Legal pitfalls in revenue-based financing for start-ups

In the early and growth phases, start-ups regularly face the same challenge: capital is needed without immediately giving up substantial company shares or creating complex shareholder structures. In addition to traditional instruments such as venture capital, convertible loans or silent partnerships, another form of financing has become established in recent years that is gaining in importance, particularly in the SaaS, tech and platform environment: revenue-based financing.

The basic promise is attractive. Investors provide capital that is not repaid via fixed interest or shares, but via a share in current sales. The repayment is thus adapted to the economic performance of the company. For founders, this often means: no dilution, no co-determination rights, no exit pressure. For investors: predictable cash flows and a shorter capital commitment period.

Legally, however, it is by no means a simple or risk-free model. Revenue-based financing operates in a field of tension between contract law, company law, capital market law and tax law. Many contracts used in practice are legally flawed, incomplete or harbor considerable risks – both for start-ups and investors.

The following article sheds light on the legal foundations, typical misconceptions and key pitfalls of revenue share financing and shows why a proper contractual structure is crucial.

Classification and economic functioning of revenue-based financing

Revenue-based financing is not a legally defined type of contract. It is an atypical financing model that is structured on a contractual basis. Typically, a startup receives a one-off capital contribution. In return, it undertakes to transfer a fixed percentage of its revenue to the investor over a certain period of time or until a target amount is reached.

The range of models is wide. In practice, they include

– Fixed revenue shares up to repayment of a multiple of the capital invested
– Temporary revenue shares without a cap
– Models with minimum and maximum payments
– Combinations with performance-related bonus components

What these models have in common is that they are economically positioned between debt and equity. It is precisely this hybrid nature that is both their greatest strength and their greatest legal risk.

A common mistake is to regard revenue-based financing as an “uncomplicated alternative” to traditional investments. In fact, the need for legal clarification is often greater than with standardized financing instruments.

Contract type classification and delimitation

Not a classic loan agreement

In many cases, revenue-based financing is hastily referred to as a loan. This classification is generally incorrect. A loan within the meaning of §§ 488 ff. BGB presupposes an obligation to repay irrespective of economic success. This is often not the case with revenue-sharing models.

If the repayment is exclusively or predominantly dependent on turnover, the repayment obligation typical of a loan is missing. Classification as a loan can then be legally problematic, for example with regard to termination rights, interest or insolvency scenarios.

Differentiation from silent partnership

The proximity to the silent partnership (Sections 230 et seq. HGB) is also obvious. In the case of a silent partnership, the investor participates in the trading activities of a company and in return receives a share of the profits. However, revenue shares are not linked to profit but to revenue.

In addition, there is often a lack of participation in assets or losses. The legal qualification as a dormant partnership therefore fails in many cases due to the legal requirements.

Atypical financing agreements under the law of obligations

As a rule, revenue-based financing is an atypical contract under the law of obligations of its own kind. These are permissible in principle, but are subject to complete private autonomy. This results in considerable requirements for clarity, completeness and risk distribution in the contract.

Unclear or contradictory provisions are usually at the expense of the party that drew up the contract – in practice often the investor.

Key legal pitfalls in the drafting of contracts

Definition of the term relevant to sales

One of the most frequent points of contention concerns the question of what actually counts as “turnover”. In many contracts, the term is not defined at all or only inadequately. This is highly risky from a legal perspective.

Issues to be clarified include:

– Gross or net revenue
– Revenue before or after refunds and chargebacks
– Treatment of discounts, credits and freemium models
– Differentiation between non-recurring and recurring revenue
– Inclusion of intra-group revenue or foreign companies

A blanket definition of revenue is generally unsuitable, especially for SaaS and platform models with complex revenue structures. Without a clear regulation, there is a risk of considerable interpretation disputes.

Term, cap and exit scenarios

Another key point is the question of when and how the revenue share ends. So-called caps, such as repayment of 1.5 to 3 times the invested capital, are typical. If there is no such limit, the revenue share can become a permanent economic burden.

Equally relevant are regulations for special cases:

– Sale of the company or business shares
– Mergers or demergers
– Discontinuation of business operations
– Change of business model

Without clear exit clauses, revenue-based financing can lead to significant deal breakers in M&A processes. Investors then frequently demand redemption payments or special termination rights, which often cause unplanned high outflows of liquidity.

Control and information rights

Investors regularly secure information and auditing rights in order to control the correct calculation of turnover. There is a tension here between legitimate control interests and the operational freedom of the start-up.

Legally problematic in particular are

– Inappropriately far-reaching rights of inspection
– Intervention in management or pricing
– De facto co-determination rights without a basis in company law

Such clauses may not only be ineffective, but may also establish a hidden participation or even a co-entrepreneurship, with corresponding liability and tax consequences.

Capital market and regulatory risks

Prospectus and licensing requirements

One aspect that is often underestimated is capital market law. Depending on their structure, revenue-based models can qualify as investments within the meaning of the German Investment Act. This is particularly relevant if the financing is not offered individually but to a large number of investors.

In such cases, prospectus obligations or at least extensive information obligations may be triggered. Violations of these obligations are subject to fines and can lead to claims for restitution.

The German Banking Act may also be affected if repayment claims are structured in a manner typical of capital. Unconscious proximity to banking transactions requiring a license represents a considerable risk.

Differentiation from lending subject to authorization

If revenue-based financing is de facto structured like an interest-bearing loan with variable repayment, the BaFin-relevant threshold may be exceeded. Although this must be examined on a case-by-case basis, the boundary is fluid.

International model contracts in particular, which are transferred to the German market, are regularly problematic here.

Tax implications and accounting

Operating expenses or appropriation of profits?

For start-ups, the question arises as to how revenue shares should be treated for tax purposes. If they are business expenses, they reduce the tax burden directly. If, on the other hand, they qualify as an appropriation of profits, this only has an effect downstream.

The classification depends largely on the contractual structure. In particular, being too close to equity participation can have adverse tax effects.

Value added tax aspects

In principle, revenue shares are not subject to VAT if they qualify as consideration for the transfer of capital and not for an exchange of services. Here too, the specific contract structure is decisive.

A lack of clarity can lead to unexpected VAT claims, especially in cross-border constellations.

Importance of professional contract drafting for startups

Revenue-based financing is not a standard product. Each contract is unique and must reflect the economic logic of the business model. Model contracts from abroad or simplified online templates are generally unsuitable for this.

From a legal perspective, it is particularly important to ensure that

– Clear classification of contract types
– Clear definition of revenue base
– Balanced distribution of risks and burdens
– Clear differentiation from participation and credit models
– Consideration of exit and growth scenarios

For start-ups in particular, a poorly structured revenue share can be more serious in the long term than early dilution. Ongoing revenue outflows have a direct impact on liquidity, scalability and investor attractiveness.

At the same time, revenue-based financing offers considerable opportunities if structured correctly. It can represent flexible, growth-friendly financing that maintains strategic freedom and links investor interests with the operational success of the company.

Conclusion

Revenue-based financing is an exciting but legally challenging financing instrument. Its attractiveness lies precisely in the departure from traditional investment models. However, this departure does not lead to lower legal requirements, but on the contrary to an increased need for structuring.

The same applies to start-ups and investors: The economic idea is only as viable as its legal implementation. Precise contract design determines whether revenue-sharing models become a strategic advantage or a permanent risk.

Author: Marian Härtel

Marian Härtel ist Rechtsanwalt und Fachanwalt für IT-Recht mit einer über 25-jährigen Erfahrung als Unternehmer und Berater in den Bereichen Games, E-Sport, Blockchain, SaaS und Künstliche Intelligenz. Seine Beratungsschwerpunkte umfassen neben dem IT-Recht insbesondere das Urheberrecht, Medienrecht sowie Wettbewerbsrecht. Er betreut schwerpunktmäßig Start-ups, Agenturen und Influencer, die er in strategischen Fragen, komplexen Vertragsangelegenheiten sowie bei Investitionsprojekten begleitet. Dabei zeichnet sich seine Beratung durch einen interdisziplinären Ansatz aus, der juristische Expertise und langjährige unternehmerische Erfahrung miteinander verbindet. Ziel seiner Tätigkeit ist stets, Mandanten praxisorientierte Lösungen anzubieten und rechtlich fundierte Unterstützung bei der Umsetzung innovativer Geschäftsmodelle zu gewährleisten.