From his perch as founder of Fledge, a network of social impact accelerators, Luni Libes has claimed the role of industry provocateur, critiquing the prevailing Silicon Valley model of investment and agitating for more aligned funding models. In particular, he’s an advocate for revenue-based funding, whether via loans or redeemable equity, where startups buy back their shares over time in a way that generates an agreed upon return on investment—the model used by Fledge. His revenue-sharing workshops at SOCAP draw standing room crowds (here’s a video version). In this guest post, Libes shares his thoughts on unicorpses, venture capital and the gospel of revenue sharing.
I’ve pitched dozens of California and Washington venture capitalists, and all of them were wearing shirts, pants, and shoes, but just as the folktale king wrapped himself in invisible clothes, the venture capitalists (and the Angels who follow their lead) wrap themselves in mostly useless structures that serve neither themselves, their partners, nor the vast majority of companies that are seeking capital.
The problem is that the “preferred equity” used by startup investors only works for 0.01% of startups. It works spectacularly well for that tiny percentage of startups. Some of them are household names: Apple, Amazon, Microsoft, Google, Facebook, and Intel. What you can’t name are the 87% of companies that receive funding from venture capitalists which fail, and the millions of other companies that the venture capitalists and Angels passed on investing because they were “uninvestable.”
Most of those are far from uninvestable. Most of those would make investors a healthy return, if only those investors would take a look at their clothes and take a moment to question why they chose that particular style of investing when it doesn’t work for 99.9% of startups.
This blindly following what the last investor did has a name. It’s called a paradigm. Looking around and noticing the truth has a name, too—it’s called a paradigm shift.
Few people I talk to know that venture capital, as practiced today, is a new concept. They assume it’s been around forever. Venture capital started in the 1970’s, but was a tiny industry until the 1980’s. This is an industry born in my own lifetime! It really only grew into a multi-billion dollar industry in the early 90’s, a few years before the dot-com bubble made venture capital front page news.
Given an outsized percentage of venture capital happens in San Francisco and Silicon Valley, the details chosen by those investors set the norms for the whole industry. The “California Capitalism” paradigm focused on exits—meaning a big IPO or acquisition that nets investors 10x or more returns—is so pervasive that few investors bother to consider alternatives. They don’t see that their investment thesis is a choice, not a law of nature. Or that their investment structures cause the low returns of the industry—that they are optimizing the system for the least likely case.
It’s frustrating to see all the naked emperor investors, and especially hearing their woes about have no more money to invest, as it is all tied up waiting around for exits. My solace is the knowledge that broken paradigms eventually shift, after enough evidence piles up that they are broken. The coming unicorpses are hopefully enough to start that shift.
Meanwhile, a few dozen of us have already shifted to a new way, one that aligns in the interests of investors and founders, based not on exists but on revenues. With revenue-based investment models, returns are based on companies earning revenues, not on high growth rates, winner-take all markets, and most of all not on fleeting valuations of acquisitions.
Revenue-based loans, redeemable equity, and other structures are in use today. They are proving that far more companies are investable than most investors think, and are quietly making money for the few investors that are willing to take a risk not only on startups, but on innovating startup investing. More will inevitably follow.