Q. So, this is another way of doing seed stage investing, right? And one that might be particularly good as crowdfunding gears up?
A. Yes. We’ve previously talked about the classic way– common stock or preferred stock, but those require valuing the enterprise, which is tough at the seed stage. And we’ve talked about next round notes, which don’t require that and have become pretty popular as a result. And then this is the latest iteration, revenue participation notes.

Q. And how exactly do they work?
A. An investor makes a loan to a startup, taking back a note that pays a certain amount of interest. But the principal amount of the note is not fixed. What the investor gets is a certain percentage of the revenue of the enterprise, until he’s gotten back a certain multiple of the loaned amount– maybe 5x. That provides the upside reward for the risk he’s taking, which of course a normal loan wouldn’t.

Q. And is the revenue participation amount steady?
A. Often, the investor would get, say, 5% of the gross revenue paid to him until he’s gotten all his money back, and then 2 1/2% thereafter till he’s gotten to that cap, say 5x.

Q. And what’s the real advantage over Next Round Notes? Both ways avoid the need to value the company on the investment date.
A. Right. But next round notes convert into stock later on, so the investor is in for the long haul. With these, you can buy the investor out– at a good profit, but still you can get him out of the capital structure. That’s very appealing for later, institutional investors, who often don’t want lots of small fry shareholders hanging around… in fact, that exact reason is one reason crowdfunding can create problems for companies down the road. This mechanism addresses that concern.