Photo by Erol Ahmed on Unsplash

Alternative Funding Calculus: A Quant Comparison of Tiny, Indie, and Earnest

Previously, I described the new wave of funding sources that are emerging for bootstrappers. Today, we’ll place a fictional startup named “Array” under the microscope, consider a fundraising strategy, and compare the financial outcomes of raising money from three alternative funds based on publicly-available term sheets.

Imagine you have your very own startup: Array, a video conferencing tool for distributed teams. You have a real passion for the problem because you (like every other human), knows that every existing web conferencing solution sucks. Even better, you’ve already solved the real crux of it, which required rewriting part of the standard WebRTC library using C++. That means this idea is way out-of-bounds for most web dev kids-these-days. Which is nice, because you’re not interested in going faster than you want.

So you have a real product with a technical moat. What else is great about Array? Let us count the ways.

You’re so stoked about the design and UI/UX breakthroughs that you plan to charge a premium for the service compared to other solutions like GoToMeeting. $299/mo per team (up to 10 users) has a nice ring to it. That said, you don’t plan to sell to enterprises because they will ask for things you don’t want to do, and for you, custom is loathsome.

You and your co-founder are both technical, but you don’t consider marketing a dirty word, so you spend a fair amount of time shielding your brilliant Woz from any such distractions.

Product? Check. Positioning? Check. Team? Check.


Early response to Array has been positive. You have almost 200 prospects visiting your site each month and signing up for your newsletter. Early access customers (who are enjoying a free trial) have written testimonials for your next home page. And you just wrote a killer content marketing piece that succinctly explains in 8 hand-crafted pages why distributed teams are the future because distributed teams of futurists literally distribute the future more evenly. And your, product, does, that. Wow! People love it.

Life is good, but given that your goal is to become free to focus full-time on this venture, you feel a bit stuck — Array isn’t earning the $200k-$300k per year (ARR) it would cost to feed, clothe, and shelter you and your co-founder and your families. So you’re giving some of the new, bootstrapper-friendly funding options like Tiny Seed, Indie.vc, and Earnest Capital some serious thought.

But before you engage, you wonder — what will it really cost you, and what will it take to break free? Are you better off bootstrapping? Would one set of terms work better for you than another set? Knowing there’s always some amount of give and take, what terms deserve your focus?


To decide on the best form of funding for Array, you consider two factors: your speed to market, and your profitability.

Speed analysis: Taking money would allow you to go faster, no question. On the other hand, you’re not sure you have to go faster to achieve your dreams. Your arcane, low-level moat is wide enough that an upstart can’t easily come along and steal the opportunity. That said, a large, innovative incumbent like Slack — whose video tools are used widely within the kinds of organizations you’re targeting, might have the chops and means to launch something killer if they take the initiative.

Speed verdict: We may have a strong defense from weekend upstarts, but we should move into the market with Array before an incumbent includes this as a killer feature in their in-market platform.

Second, you consider profitability. If you were intent on pushing the incumbents out of existence, you’d need to spend a boatload of cash of marketing and PR at scale. This would keep profits thin until you were dominant. You’d also need a more powerful competitive advantage — something that attracted users by the millions and took them away from the incumbent services. Something more powerful than a better experience, perhaps? You’re not sure what that is, but is it possible? Sure, maybe. And if so, a larger product team with a growth hacker or two sprinkled in, would be necessary … and expensive.

On the other hand, the nature of this market isn’t winner-takes-all, at least not now. Should you spend millions trying to make it that way? You could, but do you have to, to achieve your dreams? Could you build something exciting that was profitable instead of acquiring customers at the highest possible rate? Could you balance these and be content?

Profit verdict: Your software is going to be at a premium price point, which means your unit economics will be healthy if you’re successful. With this assumption, and the speed verdict (you don’t have to go ludicrous speed), you decide that taking a modest profit — not investing every dime back into the business to grow as fast as possible, could make sense.


With this strategy in mind, you compare funding options by creating a 3-year growth forecast using your current monthly mailing list signups (150), estimated conversion rate (5–10%), team size (2), current MRR ($2,400), and target price points ($99-$499/mo, billed annually 20% of the time, 80% monthly). Rather than open Google Sheets or Excel, you use SimSaaS to do the heavy lifting.

The first question you want to answer is how much cash you should raise. You set “Bootstrapping” as your funding model, which will assume you only have your current cash balance of $10,000 to work with.

Your 36-month cash forecast based on those inputs:

This forecast contains 10 runs, representing a range (ensemble) of market timings and momentum (because things never go according to plan). The 3 runs in this image represent a healthy good-better-best spread. [1]

To interpret this chart: if you and your co-founder were to go full-time next month at $100,000 pre-tax salaries, your bank account would bottom out at roughly negative $90,000 ($89,469) in approximately 8–10 months.

Your net income, showing strong alignment on break even at the ~8 month mark (assuming your assumptions are correct):

Lastly, revenue:

Not a hockey stick, but you’re just above $1m ARR in the best case scenario — and not doing terribly at $687k ARR in the weakest case. You’ll also have plenty of profit to re-invest in new growth initiatives.

If negative $90,000 is the nadir, raising $120k-$150k from an alternative funding source could make a lot of sense. Let’s compare taking $140k from each:

Source: SimSaaS

TinySeed

Even though more cash should allow you to grow faster (more leads), you decide to stay conservative and keep all of your growth assumptions the same, selecting TinySeed first and punching in $140k for 12% ownership, which also makes them eligible to receive dividends. If, for example, you chose to pay $100,000 out as a dividend (better than income for tax purposes), you would receive $88,000 and TinySeed would receive the difference of $12,000.

Assuming you don’t pay dividends until you reach profitability, and assuming that you only pay dividends when you have more than 3 months in expenses, the future looks like this:

This is nice.

Using the above strategy — keeping the business well-fed with 3 mos of cash (even while profitable and gaining steam) but paying dividends when possible, you have paid $583k out to you and your teammates while sending $79k to TinySeed, which is 56.7% of their original investment. This $79,502 will be subtracted from their share of any liquidity event.

Here’s how those payments appear alongside your net income:

Well-timed dividend payments (to TinySeed) in green.

Earnest Capital

Great. So far so good. You run it again, using Earnest Capital as the funding source, like so:

Using the same logic for paying dividends, the box score results are:

This is nice too … but maybe a different kind of nice?

You now realize that, although launching at the same time and appealing to a very similar audience, are not simply two species of the same fruit.

Painting by numbers:

  • Your payments to Earnest are $226k vs. $79k to TinySeed.
  • The balance of the 3x Return Cap ($140k x 3 = $420k) is $193k.
  • Team dividends are in a different ballpark — $312k (Earnest) vs. $583k (TinySeed).
  • Earnest has an ‘Equity Basis’ of $193,081.
  • Payments to Earnest have reduced their convertible ownership to 6.4%.

At the end of the forecast, their ownership is nearly half of TinySeed’s (12%). This trend means a larger exit for you, should you sell the business. How far will it shrink? Based on their terms, their stake would have a floor of $140,000 (their initial investment amount) divided by the Valuation Cap in their term sheet. In the 6.4% we are using $3m (the amount in their vanilla template); $140k as a floor for their Equity Basis would give them an eventual, residual stake of 4.6% after paying an additional $193k.

Is it worth it? Comparing the $79k to TinySeed vs. $226k to Earnest: this is due to the fact that Earnest is using ‘Founder Earnings’, not dividends, as the shareable event. Anything above a specific and low salary threshold ($45k in their template as of Feb 9, 2019) is eligible as Founder Earnings. Your $100k salaries, while barely competitive in the tech world, are well above that line.

Indie.vc v3

With those trade-offs swimming in your mind, you turn to the Seattle-based pioneers of alternative funding models next: Indie.vc.

You consider raising $140k from Bryce and company, like so:

Playing out the future with the same growth assumptions again, the scoreboard looks like this:

That’s — another kind of different.

Indie has received $130,633 in payments in the best case scenario, while the team has received $422,281. The redemption element of Indie’s terms has shrunk their ownership to 8.6% vs. their original 12%.

And what about those redemption payments? They occur regularly, monthly, after an lapse of time specified on a per-deal basis, commonly 20–24 months post-investment, like so:

Some lumps (dividends), but mostly steady as she goes (5% gross rev share).

Redemption payments may also be made in lumps, hence the decision to pay a dividend to Indie in months 22 and 34. While this removes some cash from the business, it also counts towards the 3x return cap and accelerates Indie’s ownership towards their minimum 1.2% position (10% of 12%).

Decision Time

Few, if any, of the thousands of founders that apply to these funds will have the luxury of choosing among multiple offers, but knowing the trade-offs between these offerings can help you decide what matters most to you.

In terms of equity — if you follow the payment strategy above, Earnest leads the way in terms of retaining the least ownership at 6.4% at the end of three years, but Indie will eventually fall below that, bottoming out at 1.2%. Meanwhile, TinySeed retains their 12%.

If you aren’t profitable enough to follow this payment schedule, things change, however. At a 3x Return Cap and $3m Valuation Cap, the Equity Conversion stake for Earnest begins at 14%, the highest of the three.

In terms of cash, things are reversed: TinySeed is the least expensive option in these first 3 years, receiving the fewest dollars as an investor while you capture more for your team than you would with the terms of Earnest or Indie. Earnest, meanwhile, who has given up the most equity, has captured more cash than either of their counterparts — $226k vs. $79k for TinySeed and $130k for Indie.vc.

Unlike TinySeed, however, both Earnest and Indie.vc have caps on the cash they will receive. This means that the situation flips once the latter’s return caps are reached. TinySeed’s cumulative receipts from their 12% stake will continue to grow while Earnest and Indie’s stay capped. If Array is the next Basecamp, this difference will be measured in the millions of dollars per year. This is a major point. But will the additional payouts in the short-term hinder your ability to become the next Basecamp? Indie.vc navigates this by beginning repayments at 18–36 months. Earnest does not. Moreover, TinySeed will not double-dip: payments made through dividends will be subtracted from their liquidation preference, effectively pre-paying 1x of their liquidity.

So what’s your decision? With valid legal tender and mentorship circles, all three funds are viable vehicles for getting Array where you dream it can go, but the differences are real: Indie.vc allows for a path to maximizing your ownership while delaying repayment, TinySeed requires zero cash repayments at the expense of the most long-term equity and cash in the case of profitable success, while Earnest presents a hybrid that reduces their ownership at the expense of the highest cash outlay in the early years.

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 Indie.vc 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, Indie.vc’s redemption program provides the lowest long-term equity cost by a wide margin.

Your decision is made.


Thanks for reading. If you’d like to run your own startup through SimSaaS, send me a direct message on Twitter and I’ll be happy to send along an invite link.

NOTES:

[1] It’s interesting how the three runs look very similar in the early days; it’s often impossible to know which path you’re on.

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