Investing in Sharing
No hockey stick, no problem
This week in San Francisco, more than 2,000 impact investors will come to town for the annual Social Capital Markets Conference. The team at SOCAP invited me to moderate a panel on alternative financing mechanisms for sharing economy companies, and it got me thinking. While the sharing economy is driving forward innovative business models around shared assets, the way we finance these companies is still relatively traditional. For many sharing and good economy start-ups the traditional exit model is not feasible or simply not desirable. New models are needed.
Too often funding panels host a slate of VCs talking about the financing landscape to a room full of starry-eyed (pre)-seed-stage entrepreneurs. And while it’s awesome to know what might lie ahead when your company is ready to fend off competing VCs during an oversubscribed A round, it’s more likely that what you’re looking for is some individual or institution to take an early risk on a not-quite-proven idea, and you have no idea where to go for money. So my goal with this conversation at #SOCAP14 is to offer a basic primer on some innovative financing models available to entrepreneurs and investors who want to do things differently.
Interestingly, for all their disruption, a lot of the first wave of sharing economy companies have been financed in pretty traditional ways. As Jeremiah Owyang notes in this roundup of 2014 funding rounds in collaborative economy companies, VC money is pouring into this space. Airbnb, Uber and even Zipcar have raised significant financing rounds from fairly conventional sources and through relatively traditional financing structures. After all, venture capital is only one form of available risk capital, and it is actually fairly constrained. Ultimately VCs are under pressure to return money to their limited partners.
But, the sharing economy is defined by people searching for new models. Not all sharing companies need or want venture money; not all sharing companies are aiming for hockey stick growth. There are new and creative ways to invest in sharing that ought to be named and amplified. While there are certainly challenges in experimenting with these new structures, we’re smart people, and I’m confident we can figure out how to address them.
Thinking Outside the Funding Box
If you’re an entrepreneur, I’d suggest you start by reading this post from Hallie Montoya-Tansey (Co-founder, The Target Labs) about the search for capital outside the Silicon Valley funding box. It’s an excellent primer for anyone starting out on the fundraising roller coaster. In chronicling her search for non-traditional ways to structure an early stage startup investment, Hallie references Ross Baird’s write up on the challenges of impact investing, which itself is a response to some really interesting ideas from Paul Hudnut on liquidity in the impact space.
So, the need is growing, but what are some specific examples of these alternative financing mechanisms? Is anyone actually using them? Do we know they work? Here are some quick examples of new (and not-so-new) structures to help support growth and align incentives between founders and investors.
Creative Financing Mechanisms
- Revenue-based Financing Examples: Lighter Capital and Fledge
The basic idea here is that investment comes in the form of a loan repaid from a startup’s revenue. Read this post on investing without exits from Fledge Managing Director Michael “Luni” Libes to learn more. Revenue redemption (example: Community Sourced Capital) allows investors to purchase equity, and the company agrees to repurchase shares out of a percentage of revenue. David Bangs over at Energy Friendly Ventures put together this great deck outlining pros/cons.
- Direct Public Offering Example: People’s Community Market
A DPO allows companies to raise money directly from community investors. Jenny Kassan and the team over at Cutting Edge Capital have a ton of resources on DPOs and how to decide whether they’re right for you.
- Crowdfunding Example: CircleUp
The equity crowdfunding space has been heating up the last couple of years, and there are a number of platforms that provide accredited investors access to early-stage investment opportunities. Circle Up has a mini-fund (called a Circle) focused exclusively on B Corps raising financing.
New (and Not So New) Structures
- Benefit Corporation Examples: Ethical Electric and Yerdle
A benefit corporation is a new class of corporation that voluntarily meets higher standards of corporate purpose, accountability, and transparency. (Not to be confused with B Corp, which is a certification conferred by the nonprofit B Lab.)
- Coop/(T-Corps) Example: Namaste Solar
T-Corps (aka cooperatives) have been around forever. Cooperatives are community organizations and business that are owned and managed by the people who use their services or by the people who work there. The Sustainable Economies Law Center and its founder Janelle Orsi are a wealth of information on cooperative models.
- ESOP (Employee Stock Ownership Plan) Example: New Belgium Brewery
The National Center for Employee Ownership is a great starting place to learn about these employee benefit programs - often used to buy shares of a departing founder and to reward and incentivize employees.
Challenges with New Models
As you can imagine, these structures are not without their challenges:
- Why would an investor go for some of these alternative loan structures? Essentially, you’re still asking them to take an enormous risk, but in some cases you’re capping their upside.
- What are the exit strategies here? Who creates the value? Who captures the value? Should a “sharing” company IPO? (Microfinance went through a similar identity crisis back in 2007 with the IPO of Compartamos).
- Sometimes new financing mechanisms make the cap table messy and especially make it difficult to raise follow-on financing from more traditional sources.
- Traditional investors are used to Delaware C corps. It’s a chicken or the egg problem. It may take awhile before we find more firms willing to take the risk on an entity like the benefit corporation without more examples of successful investments into benefit corporations.
- With all this talk of financing, what about impact? Do these new models increase the likelihood that a startup will achieve its intended social impact?
To be clear, there is still a whole lot of demand for traditional investment. The analysis mentioned earlier from Jeremiah Owyang tracks $2.45 billion in investment into this space in the first half of the year alone. And at New Media Ventures, we have been using pretty traditional financing mechanisms even as we support startups that we think are truly gamechanging. There are plenty of examples of more traditional deals working out.
But so many of the questions I get asked by both entrepreneurs and investors are about alternative mechanisms. And I’ve seen fewer specific examples available to the entrepreneur who wants to say, “We may not have a traditional exit, but there will be a recapitalization at some point that will return money to you as an early investor.”
In addition to the examples above, there is Union Square Ventures’ investment in Kickstarter, which has publicly stated its intentions to not IPO. Both Ethical Electric and Yerdle have raised recent, significant financing rounds as benefit corporations. The co-founder of Plum Organics (acquired by Campbell Soup Company) highlights that company’s status as a benefit corporation as “just good business sense”. We need more examples of investors who have been willing to take a shot on financing these companies over the course of multiple rounds. I suspect these examples are out there, and I hope people share them.
The sharing economy has attracted some of the most passionate and creative entrepreneurs I’ve met. Let’s meet them with equally creative financing mechanisms that support the kind of growth they want. Join us at #SOCAP14 to continue the conversation.