Co‑ops and quasi‑equity

Quasi‑equity is a form of capital which blends debt and equity properties. There is an increasing variety of financing options of this type as the funding landscape for start-ups starts to diversify.

Here we cover two that are particularly relevant to platform co‑ops: sweat equity and revenue based finance. 

Sweat equity

Sweat equity is a form of finance that accounts for the time and resources that people put into a start-up unpaid, usually at the early stages when there is limited funding or revenue available to cover costs. 

The simplest way to account for sweat equity is to record the hours that are worked unpaid, and agree when they will be paid, which can be by a certain date or when the co‑op reaches a certain income. In this case, the sweat equity should be recorded as debt. 

An alternative is to issue shares to workers in exchange for their labour. In order to use this approach, the co‑op will need to have a suitable legal structure that allows shares to be issued to employees and for them to be converted into cash should the employee leave, or when certain conditions are met.

Sweat Equity must be declared for income tax purposes and is taxable when the payment is due.

Revenue Based Finance

Revenue based finance (RBF) is a type of finance where an investment is made in exchange for a fixed percentage of ongoing revenue, until an agreed cap is reached, which is a multiple of the original investment. 

With RBF, repayments vary and are calibrated to the performance of the business in a given moment of time – when it is going well, payments are high; when it is not going so well, payments are low. 

Some RBF deals include thresholds below which repayments are not requested, so that when revenue is low or nonexistent the co‑op can prioritise keeping the business afloat over their repayments. This is a very interesting form of funding for platform co‑ops that have the potential to scale rapidly, but that might need to incur high start-up costs before they can start generating large revenue. 

However, the cost of RBF is usually high, typically 3-4 times the original investment, and a co‑op will have to prove that their revenue model is viable. 

RBF investors might also put constraints on what the funds can be used for or include clauses which give them the right to transform their investment into equity should the enterprise decide to issue shares. In most cases, investors will not expect voting rights with the shares, but they will want to not lose out, should transforming their investment into equity be a more profitable option.