Startup funding is clunky, founders get large pools of capital dumped on them based on projected/aticipated growth and often times mis-sizes the business. A few months back I wanted to get a new Cash App Account from Square, I was amazed at how easy it was. I downloaded the app, opened a new account, deposited some funds, and had a debit card on the way (with a virtual one available immediately in apple pay). The whole thing took 5 minutes. Now consumer trends tend to be ahead of business trends (businesses are notoriously conservative about change) but startups and startup financing has been around for 20 years now, the systems that have been built and the metrics that we can track are well documented, similar to Cash App, with just a few of the right data points, they can make personal financial products easy. It’s time we do that with startups.
If you are a homeowner, think about when you bought your first home. You know the price, you know how much you needed to save to put down, what the interest rate on the loan was, and how much you would owe each month. You had very clearly defined targets that you knew if you hit, the bank would issue the loan and you would be able to purchase a house.
Most startups today are built on recurring/subscription revenue. The beautiful thing about recurring revenue is just that, it recurs, month-over-month, and with access to the right systems and data, you can start to track the behavior of the subscriptions that make up your revenue stream. How much do they pay you, how many of them are there, how quickly are you growing, how long those customers stick around (retention), are you able to upsell them after they initially sign up (expansion). This is a startup's down payment, how well they need to acquire and retain healthy revenue in order to be eligible. So now that we know how efficient you are with your customers, let's see how efficient you are with your dollars.
Next, we need to determine your interest rate, for our purposes, this is the amount of exposure we are willing to take, startups after-all, are risky ventures no matter how you slice it, but if you slice it correctly, you can usually find really healthy and efficient recurring revenue. From this we need to understand how capitally efficient the business is. With access to accounting/bookkeeping software we can easily track expenses in the business related to the customers and their subscriptions that we discussed above. Through this account and revenue data, we can track how efficiently a startup is at acquiring and retaining $1 of retention profit (ie. $1 of take home profit after you keep a customer month-over-month). We call this metric, Cost Per Recurring Retention Profit Dollar (see our blog about how to calculate it here). The formula tells us how much it costs a startup to acquire and maintain $1 of retention, or take-home profit each month. The healthier a startup's CRPD, the great the exposure an investor can take given that the revenue you can underwrite is sturdy and will pay itself back over time.
So now that we know our interested rate (capital efficiency)and the down payment (revenue retention), we can calculate our monthly payment, or in this case how much capital a startup can draw down on each month as they hit certain milestones based on the two metrics above. For founders, deferred revenue is a blocker to growth, that is why many startups raise venture style capital, that money is covering expenses while deferred revenue is realized. But what if as an investor, if we worked with a founder to understand the durability of their revenue/customers and the efficiency at which they maintain that revenue stream. Could we unlock annual cashflow (up to a certain amount of exposure) each month as certain milestones are hit, enabling the founders to take that money and immediately re-invest it in the business.
Think of a startup with $25K in MRR at 102% NRR and a CRPD of $0.80 at 40% MoM Growth, as this startups venture partner (let’s say I already have $75k invested in the seed round for 7% of the business), what if I was willing to expose myself to 10 cents on the dollar of their revenue, $2.5K in MRR. Annually that is $30K, minus a standard annual discount of 20%, you can underwrite those subscriptions and advance the founder $24K that they can use to re-invest in the business immediately. You just put an entire month of MRR on their books, imagine the growth opportunities you can capitalize on when the founders get access to that kind of liquidity. Yes, the investor gets to then collect that $2.5K in revenue each month for 12 months, but at 40% MoM Growth, the following month their MRR should increase by about $9K, paying for the annual cashflow injection in just one month, plus with the correct investment of that $24K, you could even accelerate that growth. Oh, yeah it’s all non-dilutive to the startup too which is a win for everyone.
The best part, this process can be automated, transparent, and smooth. With access to the right data, each month we could recalculate a startup's growth, retention, efficiency, and how much exposure an investor already has to simply let the founding team know how much liquidity they have “unlocked” and can be drawn down without dilution. Another benefit, with operationally-minded GPs behind this kind of investing, the data generated to offer this type of financing would also empower the founders and GP to strategize over the best playbooks for growth, retention, and efficiency which will result in more successful startups in the long-run.
This would also create a return profile for early-stage investors that they never have had before. You are no longer exclusively locked into long-term, risky equity positions. These cashflow injections payout over a 12 month period meaning that funds could both support their founders and generate short-term returns that they could payback to their LPs while they work with their founders to grow and scale the business they are invested in. Could this liquidity lead to more patient investors? Could venture "style" investors back a wider range of startups that fall on different points of the growth spectrum knowing that they can generate returns from more than just unicorns? It is an interesting scenario to think about.