October 30, 2018

Help us design funding for bootstrappers and Indie Hackers

This is a post about the technical decisions we’ve made on a new “funding structure for bootstrappers” and a call for feedback from the founder community. https://earnestcapital.co/funding-for-bootstrappers/


  1. 11

    @tylertringas well done for putting this out there!

    Really exciting to see you joining @robwalling and a few others who are dipping their toes into the water to solve this problem/plug this gaping hole in the funding market.

    Having raised a few 'normal' rounds of angel/micro-vc money before, here are my thoughts/questions/opinions after reading your blog post and the draft term sheet...

    • Lose the fee reimbursement (eg by tweaking the other terms slightly more in your favour to account for the expected legal costs).

    • Information Rights (the part of the term sheet where you can verify if you're being paid the correct amount) --> who pays any extra costs resulting from this? In the case of a dispute, who arbitrates and who pays the cost of the dispute?

    • I'm surprised there isn't a discount for paying you (the investor) back early. Eg a normal return cap of 4x, reduced to 3x if paid back within two years, and 2x if paid back within 12 months... Any thoughts on that?

    • Say you invest in a company which has two equal cofounders. One cofounder wants out after two years, and wants to sell their stake in the company to their cofounder/anyone else. How do you account for that? Seems like they'd be stuck given the current terms.

    • Maybe a slightly silly one, but who exactly qualifies as a founder?

    • In general, as a founder I'd want to see some deadlines/time limits set for decisions regarding equity conversion.

    All in all, this seems super exciting. Looking forward to seeing how it works out. Good luck!

    1. 3

      I'd like to echo and agree with a few thoughts Louis mentioned:

      • agree re: the fee reimbursement.

      • Also, I agree about the discount for early repayment. As a solo-founder, if things go extremely well and we can return the capital much faster than expected, you see a return on your investment and we can continue on growing the company. That's a win-win. Ideally, over this time period, we realize that working with you and the Earnest capital "mentor network" is a value-add, so this wouldn't necessarily be the end of the relationship.

      ---------------------------------------------------

      A few more thoughts:

      1. If the mentor network is valuable, that's worth some equity in the company. I'm already doing this for formal advisors.

      2. I'm not opposed to giving up a piece of my company, but I am opposed to having someone dictate how I want to grow the business, which typically happens with venture-funded companies (at least all the ones I've been a part of, even when the terms are great).

      3. Love the focus on profit-sharing. That's a great way to ensure the investor(s) are returned their capital vs. pushing for a liquidity event quickly. With that being said, I'm still a little vague on how the terms would accomodate a situation where the business takes off (but no follow-on capital is raised). For example, what happens if $1 could be reinvested back into the business and produce $3 vs. profit-sharing @ $1?

      1. 1

        Great points. In general, my goal with this structure was to be as aligned as possible with the founders' decision on what was best for the business and for our incentives to provide intuitive decision-making at each stage of the business. Specifically, if the business is at a stage where the best thing to do is rapidly reinvest all profits into growth, and the founders are financially fine living off a modest salary only, then great... don't pay us any profit-share and grow the business. Either the business will eventually become profitable and then rapidly pay us back, or it will sell or raise follow-on financing and we'll convert to equity.

    2. 2

      Great suggestions/questions!

      • Information rights: we would actually like to turn this into a resource for our portfolio by working out a deal for good, discounted 3rd-party bookkeeping services that can also handle the calculations for our investment. Agree there are a few specifics to iron out.

      • Had not considered a discount for accelerated payments. It's worth exploring but would depend on the discount rate used so I don't it would decrease as steeply as your examples, but it's an interesting idea. The primary reason not to add it would be that at some point you just have to draw a line on not adding any further complexity in the agreement.

      • If one cofounder wanted to leave but the other continued to run the business then there wouldn't really be an impact on this investment structure. The sale of stock might trigger the equity option.

      Will need some time to think through some of these other questions. Thanks!

      1. 2

        we would actually like to turn this into a resource for our portfolio by working out a deal for good, discounted 3rd-party bookkeeping services that can also handle the calculations for our investment.

        That would be great. Investors handling this sort of thing for first time founders is a great way to clear they path for them to focus on the important things.

        Had not considered a discount for accelerated payments. It's worth exploring but would depend on the discount rate used so I don't it would decrease as steeply as your examples, but it's an interesting idea. The primary reason not to add it would be that at some point you just have to draw a line on not adding any further complexity in the agreement.

        Agree regarding complexity (and my example discount was probably too steep). I like it because it aligns investor/founder on getting to profitability soon.

        Good luck!

  2. 3

    This is great Tyler. I think you hit the nail on the head, and you're considering all the interesting second order effects from this kind of financing structure.

    I will be curious what ends up being the dominant repayment mechanism, % of profits, or % of revenues, or some more complex formula. I think you're very smart to leave that open.

    Big fan of what you're doing with Earnest - the world really needs more useful ways of funding good businesses!

    1. 1

      Thanks! It's a good question. % profits (or "founder earnings" as we call it) is certainly more founder-aligned: basically we get paid when you get paid more or less. Revenue-based is better for investors but you can easily imagine scenarios where it's not good fit for the business to start pulling out cash based on revenues not profits. I'm definitely open to both though and we'll have to test it out.

  3. 2

    Most businesses don't succeed or make any revenue, what is your expectations with this in mind?

    What amount of funding will you provide founders with what expectation?

    For example, I'm an indie hacker and I would love to be funded by something like this. I'm building a web app that might generate revenue might not. If I were to get funding I'd want something like $2000 usd /month salary and live in Bangkok or another SEA city to reduce my living expenses while grinding away at my web app. 6 - 10 months of this would be like $12,000 - $20,000 just for my living which probably isn't a lot for company investment.

    Then 6 - 10 months of me grinding away at my web app, I'd probably have something significant by the end of it.

    I could also use some cash to spend on marketing or hiring help.

    And what kind of startups are you looking to invest in? Web apps? b2b? b2c? Saas? Tech companies? Service industry? Anything in particular?

  4. 2

    Tyler - this is great. Especially since you're leveraging a lot of the indie.vc work.

    As a founder of a startup with early traction ($500 MRR and a couple thousand customers), raising a VC-style seed round doesn't align.

    I'll send you an email to learn more, if that's alright.

    Mark

    1. 1

      Please do.

      1. 1

        Done!

  5. 2

    One of the most exciting aspects of shifts to funding models like this is that the kinds of companies that are good fits will be massively larger than the sets funded now. Not just bootstrapped tech companies - that's a huge category on its own for sure.

    But there's no reason why this model couldn't be successfully applied to artists, musicians, retail, online personalities, or other categories that are traditionally a no-go for VC.

    Have you thought about those businesses in relation to this?

    1. 2

      Great point. SaaS is definitely our wheelhouse but yes, I can imagine this applying to all kinds of businesses. Paid or patreon-based content is a good example. You can imagine this kind of funding backing the next stratechery.com or waitbutwhy.com - what do you think @afinn?

      1. 1

        I had that exact same thought this am! Very similar dynamics...content businesses can be built with one person, now have the ability to make revenue recurring via Patreon, and take a couple years of focused work to really get traction.

      2. 1

        Those are great examples. There is still a massive lack of funding available to creators like that. Attempts to get around that issue have mostly been mixed - like creators trying to create a traditional venture-acceptable business off of their fanbase. Much better to give them the opportunity to double down on what they're already doing best.

        Can't wait to see where this goes!

  6. 1

    I really like this approach and the potential for this. I've been working on something similar in Canada called Manual.vc.

    Here is what I would suggest:

    1. I like the profit sharing approach, but rather than set "hard" repayments amounts (ex: 4x investment), tie it to IRR. If you set a 30% IRR on the investment then it ties the payment to growth rate (time) rather than just $ amount.

    2. 40% is too high. I think you could set thresholds (as you did re founder salary) or tie it to revenue (example: 8% of rev once profitable).

    3. I think there should be a lower % post-payback of the initial amount plus IRR. This is the risk premium and can balance a portfolio. Maybe a 2-5% royalty in perpetuity.

  7. 1

    I'd echo some of what others have posted above. Seems there could be 2 workable structures here.

    ~4X-ish Return Cap for participating at the bottom of the P&L stack (i.e., profits) and ~3X-ish for participating at the top of the P&L stack (i.e., revenue). I believe 3X is market for "royalty"-style financing from the likes of Lighter Capital and others (although I could be wrong about that. Of course, they don't invest as early as you're proposing, and prefer to participate either alongside VCs or in deals that are definitely on the VC path, so perhaps that comparison doesn't hold).

    Definitely agree with others re: discount for early repayment. Else it seems like a hefty penalty for early success.

    Q: For conversion based on unpaid Return Cap, the first thought that occurs as a founder is that it's a steep cost of capital. In that scenario, I'd raise some straight bridge debt or convertible to pay off the Return Cap, and then raise the next equity round. That should effectively enable me to end-around that term, no? Or did I misunderstand something? It essentially brings back the conversion/dilution optionality to the founder instead of you. How would you prevent something like that?

  8. 1

    @tylertringas Been your fan since 2016 when I subscribed for your book's chapters. And this offer is right on spot for us! My cofounder is opposed to going the VC way exactly for the reasons you outline in your post, and I'm insisting that we need funding to go further. What you're offering is the best of both worlds, we'll definitely be applying!

    Are you going to restrict your offer to U.S.? (We are in the EU, and it's much harder to get seed investments here)

    Any chance you start this within a few months?

  9. 1

    Wow, I almost missed this post! Ironically because I was so focused on thinking about how to fund my journey! as I too have been walking the same path as you did based off your post in that I have gotten myself in to debt (bank debt) to fund my journey thus far. It is not a model that I recommend and it is not a model that is suited to beginning founders!

    I have honestly spent the last 48 hours plotting how to set up a financial model that works for me as a founder and for those who may want to invest in "ME". The important aspect I realised quickly is that I want people to invest in me, not a specific business I might create. Because there will be failures, they are inevitable! I found websites such as upstart and paved which in theory look good but still lacked what I was after.

    I hummed and harred and edited a google spreadsheet continuously for hours on end working out how this works best and how to make it a win-win. Turns out I was working towards exactly what you were proposing in your term sheet, albeit a lot less technical. I'm more than happy to give up profit in order to reach my goals sustainably! 100%.

    I'm not greedy and I'm not a huge believer in building a unicorn, the idea of a unicorn sounds great but the realities of building one do not align with me.

    These are very exciting times and I have been waiting for a wagon like this to arrive for many years. It's great to see the wagon being built and built publicly too!

    My words cannot describe the excitement I have for this project Tyler and I want to be a part of it in any way I can. Both as a potential fundee, a mentor or community supporter and eventually a funder.

    I would love to keep in touch about this. Where can I do so?

  10. 1

    @tylertringas - what are your thoughts on solo founders?

    1. 1

      solo founders are great 👍

  11. 1

    Does corporate structure matter under this model? (We're currently an LLC.)

    Really excited to see more VCs innovating in this space. Thank you for this. Cheers.

  12. 1

    Will u invest remote ?

    This is obviously difficult for presentation-stage.

    But what about a working SaaS webapp, couple of month revenue history, proficient founders, want to start scaling.

    1. 2

      Yes! Earnest is remote-first and we are very focused on backing remote companies.

      1. 1

        This comment was deleted 3 months ago.

  13. 1

    Interesting approach. When looking into the VCs, there's an additional constraint bootstrappers like myself might have. It's the need to report to the investors. The way it's usually done takes too much time and effort.

    Obviously investors need to know what's happening with their investments. Someone could come up with an easier way/method to make sure investors have enough visibility/transparency into the company they are investing in, without taking too much time from founders. Especially early in the life of the company.

    I hope I did make sense!

    Cheers~.

  14. 1

    @tylertringas Holy shit do I need this, please make it happen. P.S Where can I apply?

  15. 1

    Excellent and well thought out approach with much to chew on that might be specific to stage and type of business.

    While we have a SaaS model, our market is education where the sales cycle can be very slow, but once adopted, churn is very low. This has put us outside the conversation of most traditional capital, even with early traction. Add wanting to create a longstanding impactful (and profitable) business and not an M&A target and the conversations get even harder.

    To your question of Return Cap, we are more interested in value capital rather than just dollars, so repayment + some stake in the company long term would be more attractive.

    The clarity on "founder earnings" vs profit is key—in the end you want to optimize for more of a partnership on both sides of the coin, where everyone is rewarded for the growth and success, but the company has what is needed to grow.

    The conversion on additional financing seems reasonable and even though this feels more complex than a SAFE or convertible debt round, it takes a wider scope that has a lot of potential. I would like to email you directly for more information.

    1. 1

      Great feedback. Please do shoot me an email.

  16. 1

    Looks great and always good to see more done for bootstrappers. One question: Is this like "revenue based financing" where the amount of capital provided will depend on MRR etc ?. If not, how do you determine the amount of capital that will be invested in a company ?

    1. 1

      It's not revenue-based financing. Closer to early-stage seed capital. Amount of capital depends on what the founder's need and what we feel makes sense depending on how far along the business is.

  17. 1

    Tyler - interesting concept, looks well executed! couple questions/thoughts:

    1. What is the fund size, expected investment horizon (3 years, 12 years, etc?), avg. check size, expected # of checks written out of fund?

    2. Highly encourage a discount if paid back earlier (I'd take a look at typical RBF models, like LigherCap, Notley, etc)

    3. Different from the other posters, the legal stuff doesn't worry me as it has a cap and you're paying me anyways....

    4. Money/Equity should have a time-limit conversion cap on it - after x year or y rev. threshold - perhaps modeled off employee vesting?

    5. As an earnest founder (who did their hw), what would be ideal for me is access to short-term funding with payback options that cover the minimum, expected, and rocket-ship outcomes. This is similar to a funding round, and the "plans" you have based on how much you are able to raise.

  18. 1

    This is a bit tangential, but I'm not in need of capital, just mentorship and networking. I'm not sure how the math works out for investors, but I'd be interested in a scheme like this with a lower Return Cap and no capital. Like a clarity.fm with a longer relationship and deeper involvement.

    1. 2

      This is a great idea in theory, but I think in practice it's hard to implement in an organized way. The way to do this would be to just give advisory equity/profit-share to an individual person you wanted to advise your business I think.

      1. 1

        Makes sense :) thanks.

  19. 1

    @tylertringas - great to see new ideas for this case. it looks like the investors choice to convert to equity conversion is not constrained. assuming the company doesn't want to be bought-out while it's growing but before it's at a good valuation, is the only protection for the company to avoid a financing round? it may be useful to add something there if so to make things more reasonable, eg. if all agree a cash boost (from another raise) makes sense.

    1. 1

      it may be nice to have an explicit switch into growth mode (maybe that could make the payout balance turn into something like a convertible note), this way new investors aren't worried about the burden of cash payouts going to non-growth, and investors under this original agreement get to take advantage of growth if things truly are promising.

    2. 1

      The way we've structured it, the option to convert to equity is open if the company (a) raises a round of financing or (b) sells the company. Basically, we would just participate in the financing round. Can you elaborate a little bit more on your concern, I want to make sure I understand.

      1. 1

        sorry, didn't see your reply. not sure if i have this thought through correctly. but yeah, i guess i imagine a scenario where taking 300K, owing 4X that, getting to steady growth state and wanting to raise, it seems like the investor could easily get an unfair amount of cheap equity, compared to using a convertible note from the start w/ interest. this could disincentive would-be investors who are hoping for a larger stake.

  20. 1

    What will be the penalty for 'failure' (if any)? Also what about if the founder wants to walk away/fold the business? Not trying to focus on the negative, but more often than not there will be failure before success.

    1. 1

      Good question. If the business fails, that's part of what you expect when investing/launching early-stage businesses. This is not debt and it's definitely not personally guaranteed by the founders. If the business was still running and had revenue, but the founder wanted to walk away for some reason, we would just have to work something out (quite a few possibilities here).

  21. 1

    @tylertringas What do you think of a PE model where you buy, operate, flip these businesses? Seems like an easy way to not convolute you and the founder's incentives.

    Don't you think cash flow arbitrage for small indie businesses is dramatically weaker than high growth equity arbitrage (sv vc)? Or is your longer term bet that that's going to eventually flip?

    1. 1

      "buy and operate" is definitely a good business and is what my partner on this does at sureswiftcapital.com (not sure about flipping). In my opinion it's a model for mature businesses though and I'm focused on working with founders at the early-stage.

  22. 1

    TL;DR?

    1. 1

      No, you have to read it all 😉

      "The short version is that we will invest in companies with early-stage capital and provide mentorship from the awesome roster of investors in Earnest. We will primarily be seeking to be paid back through cash dividends—a form of profit-sharing—when your business becomes profitable. We don’t take any equity or control in your business. The option to reinvest profits for growth, raise further financing, or sell the business, will all still be on the table. This is an investment structure by founders for founders on the terms we would have taken had they been available when were bootstrapping."

      1. 1

        Hi Tyler. Was skimming the post, but couldn't get a sense of how much a typical funding amount might be? 100k? 200k? 500k?

  23. 1

    I've just skimmed through the article, so don't have any specific thoughts right now, but I just want to say thanks for pushing this narrative. It's awesome to see all the recent experimentation with funding for bootstrappers.

    1. 1

      🙏Agreed.

  24. 1

    Tyler - congrats on launching Earnest! We're seeing more nuanced and aligned capital coming in to support early-stage Founders that are not VC-manic. Would be happy to discuss about how we can align and build a bigger/broader tent of support.

    • Brian
    1. 2

      Thanks Brian. Definitely!