I like Jerry's work a lot but come to a different conclusion. My basic thesis is that we're in the deployment age of the internet/web/mobile era and there is a whole new wave of a lot lower risk and a bit less reward opportunities for companies to bring the "peace dividend" of the software areas into markets that are not winner-take-all. The upside is these businesses are much more capital efficient, can scale and potentially produce much higher returns than SMBs from previous eras. The downside is they have no collateral and are thus completely unbankable for traditional small business lending. We need a new default form of capital for entrepreneurs and we are trying to build it: https://tylertringas.com/a-new-default-funding-for-tech-comp...

pre-orders? That gives them cash to build what (pre)buyers showed they really want? It doesn’t have to be Kickstarter, per se, could be an academic grant, or a pilot project with an enterprise customer. I have seen this work well - from idea to V1 product without selling any equity. It’s a very efficient filter.

traditional VC model is great for generating scale and creating barriers to entry/competition, but few businesses warrant that kind of scale and fewer use the capital to create real barriers.

Lending is for cash flow businesses - you can have zero hard collateral (eg PPE) but if you have historical steady cash flows, you can get loans, no problem (in my experience). The problem here is few startups focus on cash generation. They are enamored with growth at all cost, aspiring to the VC model when it isn’t appropriate.

Pre-orders are an awesome way to bootstrap a business.

That's a splendid response, thanks!

Cheers. I love this topic.

The "power law" / all-or-nothing form of VC is really just one flavor of tech investing. It is certainly the most widely discussed, and maybe its the best, i dont know, but there are other successful models.

For ex, many growth equity funds focus on a "doubles and triples" strategy where the risk / return profile is somewhere in between that of a bank loan and VC. They're looking for high probability of 5-7x returns, and low probability of capital loss, for each deal. Theoretically, this "bootstrappers' VC" model can be thought of as a scaled-down growth equity model: revenue-generating businesses in growing markets with potential for near-term profitability

Biotech VC is another good example of a "singles and doubles" strategy generating outperformance. Until the last few years, it was rare for a biotech startup to get to a $1B+ valuation in a 5-7 year venture timeframe, and considered impossible for a biotech startup to become a decacorn in that time period. A successful exit was a ~$500M outcome that returned a 5-10x. These funds have outperformed tech in many cases. See 37:46 here [0]

To build a fund that can return 3x in an environment with constrained exit sizes, you need to focus on consistent doubles and triples: 1) low loss rates, 2) capital efficiency, 3) modest valuations, 4) disciplined investment decisions. I don't know whether the fund math works for this particular "bootstrappers VC" model, but it is certainly possible for a disciplined "doubles and triples" venture fund to perform well

[0] https://lifescivc.com/2019/02/our-year-in-review-annual-talk...

Defer to OP but that feels like bit lazy apologist framework for status quo.

A few (unsubstantiated) guesses at reasons to counter:

1 - Medium risk medium reward opportunities exist (a currently unprofitable but otherwise promising startup addressing a 25m niche can't get bank debt or venture funding)

2 - Could decrease risk holding reward (avg. multiple of investment) constant by having small funds with managers that have deep knowledge of particular niche deploy smaller checks in markets they are better at evaluating (v. large fund managers needing to cast net wider than their "lane")

3 - Size expectation can be correlated with risk. Can decrease risk holding reward (avg multiple of investment) constant by just having smaller funds writing smaller checks for smaller companies that be happy with smaller exits or alt. upside capture (v. forcing companies that could work with small exits into chasing big inflexible exits). Sure no 100x-ers but theoretically could see higher blended fund returns

4 - Opportunities generally continuous on risk and reward calling for equally diverse approaches to capitalization

> 1 - Medium risk medium reward opportunities exist (a currently unprofitable but otherwise promising startup addressing a 25m niche can't get bank debt or venture funding)

I think one of the main arguments in favor of a bimodal distribution of VC and Bank (or high and low risk) funding is that if you are in that middle "medium risk medium reward" zone it can be really difficult to defend your position for any stretch of time. You will be attacked from both bigger players to whom you've proven a market, and smaller players who are willing to take bigger risks to see if they can blow that market up (or bite off a smaller piece of it).

In order to maintain a medium risk medium reward business you need something approaching a monopoly, but also you need the market in which you have a monopoly to be growing and not attracting new players. Maybe some of these exist, but they are very rare and I suspect identifying them is not significantly easier than identifying startups with high growth potential.

So I think skrebbel's question is pretty fair, though I suspect OP has heard it a lot. I would predict that this fund passes on WAY more deals than even a standard VC fund, and will be required to determine the risk of the investment even more effectively. That's a tough problem, and I do really wish them luck!

I've worked at a lender that did loans to small businesses somewhere in between categories 1 and 2.

The major thing that's changed is the availability of data. A $100k loan used to take several hours of expensive analyst time to process manually, and since most would be rejected, it wouldn't be worth it. Now a business can, e.g., securely share real bank account data.

That makes the whole process much faster, which reduces the cost per loan, which makes smaller loans profitable.

I imagine something similar can apply for small business equity.

^^^ Wondering the same. Read the FAQ but still interested in the risk management philosophy.

Also interested how you guys get paid. Did you raise a fund? Are LPs mostly HNWs? Any institutions? Is the investment horizon of the fund similar to a typical VC fund?

And finally, I would imagine your SEA gets negotiated on a deal by deal basis if a portco raises more traditional VC? I'm curious what a series A looks like when there's a SEA in place that hasn't reached its return cap.

Thanks!

It's a fund. Our basic bet is that way fewer companies will fail than a traditional seed VC portfolio (tons of reasons but not forcing them to hit growth targets that they need to show to raise the next round is one). A portfolio of this kind of businesses should be in the top quartile of venture funds (not actually that hard of you look at the numbers) with lower concentration of risk and faster liquidity.

Cool, thanks for the reply. Doesn't look like you have any professional investment management experience. What was the most difficult part of raising the fund? How long did it take?

Full disclosure: I (unsuccessfully) pursued something similar and have exchanged a few emails with Tyler. I’m obviously biased toward being bullish on this as an idea. That’s because:

The usual story and rationale around VC focus and outcomes no longer makes sense (if it ever did). By their own statistics (Cambridge Associates) they’re pretty bad at their job. The power law returns aren’t just applicable to the companies they invest in but to the funds themselves. Mobile atm so I don’t have all the research to hand but up to circa 2011, it is something like 90-95% of funds did not even manage to return the fund to investors. The success of the entire industry came from the same 5-12 firms, who were largely syndicated into the same handful of investments (Yahoo, Google, LinkedIn, etc.). If you were in the breakout success story for that cycle you were a winner.

I’m pretty dubious about the generally accepted wisdom from a group who have a couple of lottery winners among a bunch of losing bets.

That’s all changed in the current cycle. I don’t think that’s because VCs suddenly got better at what they do. I think it’s because the economics of launching a company changed, as did the expectations around traction to raise your first rounds. There are exceptions in some verticals (hardware, med/bio tech, etc) but then vast majority of startups no longer have huge capital outlay just to prove technical viability. They’re not building a fab facility to produce silicon, they’re not trying to iron out how to do that at scale, they’re not dropping $40K for a single SGI server they need to rack. They’re paying very low opex, and depending on access to credits from vendors maybe not even that. For a team with tech capability they need little more than time to actually build the product to actually have something in market. Plug in Stripe or similar and they’re able to prove revenue too.

The net result is VCs are not investing in anywhere near the same level of risk as they were 10-15 years ago. There’s very little investment in a deck full of ideas (you’d need a team with previous track record) and a lot of investment in scaling working products. “Is this technically possible?” risk is largely non-existent. “Can this team build it?”/execution risk is heavily discounted. “Can this scale?” has been reduced to “worst case we can probably throw money at this with a cloud vendor to weather rapid growth”. What’s left is doubling down on sales and marketing.

What’s happened is a period of riches for VCs because founders & teams have leveraged tech advancements to reduce the risk of failure. But the investment industry hasn’t reacted and have instead captured an outsized upside. And I think the 10 year feedback loop for funds probably isn’t helping them to see it (also, what’s the incentive? Why leave money on the table as an investor?).

I see Earnest and similar initiatives as being the competitive response to correct this imbalance. In 10 years you’ll no longer have VC as an expectation to achieve a unicorn (or whatever we’re calling them then) valuation, and whatever investors you have will have an appropriately risk adjusted return.

Hey Glenn. I don't think there's anything wrong with VC per se, but it's no longer a fit for most software businesses (why the best firms are moving to crypto, robotics, AI, etc). We have an outdated association with software company needs capital = VC. https://tylertringas.com/a-new-default-funding-for-tech-comp...

Hey Glenn, would you mind sharing why you were unsuccessful? What were your biggest takeaways from the experience?