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Reviewing the SEAL: A new form of bootstrapper funding (medium.com)
19 points by wensing 9 days ago | hide | past | web | favorite | 8 comments

>> To summarize: in a traditional seed investment, the founder is giving up that which is not scarce, and which has a nominal value (stock) for that which is scarce and has immediate value as legal tender (cash). The consequence of this transaction is that he must also accept sharing some percentage of the cash that will come later if he or she is successful. However, at that later point, cash is much less scarce and has less value to the entrepreneur and the business than it had previously.

>> With a SEAL, things are quite different. The investor is providing the founder with cash when it is scarce, but their own access to cash (through payback) comes to this side of the non-linear payout of an acquisition or exit. This means that cash is still a scarce resource. While it is true that the founders themselves are also partaking in cash in the short term, it is because they are actively working on the business and creating more value than they are taking out in the form of cash.

This is just plain wrong. By binding the payback to profit (not revenue) and giving the entrepreneur a lot of flexibility in defining when to allow the (successful) business to become profitable, the investor will only have access to cash when it isn't scarce.

The author seems like a really competent person so, unless they have a bone to pick with the Earnest Capital team, I can't understand how/why they got this so wrong.

Thanks for the nod to competence.

Re: "By binding the payback to profit" -- but it isn't bound to profit. Re-read the terms. It's Founder Earnings, which is profit PLUS any founder salary above a 'low but fair' threshold. You can be breakeven or below zero and still have shareable earnings with a SEAL if you are making a market rate (not low but still fair).

I spent days thinking this through and would be happy to explore your objections in a higher-fidelity forum or longer-form format than HN comments.

For now, suffice to say I have no incentive to mislead founders.

Very interesting analysis. As a bootstrapping founder, I am thinking about possibly raising funding at some point. So it's good to see new options coming out and some way of comparing them with existing options.

To the author - I wonder if you could use the data from the Open startups (sharing their numbers on Baremetrics) and see how different funding options, including Earnest capital's SEAL, would work out for them.

Yes, absolutely. The key question in my mind still (after finishing the article) is what startups actually WOULD be smart to take money on these terms (what kind of business model, unit economics, and growth trajectory would they have to have for it to make sense).

My guess is it's a narrower slice of the startup population than Earnest intends. And my prediction is they will update their terms to broaden the slice.

The section on "Cost of SEAL Capital, in Equity" is mathematically correct, but omits a few key points that make the example unreflective of what would happen in reality. The whole point of the Equity Conversion terms is to keep open the option to raise VC if the founder wants to do so.

If after a SEAL, the business decides to raise a priced round at a valuation higher than the Valuation Cap, then the investor has the option to convert to [any unpaid amount of the Return Cap] / [Valuation Cap].

If at the time we are negotiating a SEAL this simple math shows the investor would own a giant % that would make a VC round impossible, then it closes down that option and defeats the entire purpose. It's very easy to plug in numbers that generate a result that is extremely founder-friendly ($100k, 3x, $5m cap = 6%) or ridiculous ($250k, 5x, $2.5m cap = 50%).

As part of the upfront negotiations, any honest investor would make sure the founders understood how these numbers play out in a variety of scenarios and agree on terms that are fair to both parties.

The example in the post is $250k, 4x, $3.5m and with the implied 28.3% the conclusion is "the terms will work out so poorly for you and your new investors that the most likely outcome is new investment never happens" - But by changing the cap to $5m, it becomes 20% (not an unreasonable ownership stake for a very early seed/pre-seed investment). If the return multiple is 3x, we get to 15% which can be further reduced by any payments that might have been made prior to the fundraising round.

There are plenty of fair ways to structure these terms. Though I would agree that for founders that are dead set on raising a round of VC in the near future, they should use traditional products like a SAFE or convertible note, which are built for this purpose.

Hi all, I'm the GP of Earnest Capital and I'll add here the comments I gave to Matt privately before this post. The terms we use for our Shared Earnings Agreement are the result of a transparent and honest discussion with the community via this post (https://earnestcapital.com/funding-for-bootstrappers/). I received 100s of comments about our investments structure from founders and investors, 99% of which were along the lines of "how will you build a successful fund with such founder-friendly terms."

I would encourage folks who are interested to read the very good discussion: Here on HN: https://news.ycombinator.com/item?id=18338665 On Indiehackers: https://www.indiehackers.com/forum/help-us-design-funding-fo... And directly in the term sheet draft that we posted with comments open on Google Docs: https://docs.google.com/document/d/1HoZ94eWTctYQM5O5RXDeQQ_h...

A Shared Earnings Agreement is not debt and comparisons based on interest rates are academically interesting, but misleading because you cannot go to any debt lender with a side project with $2k MRR and get a loan to take a year and grow it. A SEAL has no fixed repayment schedule, no personal guarantee, no mechanism to foreclose on the business if it fails, and critically and unlike any form of debt the investor only gets paid when the business is doing well (repayment is a % of the economic benefit the founders choose to pay themselves: Founder Earnings).

We designed it to be a substitute for equity (where seed VC is really the only real alternative most founders at our stage would have) but equity that doesn't force the company to continually raise capital or sell the business. A SEAL can still have a successful risk-adjusted outcome for the investor even if you build a nice profitable business (literally the "nice Italian restaurant" example quoted from DHH in the post).

You may as well also include the effective interest rate on every VC investment that returns 50x or 100x their investment and say "Woah what a high interest rate. Should have used a credit card." Like equity, the implied "interest rate" on a SEAL looks higher in scenarios where the business & founders are more successful (thus paying back more Founder Earnings faster) and is a nice, low 0% APR if the business fails

That said, if anyone has constructive feedback to share I would love to hear it: https://earnestcapital.com/contact/

> You may as well also include the effective interest rate on every VC investment that returns 50x or 100x their investment and say "Woah what a high interest rate. Should have used a credit card." Yeah,

This. The author seems to completely miscomprehend/discount the risk involved for both parties in his calculations.

It's important to remember that the payback is based on profit, not revenue. The author does note this, but a lot of his reasoning around the founders' hypothetical motivations only make sense if you assume the reverse is true.

For example:

> While much shorter than a mortgage, eight years can feel like a long time to owe money, especially in startup land, where 1 year can feel like a decade.

This misses the point because you don't really owe money like a mortgage. With a mortgage if you don't pay it off today, lose your job and can't make future repayments, you could lose your house.

With this SEAL, if you don't pay back the investors today and suddenly can't afford to pay anything next month, there are no negative consequences. You won't be fired, lose your house/additional equity or end up paying back more (eg due to interest).

_"A Shared Earnings Agreement is not debt and comparisons based on interest rates are academically interesting, but misleading because"_

I address this in the 'Seal Typing' section of the article.

_"You may as well also include the effective interest rate on every VC investment that returns 50x or 100x their investment"_

I address this in the "Cash & Carry" section of the article.

Hybrids are hard to design[1], hard to evaluate, and hard to compare. That's part of my worry and a lot of the inspiration for the article.

[1] https://blog.codinghorror.com/the-pontiac-aztek-and-the-peri...

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