Alternatives to Traditional Venture Capital

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importantRaising traditional venture capital, where you raise a pre-seed or seed round followed by a Series A, Series B, and so on, is far from the only path to building and growing a company. You can finance growth with savings and debt (by taking out loans or lines of credit), bootstrap, or crowdfund. Additionally, many alternative fundraising models have emerged in the last two or three years.

Where venture funding dictates that a company “move fast and break things,” choosing to bootstrap, crowdfund, or raise money via alternative investors can give you more control over your growth rate, which can often work in a company’s favor. Patagonia, for example, reported revenue of $800M in 2016, despite having never taken any venture capital funding.* That said, Patagonia took over forty years to grow to that size, and VC dollars work better for companies interested in high compound annual growth rate (CAGR), which translates to achieving high market caps and margins within five to ten years. Stories of other companies that chose to grow slowly can be found in the book Small Giants.

Other recent examples of successful alternative fundraising strategies include Buffer, Wistia, and SparkToro. After raising a total of $3.95M in angel and venture capital investment, Buffer announced in 2018 that they were buying out their investors through profits generated by their business.* Wistia did something similar, raising $17M in debt to buy out existing investors.* Also in 2018, Rand Fishkin, who previously raised $29M in venture capital for his company, Moz, announced that his new company had raised $1.2M on an alternative fundraising structure focused on profit sharing, citing, “There’s no opportunity for a ‘mid-range’ success in venture capital.”*

Alternative Investors

Choosing to fund your startup through alternative means has become something of a movement. Leaders of this movement have gone so far to call its constituent companies “zebras,” goading traditional venture capitalists who are obsessed with so-called unicorns. A new group of alternative investors is emerging who believe they have a venture capital model that will align investors’ interests with founders who want to build a profitable business growing at a sustainable pace, rather than growing as fast and large as possible and ultimately exiting. These investments are typically made after a company has demonstrated that they can bring in revenue, and investors encourage companies to focus on getting profitable quickly, rather than continuing to take on venture dollars until IPO.

Investors interested in innovating the VC model each have their own motivations and specific practices that they believe will be better for founders, and better for the world. A small number of these innovators include Indie.vc, Earnest Capital, Village Capital, and TinySeed. For a solid list of alternative investors, check out this tweetstorm by Matt Hartman.

Bryce Roberts founded one of the first ever institutional seed funds. He pioneered the VC practices of leading early-stage deals and taking an active role on the board. Today, while simultaneously directing venture firms OATV and the fund Indie.vc, Roberts is one of the loudest voices urging founders to be cautious when it comes to taking venture capital. In Meaningful Exits for Founders, Roberts rolls up research that shows how “a founder selling at the Series D price of $210M, would make the same amount of money at exit as they would have if they’d sold for $38M after having only raised a seed round.”

A good example of a contemporary company that raised a small amount of capital before becoming a breakout success is Halo Top.

New investment models also include new focus on who and what is receiving venture investment. Freada Kapor Klein, of Kapor Capital, is a leading voice in innovating venture capital through impact investing. Her criticism of venture capital centers around a belief that venture capitalists can and should do more to fight inequality. Impact investing does not seek to change how venture capitalists make money, but proves that investing in companies that want to do good is good for business. For many VCs, this is something of a reckoning. To learn more about the origins and economic rewards of impact investing, we highly suggest Recode’s 2019 audio interview with Kapor Klein.

Bootstrapping

Definition Bootstrapping describes the challenging experience of starting a company with limited outside resources. If a founder uses their own money, reinvests revenue, takes on personal debt, and brings a business into being, without the help of investors, they can claim to have bootstrapped it.

(You may have heard phrases like pull yourself up by your bootstraps. Ignoring the question of what bootstraps are, Wikipedians agree the phrase generally refers to an “absurdly impossible action.”)

Bootstrapping has a cult-like quality that is well deserved. Take MailChimp, one of the best contemporary examples of a bootstrapped business. MailChimp did $400M in revenue in 2016 without taking a dollar in outside capital.* Unburdened by the demands of investors, MailChimp’s founder, Ben Chestnut—who did a marvelous Creative Mornings talk in 2011, by the way—was free to focus on the customers he believed in.

On top of the decision-making independence, bootstrapping means you don’t have to share the success pie with anyone except the team who helped you cook the damned thing.

There are far more companies that bootstrap than those that raise money from angel investors or venture capitalists, but it’s not for the faint of heart. Lack of money can force founders to rush their way into financing by any available means, and some founders have gone into bankruptcy. The founders of Airbnb, before they took on investors, racked up more than $40K in credit card debt.* It makes for a compelling story now, but they got lucky. Founders can also take out personal loans against assets—mortgaging a house, for example. These options also come with serious risk. If you mortgage your house and spend your kid’s college savings to finance your business and you succeed, the media will call it a daring and brilliant bet. Fail, and you could end up in bankruptcy.

Jason Fried and David Heinemeier Hansson, founders of Basecamp (previously known as 37signals), didn’t outright bootstrap their company, nor did they raise traditional venture capital. Instead, once they were modestly profitable, they sold a minority no-control stake in their business to Jeff Bezos and have not taken outside investment since—Bezos takes his cut of Basecamp’s profits in proportion to his ownership.*

Many businesses successfully bootstrap, patiently learning how to deliver value to a market long enough to have multiple years of demonstrable revenue. At that point, companies can begin to turn to banks for loans to finance their growth.

Crowdfunding

If you decide to go the venture capital route, you’re likely to take money from a handful of investors in each round. Between venture capitalists and angel investors, a startup is generally raising hundreds of thousands to many millions of dollars from very few (usually less than ten, though often more) wealthy people or entities. The opposite of this model is being given a little bit of money by a whole lot of normal individuals.

Definition Some businesses seeking funding in the early stages turn to crowdfunding, a financing strategy that allows a company or a founder to raise money from a large group of people, mostly strangers. Crowdfunding platforms are websites that connect entrepreneurs to large communities of supporters who can donate to a venture securely. In some cases, individuals donate to a company or founder because they believe in their mission. In other cases, the company may offer partial ownership or special privileges like early access to the company’s platform or product, in exchange for an individual’s donation.

Crowdfunding platforms can be divided into three types:

  • Cash donation. In 2013, Patreon launched to give creators a way to get paid by their fans and has since become the most popular cash donation platform. Cash donation platforms fund creators, not individual projects or products.

  • Cash-for-support. These platforms support individual projects or products. They popped up first with Indiegogo and Kickstarter leading the way in 2008 and 2009 respectively. Since its launch, Wefunder has also become popular for this sort of crowdfunding. On these platforms, individuals essentially donate money to the entrepreneur because they want to help them create their product. In most cases, after an individual pledges enough money, the entrepreneurs will promise to send them merchandise in exchange for their support.

  • Cash for equity. In 2010, Naval Ravikant and Babak Nivi, the writers of the popular blog VentureHacks, teamed up with Kevin Laws and Stan Chudnovsky to start the most popular cash-for-equity platform, AngelList. AngelList initially started as a directory of active angels and founders, but has since evolved into a platform for startups to raise capital and recruit talent. Other well-regarded cash-for-equity platforms include CircleUp, FundersClub, Gust, SeedInvest, and Republic; even Indiegogo now allows a company to crowdfund via equity.

A recent study from the University of British Columbia found that crowdfunding helps entrepreneurs learn and make product choices based on the market, and this learning “improves an entrepreneur’s funding outcomes and reduces her likelihood of switching projects.”*

A study of over 50K crowdfunded projects found that firms that are successful at crowdfunding experience a significant increase in their likelihood of obtaining VC funding within two to six months.

caution Not all crowdfunding methods are created equal. Some platforms allow companies to raise money from unaccredited investors (in line with SEC rules on crowdfunding). This can bring far more investors to a company than any of its peer companies have, which could scare away downstream professional investors.

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