Venture Credit Unions
The Future of Funding: Part 3
In the previous parts of this series, we discussed the new trends of income share agreements and human capital investing.
Expanding on the ISA model, human capital laudably aims to solve a problem that exists in the gray zone between potential and action. The firms that are attempting this model recognize two things: raising capital can be really difficult (especially for first-time founders), and having early access to funding can grease the wheels of company creation.
To me, the most unnerving aspect of this new fundraising model is that it falls into the wealthy person’s trap of believing that problems can be solved by throwing money at them. If you’re someone who believes that more money in the hands of upstart entrepreneurs will create new businesses, then of course you’ll support a model whereby more money gets into their hands.
But the trouble with this belief is that young entrepreneurs need so much more than just capital. They need connections, mentorship & guidance, technical know-how, legal & accounting support, and (too often neglected) positive encouragement. Yes, entrepreneurs who receive human capital should be excited and proud, but they’d be deluding themselves if they believe that the money is all they need in order to be successful.
If the goal is to assist founders and spur innovation, then the model of human capital is on the right track, but missing the mark.
My suggestion instead is to use a tool that VCs don’t deploy often enough: grants.
Grants can be small, but their impacts can be enormous.
A one-time sum of a few thousand dollars is peanuts to a VC, so it won’t be as capital-intensive as a large human capital investment (thus enabling the VC to allocate more grants and diversify their recipients).
A grant also showcases how founders actually allocate their resources, which can give a VC greater insight into how the founders may run their future startups.
But the best part about a grant is that it’s not even about the capital: the money isn’t as valuable as the display of confidence in the founder, and the founder’s motivation will be more impacted by the show of support than by the money itself.
I’m writing from experience.
Many moons ago, when I was but a wee founder pursuing my first venture, I was way out of my depth. I had come to entrepreneurship relatively late in my college career and I had no idea what I was doing. But I had spirit! I was consumed by the idea I was working on and I was sharing it with anyone who would listen. I eventually got on the phone with 1517, a VC firm that prioritizes community above all else, and they gave me $1,000 with no strings attached to work on the idea. The $1k meant so much to me in those early days, and not because of the money, but because of the positive encouragement and validation. I felt that there was someone who believed in my work , and that meant so much to me. While that startup didn’t succeed, it paved the way to a second incarnation of my company that wound up being a lot more successful. The $1k grant in those early days solidified my belief in myself, and encouragement like that is priceless.
Of course, things don’t always turn out so rosily. Grants are special because there’s no expectation that the founder will return the money, so there’s no ROI for the grant-maker. That means there’s no strong incentive for VCs to give grants in the first place.
However, grants can be combined with another under-utilized tool in the VC arsenal: the negotiable promissory note.
Promissory notes are essentially IOUs, and they can be worded in such a way as to be very flexible and founder friendly. For instance, a VC can give a grant to an early-stage entrepreneur for $1k with the condition that the entrepreneur pay back the VC if the entrepreneur becomes successful.
That’s a simple case, but the magic lies in the fact that there’s lots of room for certain amendable terms. Let’s take a look at more examples:
- A founder takes a grant of $1k from a VC to work on Company X. The terms of the promissory note are such that the founder doesn’t have to pay anything if Company X fails, but if the founder starts Company Y or Z and is raising seed funding, the VC is automatically invited to join the round.
- A founder takes a grant of $1k from a VC with a promissory note whose conditions are graduated: if the founder starts a company that is worth $100k, then the founder must pay back $5k to the VC. If the company is worth $1M, then the founder must pay back $50k. Etc. (These could be flat rates or capped depending on the wealth bracket of the company.)
- A founder takes a grant of $1k from a VC whose promissory note stipulates that repayment is voluntary. The successful founder is urged to pay what she considers fair, and any funds repayed to the VC will be exclusively used to fund new grant recipients. In this way, the founder feels as if she is paying it forward and channeling her good fortune into the encouragement of new ventures.
In these examples, the VCs look less like venture capitalists and more like venture credit unionists. They are evaluating the creditworthiness (or in this case grantworthiness) of a founder based on their own metrics of risk and likelihood for success, but they could still generate a healthy ROI if some of their grant recipients become successful.
Frankly, though, I’m less interested in the financial success of venture capital firms and a lot more interested in how to best support young founders pursuing their dreams.
VC firms have long been considered the quickest avenue to secure the necessary funding for a startup, but the culture of venture capitalism comes with its own problems. Trying to fix VC firms and turn them into credit unions may be a losing battle, and what’s more, it would miss the fundamental flaws of venture capital itself.
Most VCs I’ve met have been nothing but lovely, but I find it a bit perverse that founders see VC money as a ticket to glory, and some venture capitalists see founders as little more than vehicles to make a strong return on their investments. I’ve attended pitch competitions and demo days in which VCs sit on judging panels and are portrayed as the ultimate arbiters of value, and sometimes when I talk to VCs in real life, I feel as if I’m a horse at a race trying to convince them to bet on me.
Honestly, we have to acknowledge that there’s something predatory about the whole arrangement.
If I’m a founder putting in all the hard work of starting and growing a successful company, spending nights and weekends toiling away and pouring my blood, sweat, and tears into the pursuit of my venture, remind me why VCs should become richer without doing any of that hard work? If it’s just because they had access to capital in the first place, then that rankles my inner Marxist, and I suspect it bothers you at least a little bit too.
Maybe it’s time early-stage founders ditch VCs entirely!
In the fourth and final part of this series, we’ll examine how founders can eschew VC funding altogether and rely on communal funding instead.
