Write the fallback
"We'll sort out conversion later" is not a term, it's a dispute scheduled in advance.
Volume 03, Chapter 7
Convertible Loans, Revenue-Based Financing, Profit Sharing & Silent Partnerships
None of these is "best"; each fits a different worst month. The hybrids exist to solve two walls: payments that can't be fixed, and valuations that can't be agreed.
The Golden Rule
Between pure loan and pure equity sits a family of hybrids. Each keeps some features of a loan, borrows some from equity, and drops what doesn't fit.
Real deals keep hitting the same two walls: income too uneven for fixed loan payments, or founder and investor unable to agree what the business is worth today.
The fixed-payment wallRBF and profit sharing let payments flex with results.
The valuation wallA convertible loan postpones the ownership question.
Silence isn't a machineA silent partnership is a behavior, built from parts you already know.
Revenue %, not profit %
A thin-margin business paying 5% of revenue can be handing over half its actual profit.
Profit sharing lives on the books
Everything depends on one word, and it's a number the founder's own bookkeeping produces.
The Uncle Problem
Money arrives with warm words and no paper; two years later "silent" gets loud.
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Definition
Remember Mr A's two problems from earlier chapters. A pure loan (Chapter 5) nearly sank the business, the fixed payment couldn't survive a slow month. Pure equity (Chapter 3) solved that, but only by giving away a permanent slice forever. What if a business needs the flexibility of equity without giving up ownership, or the safety of a loan without a fixed payment that can't bend? That gap is where hybrid structures live.
Between "pure loan" and "pure equity" sits a family of hybrid funding structures, each one keeps some features of a loan, borrows some features of equity, and drops the parts that don't fit a particular situation.
In One Sentence
Four structures to know. Convertible loan: starts as a loan, can become equity later, useful when nobody wants to argue about valuation today. Revenue-based financing: investor takes a % of monthly sales until they've received an agreed total, payments breathe with the business. Profit sharing: investor owns nothing, but takes a % of profits for an agreed number of years, demands trustworthy books. Silent partnership: the investor funds and stays out of the way, really a behavior pattern you can build from non-voting equity or profit sharing. None of these is "best"; each fits a different worst month.
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Why These Exist: The Two Problems They Solve
Convertible Loan
Loan now, converts to shares at a future round's price.
Postpones valuationRevenue-Based Financing
% of monthly revenue until an agreed total cap is reached.
Payments breatheProfit Sharing
% of profits for a fixed number of years, then it ends.
No dilutionSilent Partnership
Investor funds, founder keeps full control, silence in writing.
A behavior, not a machineRedeemable Equity
Real shares, with a founder buy-back right built in.
Designed exitChapter 5 ended with a business that couldn't promise fixed payments. Chapter 3 began with a founder reluctant to give ownership away forever. The hybrids exist because real deals keep hitting the same two walls:
- The fixed-payment wall, the business's income is too uneven for loan payments. → Structures where payments flex with results (revenue-based, profit sharing).
- The valuation wall, founder and investor can't agree today what the business is worth. → Structures that postpone the ownership question (convertible loan) or avoid it entirely (profit sharing).
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Structure One: The Convertible Loan
The deal: money arrives as a loan, but with a clause: at an agreed trigger (a date, or the next investment round), the lender may convert the amount owed into shares instead of being repaid.
Why anyone does this: it postpones the valuation argument. Today, MANIAC MINDZ and a would-be investor can't agree if the business is worth ₦20M or ₦30M. A convertible says: lend ₦5,000,000 now; when a future round sets a real valuation, convert at that price (often with a small discount, e.g., 15%, as a thank-you for coming early).
Worked example:
| Step | What Happens |
|---|---|
| Today | Investor lends ₦5,000,000 as a convertible loan; 15% conversion discount agreed |
| 2 years later | A new investor invests at a valuation that prices shares at ₦25,000 each |
| Conversion | Early investor converts at ₦25,000 × 85% = ₦21,250/share → receives 235 shares instead of ₦5,000,000 + interest |
| If no round ever happens | The fallback written in the agreement applies: repay as a normal loan by a fixed date, or convert at a pre-agreed ceiling valuation |
Warning
The fallback line is where careless convertibles explode. "We'll sort out conversion later" is not a term, write now what happens if the future round never comes: repayment date, fallback valuation, interest in the meantime. Every blank left "for later" is a dispute scheduled in advance.
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Structure Two: Revenue-Based Financing (RBF)
The deal: the investor receives a fixed percentage of monthly revenue (sales, not profit) until they have been paid an agreed total cap, commonly 1.3×–2× the amount invested. No shares. No fixed monthly amount. When the cap is reached, it's over.
Worked example: MANIAC MINDZ takes ₦5,000,000 at 5% of monthly revenue, cap of 1.5× = ₦7,500,000:
| Month type | Revenue | Payment (5%) |
|---|---|---|
| Strong (wedding season) | ₦3,000,000 | ₦150,000 |
| Average | ₦2,000,000 | ₦100,000 |
| Weak | ₦1,000,000 | ₦50,000 |
At average revenue, the ₦7,500,000 cap takes about 75 months (about 6 years); if revenue doubles, repayment finishes in half the time. The payment breathes, that's the entire point, and the contrast with Chapter 5's fixed ₦291,700 that couldn't survive a slow month.
Common Mistake, RBF in a Thin-Margin Business
The percentage comes off revenue, before costs. A business with 10% profit margins paying 5% of revenue is handing over half its profit. RBF suits healthy margins (MANIAC MINDZ's is about 30%); it quietly drains low-margin retail. Always translate the revenue % into "% of my profit" before signing.
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Structure Three: Profit Sharing
The deal: the investor owns nothing and is owed nothing fixed. Instead, they receive an agreed percentage of profits for an agreed number of years, e.g., 30% of profits for 5 years, after which the arrangement simply ends.
Why it's loved: no dilution, no permanent investor, no payment in loss-making months at all, and a clean built-in ending.
Why it's feared: everything depends on one word, profit, and profit is a number the founder's own bookkeeping produces. If the books are casual, every year ends in the same argument: "Was that really the profit?"
| Profit sharing works when... | Profit sharing collapses when... |
|---|---|
| Books are clean, complete, and shared monthly (Volume 04) | "Profit" is whatever's left in the drawer |
| "Profit" is defined in the agreement (before or after owner's salary? before reinvestment?) | The definition lives in two different memories |
| The investor sees the same reports the owner sees (Volume 27) | Numbers appear once a year, take-it-or-leave-it |
Sticky Note Tip
Define "profit" in the agreement with an actual formula: Revenue − materials − wages (including founder's salary of ₦X) − rent − power − transport = shareable profit. One line of arithmetic prevents five years of arguments, and note that a fair founder's salary comes out first (Chapter 1's two-hats rule).
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Structure Four: The Silent Partnership
The deal: the investor contributes money; the founder keeps full operational control; the investor participates financially and stays silent in decisions. Extremely common between relatives, friends, and busy professionals with spare money to invest.
Here's the secret: "silent partner" is not its own legal machine, it's a behavior, built from parts you've already met:
| Build it as... | The silence comes from... | The investor's return is... |
|---|---|---|
| Non-voting equity (Chapter 4) | No votes attached to the shares | Dividends + value growth, this is exactly Mr B's deal |
| Profit sharing (Section 5) | No ownership at all | % of profits for the agreed years |
| A plain loan (Chapter 5) | Lenders never had votes | Interest |
Warning, The Uncle Problem
The danger in silent partnerships is silence about the silence. Money arrives from a relative with warm words and no paper; two years later the "silent" partner is loudly redesigning your workshop, because in his mind, money = say. The cure is not rudeness, it's paperwork: write which structure this is, what reports he receives, and that decisions rest with the founder. A signed page keeps family dinners pleasant.
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And a Fifth: Redeemable Equity (the returnable investor)
Already covered from the shares side in Chapter 4, Section 4.6: the investor buys real shares, but the founder holds the right to buy them back later at an agreed formula. It behaves like equity while it lasts and like a loan at the exit, the full mechanics are Chapter 14.
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Across Industries: Matching Structure to Situation
Green Fields Farm
SituationOne harvest payment per year.
Best fitProfit sharing (annual, after harvest).
WhyFixed monthly anything is impossible; the profit is worked out once a year, after the harvest is sold.
Nimbus Labs
SituationGrowing fast, valuation genuinely unknowable.
Best fitConvertible loan.
WhyPostpones the valuation fight until a real round prices it.
Precision Print & Press
SituationInvestor wants out in 5 years, founder agrees.
Best fitRedeemable equity.
WhyThe exit is designed in from day one.
| Business & Situation | Best-Fitting Structure | Why |
|---|---|---|
| MANIAC MINDZ, uneven wedding-season income, founder wants control | Non-voting equity (chosen) or RBF | Payments/dividends flex; control untouched |
| Green Fields Farm, one harvest payment per year | Profit sharing (annual, after harvest) | Fixed monthly anything is impossible; the profit is worked out once a year, after the harvest is sold |
| Nimbus Labs, growing fast, valuation genuinely unknowable | Convertible loan | Postpones the valuation fight until a real round prices it |
| Golden Crust Bakery, steady daily sales, thin margins | Plain reducing-balance loan | Steady revenue passes the worst-month test; thin margins rule out RBF |
| Precision Print & Press, investor wants out in 5 years, founder agrees | Redeemable equity | The exit is designed in from day one |
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Quiz Yourself
Quiz 1
Which structure exists specifically to postpone a valuation disagreement?
The convertible loan, it converts at a future round's valuation (often with a discount), instead of forcing a number today.
Quiz 2
RBF at 4% of revenue, cap 1.4× on ₦10,000,000. What total will the investor receive, and what's the payment in a ₦1,500,000-revenue month?
Total: ₦14,000,000. That month's payment: ₦60,000.
Quiz 3
Why does profit sharing demand better bookkeeping than any other structure?
The investor's entire return depends on "profit", a number produced by the founder's books. Undefined or untrusted profit = guaranteed annual dispute.
Quiz 4
Your aunt wants to invest quietly. Name the three legal machines that can produce a "silent partnership."
Non-voting equity, profit sharing, or a plain loan, silence is a behavior you build from one of these, in writing.
Quiz 5
True or False: in RBF, a month with zero sales still requires a payment.
False, the payment is a % of revenue, so zero revenue means zero payment that month (the cap just takes longer to reach).
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Practice Exercise
Take the funding need you tested in Chapter 5's exercise (the one that may have failed the worst-month test):
- Price it as RBF: pick a %, compute the payment in your best, average, and worst months. Translate the % of revenue into % of profit, still comfortable?
- Price it as profit sharing: write the profit formula line (including your salary), a %, and a number of years.
- Sketch it as a convertible: what trigger, what discount, and, most important, what's the fallback if no round ever comes?
- For each version, write one sentence: "This deal hurts me most if ______." The structure whose worst case you can live with is your answer, carry it into Chapter 8.
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Quick Summary
Quick Summary
- Hybrids exist to solve two walls: payments that can't be fixed and valuations that can't be agreed.
- Convertible loan: loan now, shares later, at the next round's price, write the fallback or regret it.
- RBF: % of revenue until a cap, payments breathe; deadly in thin-margin businesses.
- Profit sharing: % of profits for fixed years, no ownership, lives or dies on the quality and honesty of the books.
- Silent partnership: a behavior, not a structure, build it from non-voting equity, profit sharing, or a loan, on paper.
- Redeemable equity: equity with a designed exit (Chapter 14).
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