Investing in the Other 95% of Startups


Less than 0.4% of American startups are funded by venture capitalists. We know this thanks to the measurement and reporting of the venture capital industry and the Kauffman Foundation. 2,000 companies were reported to receive their first round of venture capital, out of a bit more than 500,000 new companies created annually. (Both of these are U.S. statistics).

Investments by Angel investors are not accurately measured, but analysis estimate that another 15,000-20,000 companies receive some funding from Angels each year. That would, at the higher end, be another 4%.

Round this up to 5% and flip it over, and what we discover is that 95% of companies are not following the path paved in dollars, and as such, are rarely covered by the business news, which for early-stage startups covers funding as central stories.

What becomes of these 95%?

Mostly we don’t know. What we do know is that two thirds of all IPOs are by companies that grew without venture capital or major Angel funding. What we also know is that half of those 500,000 startups are gone by three years, but flip that statistic around and note that half of those 500,000 startups are not dead, but still operating.

What catches my eye in that statistic is the old lesson from Mark Suster of elephants, deer, and rabbits. Consider venture capital as a business, with startups as their customers. In that frame, VCs are focused even more than elephant hunters. They are unicorn hunting. Meanwhile, the Angels, copying the VC strategies as best they can are elephant hunting. The question then is how to be an investor and deer hunter?

For hunting unicorns and elephants, the 1 in 10 success rate works, at least for those investors that manage to successfully hunt their prey. For deer hunters, however, that model simply won’t work. Run the numbers on the traditional equity investment model, and the returns are negative without that one 10x return.

However, switch to a revenue-based investment model, and suddenly deer, rabbits, and mice can all make money. With a revenue-based investment, returns are based on companies earning revenues, not on high growth rates, winner-take all markets, and most of all not on fleeting valuations of acquisitions. To succeed at revenue-based investing requires picking companies that will use the funds to grow revenues and continue to operate.

Back to the eye catching stats, the opportunities for investors are enormous. A market exists which contains 95% of all companies, which other investors are shunning as “uninteresting” and “uninvestable”.   I say that it is the investors who have it wrong. With this insight, I’m now hearing “not ready for investors” to actually mean, “not an elephant”, and walking away from each of those conversations wondering what revenue-based terms can earn me a profit as an investor.

A few pioneers have already noticed this market, and are serving these unserved, unfunded companies. Lighter Capital provides revenue-based loans to bootstrapped, profitable, tech companies. Fledge, my “conscious company” accelerator uses revenue-based equity investments in each of its “fledglings”. And one of my fledglings, Community Sourced Capital has combined this idea with a form of financing that seemed crazy not too long ago, crowdfunding.

Investing in unfunded companies does have a bit of a craziness to it too, but I’ve no doubt that before too long investors will discover this unserved 95% of startups, and find new ways to serve and profit from funding them too.

By "Luni"


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