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Alternative funding for startups that last

There's been a lot of talk so far this year about venture capital funding as an agent of harm. This is both good and bad.

For the first time in a while, alternatives to venture capital funding are being seriously discussed, which I think is a really positive development for the industry. On the other hand, some of the discussion ventures into hyperbole, and I think there really are situations when VC is the best solution.

During 2017 and most of 2018, I was Director of Investments on the west coast for Matter Ventures, an early-stage venture capital firm and accelerator that supported teams with the potential to create a more informed, inclusive, and empathetic environment. I wasn't a partner of the firm; the closest analogue is something like an Associate+, where I had the freedom to decide who we invested in, and I sourced, interviewed, researched and effectively closed the deal with the teams, but the Managing Partner's signature was on the legal documents and he hit the button to wire the funds. Previously, my startup Known had been funded by the same firm. And before that, I'd co-founded another startup, which was grown without outside investment for its first few years. I've also been an advisor to, and employee of, VC-funded startups ranging from early rounds to hundreds of millions of dollars.

So I've seen various kinds of funding, and I've been involved in deals on various sides of the table. And I have some pretty strong opinions.

Investment isn't something most founders get to do without. It takes a certain amount of privilege to be able to start something without outside money. My first startup was bootstrapped, but I would be dishonest if I said that bootstrapping didn't include socialized healthcare (I couldn't have done it without the NHS), and help from my parents, whose house I lived in. Not everybody has the benefit of a strong safety net, or that kind of family support. And in particular, if you want (or need) to live in a tech hub, or you have to pay developers, or there's a legal cost involved, then outside money is required. Bootstrapping is not a realistic route for most people. It should go without saying that the people most able to do it are affluent white men - and that's not the only demographic we want to see starting and running businesses.

So startups typically need investment. Ideally, that investment should not just support the startup's financial goals, but its strategic and ethical goals, too.

I'm proud to know the founders of the Zebra movement, which seeks to establish a new movement for startups that champions more sustainable growth, more inclusive, cross-disciplinary teams, and revenue-bound business models.

I think it's one of the most important change movements - if not the most important - in the technology industry today. While venture capitalists are looking for unicorns - startups that grow quickly to become worth more than a billion dollars - zebras are more common, very sustainable, and actually real. As the New York Times reported:

But for every unicorn, there are countless other start-ups that grew too fast, burned through investors’ money and died — possibly unnecessarily. Start-up business plans are designed for the rosiest possible outcome, and the money intensifies both successes and failures. Social media is littered with tales of companies that withered under the pressure of hypergrowth, were crushed by so-called “toxic V.C.s” or were forced to raise too much venture capital — something known as the “foie gras effect.”

If only startups with the potential to rapidly become billion dollar companies can obtain investment, we'll only get to use certain kinds of services.

VC-funded businesses need to grow fast - not necessarily in terms of user numbers, but in terms of perceived value - and don't have an incentive to become profitable until much later in their lifetimes, if at all. A VC-funded startup will typically raise "friends and family" funding (more on this later); then, once they've de-risked their business a little, they'll raise a "seed" round (usually $1-1.5M); then more de-risking before a "series A" ($5-10M); then a "series B" ($15-30M); etc, until the startup is either acquired by a larger company, or makes its shares available on the public markets through an IPO. At each stage, investors buy a stake in the company at a more expensive price, driving up the valuation. Sometimes investors from earlier rounds can sell their shares as part of a later round, but the most money is made during an acquisition or IPO.

In other words, either the startup becomes strategically valuable to a larger entity, or it becomes enormous and valuable enough to float on the stock market. VC doesn't leave much room for anything else. Venture capitalists take money from Limited Partners (wealthy individuals, pension funds, university endowments, etc) who expect three times their money to be returned within a short time period (8-10 years is normal). Because most startups will fail, that means VCs are looking for ones that have the potential to return 30-40X their money in under a decade.

That’s a tall order for just about any business. And note that sustainability or societal impact are not considered here. These startups are, in effect, a financial vehicle. And while venture capital certainly has its uses - startups like Facebook and Uber were able to ride VC funding to great effect - a world where it's the only available model leaves a lot of use cases and communities unaddressed. It's worth saying that most venture capitalists are white men, and 98% of VC funding goes to men.

It also puts startups in great jeopardy. To raise a further round of funding, you don't just need to grow and de-risk your business; you also need to be in an industry that venture capitalists continue to be excited about. Because some years may pass between funding rounds, it's possible that the internet landscape has changed in that time, too. Whereas a profitable business is master of its own destiny, businesses that require future investment to survive are subject to investor whims.

We've seen the human impact of this problem several times recently. In the media industry, layoffs at companies like Mic, BuzzFeed and Vice have shown the limitations of the model. As VentureBeat reported last year:

But while corporate owners continue to fumble around in search of a solution, the reality is that venture capital was never going to be the answer for news outlets. VCs demand big returns that require bigger growth and soaring valuations. That‘s fine when you’re talking about things like social networking sites or a software or cloud service that might have big upfront costs but can clearly deliver sustainable profits once it reaches scale.

Some industries are incompatible with venture capital, regardless of their value. For these industries in particular, alternatives are needed.

It's a complicated problem: investors rarely participate alone, so there needs to be an ecosystem for a new model to become widespread. Until then, VC remains the most accessible, and in lots of ways pragmatic, funding route for most startups. It's exciting, then, to see alternative forms of investment emerge.

When I was still running Known, we applied to (and were rejected) by, an off-shoot of O'Reilly Alpha Tech Ventures, which was the first firm to really publicize revenue-based models. Bryce Roberts gave a talk at IDEO in San Francisco, and I was enamored. Whereas VC prioritizes growth, makes money when startups make revenue. Its deal documents are publicly available on GitHub: the short version is that at a pre-arranged time after investment, the startup buys back an equity option from the investor as a percentage of its revenue. If it chooses to raise VC funds instead of making equity (or decides to sell), the investment converts into a percentage of the company., by its own admission, is designed for post-revenue startups: if you need money to get to that stage, it's not going to help you. As I've already mentioned, most founders need help getting their venture off the ground to begin with. While some can raise money from friends and family, there is inherent privilege here: most people don’t have friends and family with that kind of money available to invest.

The Matter portfolio company Creative Action Network, which had gone through Matter's second class, raised further money by converting to a steward ownership model after years of bootstrapping:

We connected with Purpose Ventures, a new firm based in SF and Germany who liked what we were doing and more importantly, introduced us to a novel model for companies like us who needed capital and wanted to stay independent. The ownership concept is called Steward Ownership, the idea that companies should exist to do something for society beyond maximize shareholder profit — a fairly commonplace notion in Europe (and throughout American history) and that the people making decisions for the company should be the ones running it, not a board made up of outside investors.

Purpose is a little more dogmatic: whereas gives startups the option of following a VC route, steward ownership companies are less likely to follow that path, not least because Purpose requires companies to disallow investors from having controlling rights. The flipside is that it may invest earlier in a business's life, as long as it promises to restructure to follow this model. (Alongside CAN, Purpose Ventures has also invested in Buffer, which is a poster-child for transparency and alternative investment.)

There are two new entrants into this market: TinySeed, an accelerator for bootstrappers, and Earnest Capital, which presents itself as early-stage funding for boostrappers. Of course, by definition, any company taking funding from either won't be bootstrapping, but I like that they exist, and it's a good way to position yourself as being in contrast with VC.

Both have a very similar model to the investor takes a percentage of revenue, but can also retain a percentage of equity in the company in case the founders decide to pursue VC or a sale later on. The result is optionality for the founders, and downside protection for the investor.

Matt Wensing created a financial model for each investor, using a hypothetical software company called Array as a lens:

For the scrappiest founders (with minimal salary requirements), Earnest offers reduced ownership, assuming strong early-stage profitability to enable repayment and a long horizon to enjoy the cap; for suburbanites looking to quit their day jobs, or businesses investing 100% back into growth, TinySeed and are strong options, as their cash draws are simply smaller early on with salary triggers that are higher or non-existent. For TinySeed founders, this will come at the cost of cash in the post-seed, pre-exit phase. Meanwhile, if you plan to raise a single round of capital,’s redemption program provides the lowest long-term equity cost by a wide margin.

I'd be interested in a financial analysis from an investor's perspective. I'm particularly excited about TinySeed, which also provides a year-long remote accelerator, the value of which is not to be sniffed at. But all of these are solid options.

Which brings me back to media. Matter invested in early-stage media startups, but using a venture capital model. I no longer have access to its portfolio data, but I wish I could run an analysis to see what effect a TinySeed-like model would have had on fund profitability. Of course, it would have made different decisions, too: it likely would have chosen its ventures using a stronger revenue lens, testing for bootstrapper mindsets. Whereas media is not necessarily a strong venture capital market - mostly because many VCs have lost interest - I think there's real potential for investors to make money from revenue-driven media startups using a revenue share model.

We won't know for sure until more investors embrace alternative models, experiment with new kinds of deals, and empower a wholly different set of entrepreneurs. That'll take time, analysis, and not a small amount of failure while the ideas are honed and processes optimized.

And that's another reason why those Zebras are so important. They've convened a space for this conversation to happen, for information to be shared, and for new investors and founding teams to rise from the ashes of discarded old models. I'm very grateful they exist. They have the potential to change the way the tech industry is funded. And through that, how the world creates, discovers, and shares information.

Things are changing, and a growing number of founders and investors are here for it. I certainly am.


Photo by Lisa H on Unsplash