Indie.vc: Unicorns Are Out, Profits Are In
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Right now we're seeing a trend of larger companies taking an ever larger piece of the market share, and the total number of firms decreasing. While encouraging founders to form smaller companies with shorter time to profitability undoubtedly results in more companies surviving 3, 5, and 7 years after founding, that's not what we're optimizing for. An investment strategy with high rates of failure, but producing larger companies with those few successes is still yields the potential for larger overall returns.
1. What does it mean by 10% vs. 44% of companies surviving? Presumably it means that 10% of traditionally funded companies exist X years after founding versus 44% of Indie.vc founded companies. But this is a strange metric to give without specifying how many years we're talking about.
-> so basically, Canadian "venture" capital. They don't even want to talk to you unless profitability is there or within a few months. So, basically, it distills to a barely riskier than usual bank loan, except you pay the loan with equity.
Perceived Pros:
- Many STEM grads
- Gaming and AI industry, 2+ top AI schools
- Relatively little competition for engineering talent compared to SV
- Many engineers who are barred entry to US based on country of origin
- Easier work visas (to be confirmed)
- Free healthcare and other social services, and less violence
Perceived Cons:
- Cultural lack of ambition, entrepreneurial dreaming.
- Excessive reliance on government subsidy (the government is the customer)
- Risk averse VC
- Shallow bench of experienced operators to mentor, invest, and manage
- Brain drain to SV of best talent
- Higher taxes
Shopify is a perfect company for Canada - they are not making 'tech for other techies' and don't require all the best devs in the world. It took a while to get going, so costs needed to be lower. They can make some income early on, thus 'proving the model'.
There is a reason that the nations top social network started at Harvard, which has an elite status among young people. There's a reason that Snap was started by an attractive young man from Cali, from a the top school in Cali. Glossier, a 'makeup company' is actually, truly a 'social network', and there's a reason it was founded by an ex-model/reality TV star with deep connections in LA/NYC.
On the technical side, there's a reason that certain companies really need to be in the Valley as well.
So if your business needs to be in the Valley, it might make sense to do that, but if it's a 2cnd-tier kind of thing, not something the FAANGS would ever look at, and doesn't require the best technical talent in the world, than you can do it other places.
Montreal a tier 2 cities, Ottawa/Vancouver, not really tier 2, Toronto is probably a solid tier 2. FYI that is actually not bad considering tons of American cities are not tier 2 either. Chicago, Toronto's 'twin' really might not even be Tier 2, there is a weird lack of entrepreneurial activity there for its relative size and power.
Montreal has cheap prices, decent AI grads, stable economy, supportive government, weak VC but the top could of firms are fine places to go for smaller up to round A, and if your business fits well into Quebec's strategy, following rounds can be supported by Desjardins and nationalist players.
Also, Porn.
I love this. I wish it were a thing, "The Canadian Model".
It doesn't do a great job of serving the country's social needs, and it also doesn't do a great job of producing competitive businesses.
There's a fair number of public funds that get funneled into unproductive firms through things like innovation grants, and there's a lot of protectionism for incompetent incumbents. All of this seems to enrich a small class of elites, at the expense of the public purse. Most Canadians just shrug their shoulders at all this, and move on with life.
On the other hand - Canadian business expenses are still quite high, but quite a bit lower than US business expenses. Healthcare and cost of living are huge factors in labour costs.
If they were productive firms, they wouldn't need government money. This is why free markets work better, because free markets allocate resources to the most productive uses.
You misspelled profitable.
So, this isn’t really my area, but if the market is efficient shouldn’t these come up about the same over a long enough period? In other words if one or the other has dramatically better returns that just means the risk was mis-priced to begin with.
The immediate objection I can see to this (without expertise) is assuming that private markets are at all efficient. But that would point to a fundamental problem with pricing in private markets, not the merits of one strategy or another.
Cue theranos on one hand and probably many companies with potentially profitable innovations that never got funded and we never heard of.
This is one thing that the left social justice crowd does get right - Never forget that at the end of the day, the system runs on wetware - people with faulty ideas, preconceptions, biases and limited knowledge.
You can already see this playing out in the public markets. Stocks produce far higher returns than corporate bonds, which produce higher returns than treasury bills.
There's further nuance here around systematic risk vs unsystematic risk, but I don't think it's as relevant to VCs since their number of investments is too small to diversify away all unsystematic risk.
Having a higher potential return and actually being +EV aren’t the same thing. Just ask any bookie.
Well yes. This is exactly why higher risk generates higher EV in an efficient market. Because of the significant chance of lower returns.
> So if a basket of risky assets predictably overperforms... it isn’t actually that risky
Depends on your time horizon. The S&P 500 predictably generates higher returns than T-Bills, over a 100-year time horizon. But it is still very risky to a 70 year old retired pensioner. This risk is why the S&P 500 generates higher average returns than T-Bills
As an anecdote, in 2014 we looked for ~$250k investment. We had a business model that realistically took us to ~$5mm/year revenue in 5 years. We pitched various "traditional" VCs. The overwhelming feedback we got was that nobody doubted our team, the product, or the model. The problem was that the returns weren't big enough. The product was niche and could never become an "Uber" without really stretching the imagination. In the end, we found an angel investor in our space. We indeed did turn that $250k into $5mm/year revenue in 5 years and sold the company for 8 digits.
If not, if someone can establish a term it'll be easier to talk about this.
They just don’t do tech. This is because their risk models are built on 30+ years of priors and the financing is very often business sector specific. Tech is too much of an unknown for this model.
There are many tech businesses that can and do qualify for traditional financing/funding. The difference is that banks aren't interested in funding high-risk moonshots.
Simplified examples:
Tech Biz #1: Founder identified a niche, has a few customers, and has been working on making the consultant -> product jump. They're paying the bills but see an opportunity to offer their product to many more customers and would like to work on the business instead of working in the business. They want to hire a programmer and invest in marketing but need to borrow money to make it happen.
Tech Biz #2: Founder wants to build X for Y and change the way people do Z. It's going to take many programmer-months to build the product and a sales and marketing team to change consumer behavior. There's no guarantee that they'll find product-market fit but, if they do, the business has the opportunity to scale rapidly with strong margins.
The issue is that the banks will pretty much provide loans for anything with consistent cashflow. This includes tech companies.
The problem is getting investment when you have no cashflow.
They have a manifesto on what a zebra is, that contains a nice image comparing with unicorn approach: https://medium.com/@sexandstartups/zebrasfix-c467e55f9d96
Also, congrats on your success!
Sahil @ Gumroad has talked about this in good detail. The VC idea that "yes, your business/idea is/will be profitable but you shouldn't waste your time making money when you could be working on changing the world"
The "changing the world" business will also hopefully be profitable and make money down the road but they are looking for outsized returns from a market disrupting unicorn.
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Regarding the "new VCs" concept. Alex Danco and others have discussed this and the funding model ceases to be VC when it is low-risk, medium-reward.
It's possible that many areas of tech are maturing to a point where VC will no longer be the optimal funding model, outside of high innovation specialties. As the industry matures, there are many businesses that might provide stable returns and have a risk profile that is different from that of the unicorn VC-startup. These businesses might be better served by debt funding and a debt-based investment vehicle/product might attract more investors and allow for greater de-centralization of tech funding.
Linking Alex's blog post below instead of rambling in this comment.
VCs need to have a chance of "returning the fund". If they are investing out of a $200m fund, and they own 15% of your company at exit after 5 years and subsequent dilution, that 15% has to have a chance of being worth $200m.
Otherwise the math does't work.
As an analogy, you can have an investment thesis that vending machines with bottled sugary water have extremely high ROI... but you are missing the elephant in the room which is you'd have to compete against Coke and Pepsi's infrastructure and brand.
Similarly, if you are raising a fund and want to play the high risk, high reward game, you need to consider what the market conditions are.
First, it's definitely not an even playing field. Connections and brand mean a whole lot. The leading VCs have all the best deals coming to them and have a bunch of management consultants in the backroom trained to spot large market opportunities. The volume of deals and strong connections allows them to pick and choose the best opportunities, and everyone else is left with scraping the bottom of the barrel.
Second, there's only around 15-30 billion dollar companies created per year in the US, and there's probably 30-100x the amount of incubators or venture firms. It's just a limited market overall.
That's the game. In a theoretical sense, yes high risk, high reward opportunities have better ROI, but only if you are at the top of the game. So I'd hesitate to say that this is an objectively inferior model because for some investor's positions, this strategy would probably yield a much higher return.
Its probably better to compare the two models like Residential and Commercial asset types (a quick google search to show the comparisons: https://www.fortunebuilders.com/commercial-vs-residential-re...)
It seems like it's just a really, really, really expensive loan. They make it sound nice with their anti-VC, pro-founder marketing angle. But at the end of the day, they are charging you 3x what you're borrowing.
3X in 7 years implies a yield-to-maturity of 17%. Why would any company pay more than three times the cost of capital they can get from much larger, more liquid, and established Wall Street financing?
[1] https://us.spindices.com/indices/fixed-income/sp-lsta-us-lev...
Personally I'd be really excited to see better loans being offered to startups, but this isn't it.
EDIT: Also you're assuming a 7 year payback period, and I would guess it's a lot shorter than that for the average indie VC customer.
This would be very attractive to someone who wants to grow their business without taking (more) personal risk than they have already.
Now I'm sure they're not using exactly the same definition. Plus we have to take into account recovery rates. But the point is that this VC program almost certainly is not funding the "average startup". To achieve those low levels of default, their investment pool has to be significantly safer and more stable than the typical Valley startup.
So either their typical investment is safer in obvious ways, like interest coverage and EBITDA multiples. In which case they should be able to access traditional credit markets at much more favorable rates. Or the VCs in question have a unique ability to identify sure bets in opaque ways. Ways that other investors just can't see. In which case the secret sauce isn't the funding structure, but the preternatural giftedness of the firm's general partners.
(Or there's a third option, which is that the fund's track record has just represented a string of good luck. They've been fooled by randomness and future returns will not live up to past history.)
After experiencing it myself, I think that the push to grow big is a very big deterrent for me to take on VC money. The lifestyle is just not worth it.
Bootstrapping a company from the ground up works if you have the necessary skills and idea, but some ideas need access to capital, especially if they are operationally intensive. So I could see this model being pretty attractive in those situations.
Why pay for a loan with equity when you can pay cash? The interest rate on equity payment is exponentially higher than it is for cash.
Plus, if you already have attractive traction, why do you need the "premium features" a VC offers versus a bank which are extra experience, some networking effects, and maybe some insider info on acquisition opportunities? So you can be forced into expedited aggressive growth and turn into WeWork or make less money if the company is acquired? No thanks, the business is already proven and working!
Traction for VC money makes no sense to me.
...Unless you secretly have ZERO intention of ever selling and just want to pocket some play money for the business.
I say this as a founder that prioritized profitability and outlasted many VC backed competitors and was sick of VCs telling me to increase burn and growth and ignoring my warning of the long term perspectives and risks. We decided not to take VC and are smaller but killing it.
I am glad to see this perspective but it only lasts during a financial crisis then it’s right back to fetishized hyper growth.
As far as I am concerned go ahead and keep your hyper growth VC dollars, I’ll buy your bankrupt portfolio company in a few years with our profit.
As YC says, get to ramen profitability as early as possible and be a cockroach that will survive.
Consider that you want to make an App store where you add value by manually validating every app available through your store and build trust with your customers by only serving the best apps.
How can you compete with the Apple App store? You can't. At least, not without creating a hardware/software ecosystem with millions of users.
You could shortcut that buildup of scale by only targeting android users but then your competition against the Apple App store will be entirely dependent on the strength of Android ecosystem.
Our company, Qbix, is a poster child for the preaching of the Basecamp folks. We raised $107,000 from friends and family and then generated revenues, then another $135,000 and generated more revenues. We are up to almost $1MM in revenues now. Also we have attracted 8 million users and growing.
But many VCs have turned us down because they look for hockey stick growth and zero friction, and don’t like “the agency model” companies which make money. Actually, they’re just applying pattern-matching to reject the vast majority of startups unless they are hockey stick growing.
Clearly there was more silly money being throw around in the late 90s and into 2000, but by 2002 the mantra in was "ROI, ROI, ROI!"
[1] https://en.wikipedia.org/wiki/Dot-com_bubble#/media/File:US_...
Seems like you're doing something wrong if you raise seed and A rounds[1] and have given away enough board seats that they can push you out 4 months later.
Also, why would anyone take out a million dollar personal loan to fund a startup? I have heard of founders spending their own money to get things off the ground, but usually it's $50k or so, and it's never a bank loan.
I'd agree that this guy is rightly wary of going back to VCs, but his experience seems like an edge case (which is perhaps why it's featured in this article).
1: https://www.crunchbase.com/organization/retracehealth#sectio...
These current models don't only want the icing (their returns on initial investment) but they want to eat their cake too; they're currently doing this because they can get away with it because their current competition, traditional VCs, is far worse - but once a new competitor comes in that only wants the icing but not the cake from the transaction, they'll lose out on potentially a lot of this deal flow.
Is this measuring revenue, users, profits, or something else? If it's revenue or users, I would guess that most VC-backed startups grow faster than this. If they're looking at profits, then probably the VCs do worse.
> Plus, the fund’s mortality rate is 10% — compared to about 44% with traditional VC-backed companies.
Are they looking at the same time period? If Indie.vc's portfolio is younger, then they would obviously have fewer deaths than traditional VCs.
Basically, it looks like the author wanted to put down impressive-looking numbers without the context that would make clear if the underlying facts are actually impressive or not.
The Indie.vc model is contrarian and probably doing well. It will continue to do well as it becomes imitated. And then the cycle will repeat. So keep your eye on unpopular unicorns!
It also sounds like it could work, if there's enough demand = enough obvious good apples, which are willing for the deal because of not enough supply in financing instruments.
I can understand that investing in unicorns can also work. As many unicorns fail after their initial hype, investing in these normal companies sounds less like gambling on hype than investing in unicorns.
But the point still stands: they are using a medium that hurts the message, and in a way we are paying - with our time and patience.
Or audio. Or a gif, or comments. Sure you can host them elsewhere, but how many secondary services am I meant to use for a personal blog?
As i get older, I seem to be growing respect for legacy software: if people are still using it after 30 years, it probably got something right.
As for gifs and comments here's a link to my ghost blog with a gif as well as comments(disqus) https://thoughts.willcipriano.com/weird-python-tricks/
Embedding third party services may go against the values of some Richard Stallman types, for me however it enables me to host behind cloudflare with a $5 a month digital ocean droplet and not have to worry about getting hugged to death. I can live with the tradeoff.
But as I said, it's unfortunate that comments sound and video have to be hosted externally.
In my mind , my domain is where I make the rules. I do not want my self-hosted blog to be subject to flavour-of-the-month demonetisation, copyright and censorship of like 5 different teams. Think of youtube banning any video mentioning corvid.
To the companies: make sure that when you post, distribution setting is OFF. This is a kind of dark pattern by Medium, which is why it's confusing, on purpose. What it really means is, distribution exclusively for paid Medium subscribers is off - meaning any person, anywhere, can view it.
Do banks have something against software businesses ? Are there software companies that have bootstrapped themselves with loans (not friend/family loans) as opposed to VC ?
Banks are risk averse. Lending to a restaurant they can always recoup a lot of material and other physical assets as collateral. Not necessarily so for most software dev.
That's my perspective.
Software is global, and is fundamentally an innovation business. Once you've written a piece of software that does something useful, you can sell additional copies at zero marginal cost. This tends to make software into a winner-take-all market: there is realistically only one Google, only one Facebook, only one Salesforce, one Amazon, etc. If you try to get into a known market, you are almost certain to fail, because you have to pay all the R&D costs that your competitor has already paid and they can just sell to the customers you would otherwise have gotten at close to zero cost. That means that successful software businesses are almost always doing something fundamentally new - either selling into a new market, or selling a new and different product into an existing market that has changed in some way. Banks are really bad at forecasting the success of new business models that have no financial data to go on - their whole core competency is evaluating financials, so if a company has no revenue but lots of expenses and an uncertain prospect of ever making money, it looks like a universally bad bet for a bank loan. The venture capital industry is all based around answering "How do we finance businesses where success is binary and information about whether the company will be successful is scarce?"
2. Marketing Costs
3. Compute Power
4. Software Pricing
can all be quantifiable in numbers. Again I don't know how loans operate.
To be a cynic, I think the software free lunch is over. Data will be increasingly localised. More draconian laws to come, let's hope they are stupid. Algorithms have also become "scary" for normal folks.
Whereas if you open a restaurant, you can make solid projections where "If we fill every table, we make $Y. If we're 1/3 full, we make $X. We're unlikely to be less than 1/3 full", and these are typically completely reasonable because you can see how other similar restaurants have done. For a restaurant, having a similar restaurant be successful is a very positive indicator. For a software company, having a similar software company be successful is an indicator that the market niche is already filled.
As long as market actors don't do anti-competitive practices, I still don't see why a successful software can't be replicated and you can't compete in the same market niche. The user interfaces are one area which can obviously be different. Enterprise software is full of replicas.
If so, how is it different from what VCs are doing now?
Also, from the article "And founders can even buy back the stakes (ranging between 10% and 15%) by hitting certain revenue targets"
10-15% interest on a crazy high-risk loan makes absolutely no sense to me whatsoever.
The article mentions the indie.vc "mortality rate" is 10% whereas for VC-backed ventures it's 44%. Granted, just because a company is alive doesn't mean it's making the investors much money.
I imagine having more companies around for longer would ultimately mean a lot of little payoffs that cover their own investments rather than one big payoff that covers every other investment.
That's hardly enough time or data to tell what the actual mortality rate is full cycle. A lot of startups will fail in year 6, 7 or 8 after years of pivots and trying to grow.
> On average, they’re growing 100% in the first year, and 300% the second year
Assuming $0 in rev on day 1, of course they grow 100% in Y1. These numbers don't mean anything.
Philosophically I agree with Indie.vc. I think there is untapped potential in smaller companies/markets that mostly is overlooked by traditional VC. But I don't think VC is the answer to that problem. There needs to be some other funding vehicle that can withstand smaller returns over longer periods of time (like a loan, which this seems to be closer to).
I'm assuming the overhead of vetting a deal is a mountain of toil for the VC firm, and there are going to be some fixed costs - eg filing fees for S or C-Corp paperwork, lawyer time. But outside of that, I'm not familiar enough with what a VC does to understand why current vehicles can't scale like , and why a different type of funding vehicle is necessary for $10k investments to become the norm instead of $1mm or $10mm?
Could a tech company automate the shit out of all the toil involved with VC deals and do VC-funding-as-a-service? Stripe Atlas already makes it trivial to spin up a company so further automation doesn't seem unrealistic.
> Could a tech company automate the shit out of all the toil involved with VC deals and do VC-funding-as-a-service?
At least for Germany: no. Things like notary fees are pretty fixed, and you can't do that stuff without them (well, you can, but than it'll basically be "here's money, please don't screw me as I have zero ability to enforce anything").
Find deals & founders worth investing in is super hard. Might as well back up the truck and put large amounts to work when you do...
WeWork entirely failed to IPO, so early investors not named Adam Neumann got screwed. Thus, on the spectrum of gregarious companies, with WeWork and one end and Uber at the other end, a company just needs to be on the Uber level of gregarious.
I wouldn’t call making a bad bet getting screwed. There was no fraudulent numbers I am aware of.