
Indie.vc: Unicorns Are Out, Profits Are In - BobbyH
https://marker.medium.com/indie-vc-unicorns-are-out-profits-are-in-648d2576319
======
manfredo
In short: this author is endorsing a funding model focused on low initial
investment and faster profitability. The benefits key benefits are that this
funding model results in more women and minorities getting funding, as well as
higher rate of companies surviving (10% vs. 44% [1]). The former is good, but
probably isn't sufficient to motivate most investors. The latter doesn't
necessarily translate into better returns on investment. Throughout this whole
piece I was looking for a comparison on the net return on investment of the
traditional VC model and this Indie.vc model. This comparison is never done. A
high-risk high-reward investment model may still produce higher rates of
returns than a low-risk low-return model.

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.

~~~
leesalminen
I think both worlds can exist. You can have the "traditional" VCs going for
the high-risk, high-reward model. And you can also have "new" VCs going for
low-risk, medium-reward.

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.

~~~
epicureanideal
Is there any existing term for "funding for business that will never be a
unicorn but can clearly become profitable and provide good returns"? Is there
an equivalent of VC for "lifestyle businesses"?

If not, if someone can establish a term it'll be easier to talk about this.

~~~
teej
There’s tons of existing finance infrastructure for this already, it just
doesn’t reach tech. Small business loans, traditional banks, franchisors,
local business investor groups, etc all facilitate these sorts of businesses
today.

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.

~~~
grumple
Are you saying banks won't provide loans to small tech businesses, but they
will to things like restaurants?

~~~
molsongolden
Differentiating between "small tech businesses" and VC-style startup tech
might be useful here.

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.

------
a13n
As a founder of a bootstrapped & profitable company, I don't really get what's
so attractive about this funding model.

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.

~~~
dcolkitt
I agree. This isn't quite an apples-to-apples comparison. But middle-market
companies with okay-ish financials can easily get covenant-lite leveraged
loans from the gigantic private credit market, for well under LIBOR + 1000
basis points. The current yield-to-maturity on the leveraged load index is
5.64%[1].

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...](https://us.spindices.com/indices/fixed-income/sp-lsta-us-leveraged-
loan-100-index#overview)

~~~
smachiz
Virtually no startup can get loans without a PG at any non-loanshark rate.

This would be very attractive to someone who wants to grow their business
without taking (more) personal risk than they have already.

~~~
dcolkitt
The historical default rate for leveraged loans is 2.9%. This VC program
claims a mortality rate of 10% over a 5+ year horizon. I.e. a 2% annualized
default rate.

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.)

------
digitaltrees
Let’s see how long that lasts when follow-on financing doesn’t materialize and
limited partners pull capital and give it to Unicorn.VC because their results
are more “exciting”.

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.

------
gigatexal
in my humble and unwarranted opinion (see also not having run a vc company or
a company for that matter) profits should have been the idea from the get go:
all of this effort to get large and then use economies of scale to defeat
rivals and then start making a profit is just wrong

~~~
shuntress
For some products, this is just not possible.

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.

------
EGreg
Oh really! I would like to see the day.

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.

~~~
yowlingcat
If your firm is making money (especially to the tune of $1MM -- is that per
month or per year?), it might be a perfect match for the more old-fashioned
form of non-dilutive fundraising: lending. There are a lot of firms out there
which capped revenue based funding, but the biggest one I know is Lighter
Capital [1] (no affiliation), and I believe there's a good amount of
competitors [2] which do the same thing. Why not consider reaching out to them
and seeing if you're a fit?

[1] [https://www.lightercapital.com/](https://www.lightercapital.com/)

[2]
[https://www.owler.com/company/lightercapital](https://www.owler.com/company/lightercapital)

------
wiremine
I remember this being a theme during the 2001 recession. I can't find the link
right now, but I remember more than a few articles about this trend back then.
I was able to find VC capital investment. [1]

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_...](https://en.wikipedia.org/wiki/Dot-
com_bubble#/media/File:US_VC_funding.png)

------
awinter-py
in a recession it's better to be a cockroach than a unicorn

------
gnicholas
> _Just four months after closing a $7 million funding round for his first
> startup RetraceHealth in 2016, Aderinkomi was pushed out of the startup by
> the new board. This was after he had spent three years and taken on $1
> million of his own personal debt to build the company._

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...](https://www.crunchbase.com/organization/retracehealth#section-
overview)

------
foobar_
This is probably silly but I have often wondered why you don't get
straightforward loans in Software. If I were to open a restaurant I would
hardly go for a VC.

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 ?

~~~
nostrademons
The market structure is pretty different. Restaurants have geographic barriers
to entry - your restaurant is probably only serving customers within a ~20
mile radius. And the economics and business model are well-known: you know
exactly how much rent is going to cost, how much labor is going to cost, how
much food is going to cost, and how many tables you can turn over a night, and
so you can build reasonable financial models for how much you might make.

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?"

~~~
foobar_
1\. Developer Salaries

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.

~~~
nostrademons
Sure, and once you have those in place you have a startup that eats money and
doesn't necessarily make any money. The vast majority of software startups end
up building something that nobody wants anyway, because if there's something
that lots of people want, somebody has already built it.

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.

~~~
foobar_
Thats a simplistic view of restaurants. From a purely market perspective,
people already do this with personal loans, credit card or otherwise. I do
agree that evaluating the final software's value is difficult but for a loan
lender, it's only a matter of credibility rather than success.

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.

------
loceng
Does anyone know a VC similar to Indie however that doesn't convert to equity
if more funding occurs from another party? Give me $100k and sure I'll pay you
back $300k, however let me use that $100k to see how much more valuable I can
make my company and therefore leverage its new metrics including revenues.

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.

~~~
thatthatis
[https://techcrunch.com/2019/08/19/who-are-the-major-
revenue-...](https://techcrunch.com/2019/08/19/who-are-the-major-revenue-
based-investing-vcs/)

------
lawrencevillain
So VC's are out, bootstrapping is in?

~~~
qppo
Debt convertible to equity is in.

------
gnicholas
> _the companies that receive Indie.vc funding seem to be much more robust
> than their peers, especially in a challenging economic climate. On average,
> they’re growing 100% in the first year, and 300% the second year, says
> Roberts._

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.

------
georgeecollins
What I take away from this is that soon it may make sense to invest in
unicorns! Initially investing in money losing companies was a contrarian
investment strategy. Then everyone piled in, making it an even better
investment strategy as assets became overpriced. Think Uber. And authentic
opportunities became scarce, think Zume.

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!

------
tommilukkarinen
Let's say the model is to get 3X return in 5-7 years - 10% mortality. Sounds
like a great instrument to me.

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.

------
troughway
So this is initial seed/angel venture capital without huge ROI expectations?
Is that the idea?

If so, how is it different from what VCs are doing now?

~~~
ryanSrich
VC without huge ROI expectations doesn't work. Like the actual economics don't
work. I don't really understand the point of any of this. VCs need massive
outsized returns because 99% of the companies they invest in will return $0 to
the fund. You need that one company that returns the entire fund (ex: $500m) +
some percentage.

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.

~~~
fragmede
Another part of VC economics to understand is to look at Uber. Total disaster,
right? Softbank and retail investors got totally _screwed_ by the IPO due to
questionable economic assertions made by Uber. But the angel and early series
investors, circa 2011? Still made out like bandits. An IPO price of $72, when
you paid pennies per share, times several hundred thousand shares equals a
cool $10mm, easy. Perhaps not as much as they would have liked, but that's
still a pretty good payday considering later investors lost money.

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.

~~~
lotsofpulp
> Total disaster, right? Softbank and retail investors got totally screwed by
> the IPO due to questionable economic assertions made by Uber.

I wouldn’t call making a bad bet getting screwed. There was no fraudulent
numbers I am aware of.

------
halite
Alternate: [https://docdro.id/ueWWcKf](https://docdro.id/ueWWcKf)

~~~
eitland
I think that site just popped me a scareware scam?

------
burtonator
@Indie.vc ... you spent a ton of time writing this post only to have it
paywalled by medium. I can't read it... Ditch medium as they aren't compatible
with your business model :-P

~~~
derekdahmer
It's not paywalled. You can read it with a free account.

~~~
eitland
Or in a private tab.

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.

------
jiofih
Poor independent founder who spent $1M out of pocket on his first startup.
Let’s hear his story.

------
remotists
TLDR: Advocating for fundraising that at its core is a less risky bank loan
except here you part with equity.

------
Peteris
Paywalled.

