see fit, without restrictive stipulations.
• Long-Term Partnership. Many flexible VC firms maintain a small ongoing stake in the company even after the initial return target is met, fostering a long-term alignment of interests comparable to that of equity VCs.
• Suitability for Early Stages. Similar to conventional equity VC investors, flexible VCs are well-equipped to handle the inherent risks associated with seed-stage investments, unlike some traditional revenue-based financing options.
• Potential Tax Benefits. If structured as equity, the investment may qualify for favorable treatment under the qualified small business stock exemption, though specific details are outside the scope of this discussion.

Flexible VCs also present investors with advantages similar to those of revenue-based investment (RBI):

• Defined Return Expectations. The return cap represents a clearly stated multiple of the initial investment, typically ranging from 2x to 5x.
• Faster Liquidity. Unlike the slower returns typical of equity VC, flexible VC offers opportunities for earlier liquidity, allowing for reinvestment or distribution to limited partners.
• Sound Financial Planning. All stakeholders prioritize the company’s ability to meet its payment obligations and ideally achieve a swift return. This encourages realistic financial projections, transparent communication, and a focus on achievable business goals, moving away from unrealistic growth expectations.
• Emphasis on Profitability. The revenue used to fund company growth is the same revenue that enables investors to reach their return cap. This inherent connection incentivizes an earlier focus on profitability than is often seen with traditional equity VC backing.
• Founder Control. Flexible VCs commonly acquire nonvoting common stock, or even assign voting rights to the founders, ensuring the founder maintains leadership of the company.
• Increased Inclusivity. Flexible VC is proving to be particularly appealing to women and underrepresented entrepreneurs. [See Why Are Revenue-Based Investors Investing in Women & Diverse Entrepreneurs?]

Flexible VC also provides distinct advantages:

• Simplified Equity Integration. If a subsequent equity round is needed to support rapid expansion, incorporating a flexible VC investor into the round is a straightforward process.
• Adaptability to Growth Scenarios. While prepared for rapid scaling, flexible VC doesn’t require or necessarily expect it. Tim O’Reilly, CEO of O’Reilly Media, suggests that “blitzscaling isn’t really a recipe for success but rather survivorship bias masquerading as a strategy.” Flexible VC accommodates companies that may not experience explosive growth while still allowing for that possibility.
• Relevance to Impact Investing. Our research indicates a strong interest in flexible VC from impact investors, who typically require some financial return but may not desire a full exit, as exits can sometimes compromise the company’s original mission. Flexible VC allows impact investors to balance these priorities.

However, it’s important to acknowledge that no investment model is without its drawbacks. The unique disadvantages of flexible VC include:

• Potential for Investor-Founder Disagreements. As with any financial obligation, friction can occur if the founder struggles to meet payment commitments. While traditional equity VC investors might choose to withdraw, restructure, or replace management when milestones aren’t met, they generally avoid demanding immediate cash payments when the company is facing financial constraints.
• Complex Cost of Capital. If the company grows profitably or secures additional VC funding, the return cap may be repaid sooner than anticipated. This can result in a higher cost of capital for flexible VC, often measured through IRR (similar to an interest rate), compared to venture debt or traditional RBI. Conversely, slower growth automatically lowers the effective cost of capital. In the event of company failure, the investor typically receives nothing, similar to traditional equity VC.
• Potential for Co-Investor Conflicts:
  • Early-Stage Investors. Investors who participated in earlier, riskier equity rounds may be hesitant to allow a later investor to receive compensation before them.
  • Syndication Challenges. The lack of standardized flexible VC terms can make it more difficult to attract multiple investors. Many flexible VCs lead rounds and often take 100% of the round to mitigate this risk. However, Jonathan Bragdon, general partner at Capacity Capital, notes that flexible VC terms “twin” well with equity, offering less dilution while still providing investor support.
  • Later-Stage Investors. Debt or equity investors joining at a later stage may have differing interpretations of the obligations and ownership rights associated with the flexible VC investment.
• Incompatibility with Traditional VC Funds. Traditional VC funds may face challenges investing through this structure, prompting innovation in fund structures.
• Evolving Regulatory Landscape.
• Limited Industry Familiarity. Zack Mueller, attorney at Ireland Stapleton Pryor & Pascoe, PC, observes that “no one, from LPs to entrepreneurs to attorneys, has much experience with these instruments. Generally speaking, uncertainty and unfamiliarity with novel investment structures leads to slow adaptation.”
• Collection Challenges. Zack Mueller also noted, “The key is determining what the flexible VC instrument is [debt, equity, etc.], as that will determine how easy collection is for the investor.”
• Limited Historical Data. Marco Cesare Solinas, VC analyst with Blue Future Partners, stated, “From the LP perspective, another disadvantage is the lack of track record given the early stage of the concept. It will probably take some time to have valid proof points.”

The industry is still working towards a standardized template, similar to the NVCA template commonly used by traditional equity VCs. Several organizations have proposed templates:

• Earnest Capital Shared Earnings Agreement v1.3.
• Indie.vc has open-sourced their investment structure, now on version 3.0, which they co-developed with Fenwick & West.
• Santa Clara University shares their demand dividend structure.
• Womble Bond Dickinson has released a white paper on Performance Aligned Stock and a term sheet on Impact Terms.
• (If you are working on any other flexible VC templates, please contact us.)

Emily Campbell of The Campbell Firm PLLC, a New York City law firm, commented, “The blended [VC] model has a lot of appeal for entrepreneurs … These types of investment models can allow more of a balance between the entrepreneur’s goals and the investor’s goals.”

We recommend that founders thoroughly investigate the nuances of different flexible VC structures before seeking capital. Several firms offer tools to model investments, such as Capital’s Cost of Equity estimator; Lighter Capital’s Cost of Capital Calculator; Indie.VC’s Cap Table Comparison Model; 645 Ventures’ cap table simulator; and Bootstrapp.co’s Comprehensive Cost of Capital Calculator. Venture Dealr is another similar, open-source, visual tool focused on VC, and NoteGenie.io is also available.

A significant 83% of entrepreneurs have not been able to secure capital from traditional venture capitalists and banks. We believe flexible VC offers a viable solution for many of them.

Appendix: Formal comparison of common growth capital sources

The following summarizes a comparison of flexible venture capital with standard industry practices for traditional equity venture capital, venture debt, and revenue-based investment (RBI). For the sake of clarity, flexible VC is presented on a spectrum of increasing risk. However, as John Berger points out, “I can easily structure a low-risk, debt-like flexible VC deal, or a high-risk equity-like deal, using the same term sheet with differing terms. The idea of a strict risk continuum isn’t accurate. These are more akin to derivatives – their characteristics depend on how they are configured. It’s about having more adaptable structuring options to align investor and company interests when those interests aren’t naturally aligned.” To maintain simplicity, we have not included a separate column for convertible notes (such as SAFEs) that ultimately convert into preferred equity.

Further reading:

• The Evolution of Entrepreneurial Finance: A New Typology
• Impact Terms: Emergence of New Capital Providers — Exploring Alternatives to Traditional Expectations and Structures
• Vocabulary for the New Risk Capital Landscape
• Series: Overview of Revenue-Based Investing
• Fundraising Hacks: What type of capital should you raise, and how do you meet investors?

Thanks to Leeor Baskin, Google; John Berger, director of Operations & Impact Solutions, Toniic; Jonathan Bragdon, general partner, Capacity Capital; Emily Campbell, Esq., of The Campbell Firm PLLC; Keith Harrington, co-founder/managing director, Novel Growth Partners; Brian Mikulencak, tax alchemist at Blue Dot Advocates; Samira Salman, CEO, Salman Solutions; Zachary Mueller, attorney, Ireland Stapleton Pryor & Pascoe, PC; Pam Rothenberg, attorney, Womble Bond Dickinson; and Mark Newberg, president, Stockbridge Advisors for providing valuable feedback.

Disclosures: Blue Future Partners is a member of the Advisory Board of ff Venture Capital, where David Teten was formerly a partner. David Teten was also formerly a managing partner at HOF Capital. Emily Campbell has previously provided legal services to David.