How alternative financing models are disrupting the start-up economy

By Gregory Smith

Posted October 22, 2018

Originally posted on Medium.

Greg Smith, Chief Investment Officer, TIMIA Capital

The question on everyone’s mind these days is, “How close is the tech bubble to bursting?” To put it more succinctly, “Who among us is the greater fool?” From the outside, the industry looks stable. Under the covers, most investors follow the same playbook: provide funding to start-ups to drive growth; demonstrate growth to secure more funding; rinse and repeat until the company goes public or bust. Unfortunately, for most start-ups, the latter is more often the case.

According to research by Harvard Business School, at least 75 percent of U.S. venture-backed start-ups fail. To be clear, it’s not the venture capital funding that’s the problem. It’s the expectations that come with it. It can encourage a swing-for-the-fences mentality that causes some companies to take their eye off their raison d’être — value creation — to focus on a level of growth that they are not yet built to sustain. This has the paradoxical effect of driving growth that ultimately results in the demise of the company.

Photo by Sai Kiran Anagani on Unsplash

It’s not just entrepreneurs and early investors that are failed by this system, late investors are also at risk. In fact, many high-profile industry players — Chamath PalihapitiyaSteve BlankMark Cuban, and others — have likened the start-up economy to a multivariate Ponzi scheme.

For the sake of the wider start-up economy, we need to take the focus off the funding and place it back on business value creation, revenue growth, and return on investment.

The trouble with the triple, triple, double, double, double

Every venture capitalist talks about it and every start-up SaaS company aspires to it. The triple, triple, double, double, double (T2D3) is the revered framework for SaaS go-to-market success. It’s based on the premise of getting to $2M in revenue, then tripling to $6M, tripling again to $18M, then doubling to $36M, doubling again to $72M, then doubling yet again to $144M.

While some rare companies survive this incredible growth trajectory, many die trying. Incorrect market sizing, bad unit economics, lack of customer acquisition channels, and organizational scaling challenges are just some of the roadblocks that get in the way of the perfect T2D3.

Thankfully this is not the only route to SaaS success. There are many examples of companies that have grown more modestly in the early days to reap the benefits later in the growth curve than T2D3 yet still delivered up to 10x gains. Eventbrite and Shopify both grew slowly and waited three or four years before their first venture rounds. Eventbrite was valued at $2.8B on its market debut when it went through its IPO in September and Shopify was valued at $2B on its market debut in 2015 — neither of them ever tripled their growth rate but both made substantial gains before seeking early-stage funding.

A more sustainable path to funding your business

Entrepreneurs, by their nature, challenge the status quo. It’s time to challenge the start-up funding playbook i.e. asking friends and family for funding, then raising a seeding round, then raising rounds A, B, C, and so on. The problem with this model is twofold — you’re giving away a piece of your business with every round of funding and you’re being held to unrealistic growth rates as a result. I challenge entrepreneurs to rethink this model and take a path to sustainable growth:

Step 1. Ensure you have a solid product-market fit

Step 2. Get to know your customers and your market

Step 3. Acquire as many customers as you can while meticulously monitoring your key performance indicators

Step 4. Seek out free sources of capital to offset your expenses (government grants, tax credits, employee salary offsets)

Step 5. Consider alternative forms of growth capital to scale faster

Step 6. Go to a venture capitalist

Step 6 is now optional. It’s not the only path forward. If you compound a 20 or 30 percent growth rate over ten years by completing steps 1 through 5, that’s tremendous — and you don’t have to give up any equity to get there.

Revenue financing: A sustainable alternative to venture capital

Revenue financing — also known as revenue-based financing or RBF — is a type of financial capital provided to a start-up in exchange for a percentage of future revenue.

Unlike debt, revenue financing doesn’t restrict operational flexibility. And unlike angel investment or venture capital, the investors don’t take any equity in the business. Instead, the capital loan payments are tied to monthly revenue, increasing in strong revenue months and decreasing in low revenue months until the initial capital amount, plus a multiple, or cap, is repaid.

Revenue financing places the focus back on business fundamentals — customer acquisition costs, cash conversion cycles, customer payback — and away from the ego-driven hype around new funding round press releases. It creates a more sustainable standard, reducing the risk of your startup’s bubble bursting and ensuring there are more winners than losers overall in the start-up ecosystem.

Be up to date with the latest news