Today we cover Part 2 of Reinventing Venture Capital with Bryce Roberts of Indie VC. In this segment we address:
- What are your filters, what level of traction are you looking for and what else do you like to see in prospective applicants?
- Many VCs target 100x+ exits for success… what does winning look like for Indie and how do you measure success for the fund?
- Do you expect faster returns and liquidity, which will drive better IRRs w/ your model?
- Why do you think others have not employed a similar strategy?
- If we could address any topic in startups/venture, what topic do you think should be addressed and who would you like to hear speak about it?
- What startup investor has inspired and influenced you most and why?
- What’s the best way for listeners to connect with you?
- Indie VC
- Bryce’s Blog
- Bryce on Twitter
- What is Indie VC
- Indie VC version 2 release notes
- Github link to C Corp term sheet
- Github link to LLC term sheet
- Part 1 of the interview
1- The Role of Seed Capital
When Bryce first launched O’Reilly AlphaTech 10 years ago, he asked himself; “What is the objective of seed investing? Should it just be a bridge between angels and series A investors? Or should it create optionality, where the capital can afford different types of options to the founders.”
Those options, as he described them were:
1. The traditional path which is to get momentum, hit the milestones and then raise a subsequent round from traditional VCs.
2. Build something of value quickly and take advantage of early acquisitions from strategics or
3 The ability to continue running the company, as long as the founder would like, if it achieves healthy profitability.
However, what Bryce found is that instead of creating optionality, seed capital actually got startups hooked on this perpetual capital raising path; which reduced instead of increased optionality.
2- Profile for companies that are a good fit for Indie
1. Revenue: Startups with growing monthly revenues. At least 10-20k and even better at 50k. Companies that, when they bring in cash, they know where to invest it to grow
2. Sectors that can be cash efficient… but not sectors that require winner-take-all businesses
3. Primarily software tech or tech-enabled businesses
3- Indie VC’s New Terms & Structure
The standard convertible note anticipates another round of funding. And due to this they have interest rates, maturity dates, discounts and triggers. Indie, on the other hand, came up w/ a note that is indefinite. It does not convert as w/ the traditional convertable.
Indie VC has three main features to their investments:
1. They choose to sell the company, then Indie converts to common stock at a previously agreed upon percentage.
2. If they ever do a fundraising round, then Indie converts to preferred stock at a previously agreed upon percentage.
3. Cash distributions that a founder decides to make will be split between the companies employees and Indie VC, until a return multiple is reached. The way that this works is that a standard industry-rate salary is agreed upon upfront, at the time Indie invests. Then, if the founder ever decides to take more than 150% of that salary, it will be considered a cash distribution. And Indie participates in cash distributions. They will take 80% of all profit distributions made to the founding team and employees, until they’ve recouped 2x of their investment. And they’ll take 20% of profit distributions up to a 5x return on investment. And, finally, if the startup hits that 5x distribution within the first four years, Indie will cut their equity option in half.
Fortunately, Bryce walked us through a hypothetical example:
In this example…
Indie invests $500k in a business.
They agree that Indie receives 10% in the event of a sale or subsequent fundraise
They also agree that an industry standard salary for the CEO is $100k
Now, a few years later the founders want to bonus out $1M to theirselves & employees
Indie VC will receive 80% of that $1M profit distribution, which is $800k for Indie and $200k for the employees. And they will continue receiving this 80/20 split until 2x of the original investment is recouped.
In this case, the original investment was $500k. So, once Indie receives a $1M return, then the percentage flips to a 20/80 split. Then, assuming the $1M is recouped, a future profit distribution of $1M would result in $200k to Indie VC and $800k to employees.
And remember, once Indie as recouped 5x the original investment, there are no more distributions to Indie VC. So, in this case, once $2.5M is returned to Indie, 100% of profit distributions go to founders and employees.
And the last feature, in this example, is if that 5x return is achieved in the first four years, then the equity option is cut in half. So, assuming this business returns 5x to Indie in year three, their equity option, in the event of a fundraise or sale, drops from 10% to 5%.
Tip of the Week: Hidden Opportunities & The Best Kind of Pivot
Nick: Can we talk a little bit about the companies that you’re choosing for the, for the investments? Can you talk maybe about your filters, what level of traction you’re looking for and what else you like to see in prospective applicants?
Bryce: Yeah, sure. So, so the first group of companies we chose, it was kind of a cohort or a batch of companies. I’m always reluctant to say batch because I think that already forces you into this idea of an accelerator or incubator. And it was one thing we really, we really, really tried hard to avoid all the way down to, you know, most accelerators or incubators make you move to the Bay area or move to their headquarters. And we have a philosophy of great things are going to happen everywhere and that you should bloom where you’re planted. And, and that if you are somewhere non-geographically in the Bay area that you actually end up getting massive amounts of leverage and having a partner like us who has access to those networks that you wouldn’t have otherwise. And so initially we, we looked at a bunch of different types of companies, both in terms of sectors and in terms of stage. I would say really with the idea that we wanted to be able to learn from as a wide a group as possible. So then for V 2 we’d be able to be much more explicit about categories or stages. I think what became really clear early on was that companies with some amount of revenue, 10K, 20K a month, were so much more advantaged and got so much more out of the initial program and the capital even, that it was just obvious to us that things that didn’t have any revenue coming in just weren’t getting the same kind of bank rebate. The other challenge with things that didn’t have much revenue or any revenue coming in is they tended to fall back on fund raising to solve their, you know, to solve their cash crunch.
Bryce: versus kind of turning the customers. And so there were a few instances early on where, you know, some companies who hadn’t had revenue or maybe had been through an accelerator but didn’t have a whole lot of investors involved, the, the fast twitch muscle memory was always to, you know, kind of go back and, and try to raise another 200K or 500K or whatever that was. And so that was something we were really trying to avoid. You know, so much so that in the first year that we were working with these companies, meeting with them, having bi-weekly calls and quarterly meet ups, not one time did we ever go through investor presentations, not ever did we talk about strategies for attracting VCs, not ever did we go through our rolodexes and figure out who the right investors were to get them introduced to. We were solely focused on getting them to profitability and sustainability. You know, what we would consider kind of market salary profitable, where they can pay themselves a reasonable salary without being dependent on another round of funding.
Nick: It’s a pretty
Bryce: And so
Nick: substantial shift.
Bryce: Yeah, it was. It was a big shift for them and it was a big shift for us as well. So I think where we’ve kind of shaken out with V2 is we’re saying at least 10 to 20K a month in revenue. We may have even said 50K a month in revenue. But I don’t, I think we still said 10 to 20. We just want companies who, you know, when they, when they bring in a little bit of cash they know exactly where to invest it again. So one of the companies we invested in in our V2 is a company called #Cotton Bureau. #Cotton Bureau has been bootstrapped. It came out of a professional services company. They’re doing multiple millions in revenue. They are profitable. But there were, you know, there were these kind of paying points they had or these opportunities they weren’t able to capture out of their own cash flow. And, you know, the founder there wrote a great blog post about their decision to work with #Indie VC. They turned down and had not pursued venture for so long, they wanted their customers to understand the relationship. And he had this, he just made a great point that when you’re already profitable, a little bit of free cash flow, a little bit of extra money can actually go a long way to exploring and accelerating different opportunities. And I think we, we, we’ve really seen that. I think we’ve gotten our religion around that in terms of the companies that we’re looking for, at least in our V2. And then, you know, the first version we ran for a year. V2 will run for a year, and after a year we’ll step back and we’ll look at the results of this version to see whether some of those assumptions were right. I mean, I think #Indie VC has always been thought of from our stand point as an experiment that’s a way for us to explore an opportunity space but not be prejudiced about how we, how we get there. And so, so revenue is one thing we’re focused on in V2. There’s no magical number but we at least need to see tens of thousands of dollars in revenue that, that folks are generating already. Sectors that can be cash efficient, whether it’s overlooked sectors in software, whether it’s overlooked sectors in e-commerce, there’s a lot of sectors that come in and out of favor in venture. And we think that oftentimes they get overlooked because there’s this belief that these are winner take all markets, and once a winner has been declared there really isn’t any opportunity left for anybody else. But I think history has a funny way of showing that there is a lot of winners that come behind what’s originally perceived as a winner when VCs lose interest. And so those are categories we’re interested in. I’m reluctant, as you can probably hear, to say specifically we want SaaS businesses, we want these kind of businesses. I think that profile we still want to really be able to explore because I don’t know that we can say today or even that we would want to say what those might be. Because any kind of box you might give to an opportunity leaves a lot of others on the outside of it. And I think we’re trying to give ourselves appropriate constraints around our models without necessarily ruling out or being dogmatic about what does or doesn’t fit in it.
Nick: I imagine you’re targeting mostly tech businesses but I’ve
Bryce: Yeah, so, so that’s fair, yeah, I would say, you know, we, we want businesses that are tech or tech enabled. I think there’s probably lots of people who can make money on yoga studios. I just don’t know that our network leads, you know, to the most value for, for those folks, and that we can be nearly as helpful. So when I, when we look at what we want to be able to bring to these companies, it’s, you know, it’s the thirty years of #Tim’s relationships, it’s the 15 years of, of my venture experience and relationships, it’s you know all those years of working with entrepreneurs on product and decision making. And, and most of those are probably better tuned to technology or tech enabled businesses than, you know, say a restaurant or some of those, some of those other types of firms.
Nick: Sure, understandable. I mean one of the, the interesting non-tech things that came across my desk a couple years ago was a company that was producing inventory all by hand, so producing hardware. It was a successful brand, they had multiple millions in revenue but they had no automation set up. And they wanted to automate the process, produce more inventory and the banks wouldn’t lend them money, they weren’t big enough. So they had no access to capital. But, you know, VCs, it was not investable for VCs.
Nick: So fortunately that’s not tech of course, but there’s, there’s a place for companies like that that can share in the cash flow and share in the distributions, but can’t afford maybe a million dollar cap x out front.
Bryce: Well, it’s, yeah it’s been really fascinating. I mean, I think when we originally published the site, there were a lot of people who were quick to say #Indie VC is out to disrupt venture. And I, you know, I always stay really quiet when it comes to conversations about venture or what our ambitions are or what our grand plan is because it doesn’t really do anybody a service. I would say, you know, one of, one of the push effects we had early on was like wow this feels pretty expensive specially compared to banks, and if I’ve got a profitable business, if I’ve got an ongoing concern I can just go and get a bank loan. Our answer is generally like good luck, like go try that. I think we, you know, most of the companies we’ve talked to, like banks just simply don’t lend. And so I think, you know, where we established #OATV early on as that kind of filling a gap that’s out somewhere between angels and, and VCs, I think as much as I don’t like it, just because of the framing of it and there’s probably some reframing of it, we’re going to have to do but, you know, there’s, there’s probably some gap that sits between traditional banks and, and VCs that potentially #Indie VC fills. I mean, I think a lot of the lending platforms we’ve seen that have been targeted at small and mid size businesses, their effectively just a front end for banks. Their job is essentially to initiate loans and then package those loans up to large financial institutions to buy them in the same way that they used to buy mortgages, right, or they still buy mortgages. I think many of those services kind of have that aspect to it. And so that’s, that’s why we really try to steer clear of anything that sounds or looks like that. But, you know, we do think there is a huge, huge untapped group of founders and companies that are either wary of VC, that don’t fit the pattern but that could benefit wildly from a little bit of cash and a lot of, a lot of connections and oversight and, and peer group for building what it is they’re setting out to build.
Nick: Sure. So #Bryce, most VCs are targeting 100+ exits for success. What does winning look like for #Indie and also how do you measure success for the fund?
Bryce: I think, I think success for us looks like entrepreneurs building companies on their terms independent of where or what people want or need them to be building. And I think if we’re successful in doing that, I actually think we’ll end up having wildly outsized returns. When, when we got started, one of the things that influenced our thinking at least in terms of how we’re looking at our portfolio of companies is there was a, a site that the #Basecamp team did a while ago that was called #Bootstrapped, Profitable & Proud.
Bryce: And I think that site, if you google that, I think it’s still around. But it was a site with about twenty to thirty companies on it. Most of the companies you probably haven’t heard of. But the profile of the companies was interesting. It was companies who, who had achieved a million dollars or more in revenue without having to take outside funding. Now as you pick through the companies, you’ll see, like I said, most of you probably haven’t heard of the bootstrap businesses. They aren’t seeking a whole lot of press or outside attention. But in that group of 20 to 30 companies what you’ll also see is, are companies like, like #Braintree that, that #Paypal ended up buying for $850 Million. You’ve got #GitHub in there that #Bootstrap in their first round of institutional VC funding, they took it close to a billion dollar valuation. You’ve got companies like #WooThemes that ended up getting bought by #Wordpress for, you know, $75-80 Million in revenue.
Bryce: You’ve got, you know, companies that have gone on to raise from large VCs to later stage, you’ve #BigCommerce, you’ve got #Campaign Monitor, you’ve got I think #Atlassian was on there which, you know, which went public last year. So, I mean, you know, I think what a lot of people want to frame us as has been, you know, we’re looking for small outcomes, we’re looking for companies that VCs wouldn’t be interested in. And as a result like, you know, we, you know, where this is more, more charity than, than seeking return. But I’ll tell you what. If you, if you held up that, that site, that portfolio, you know, if #Bootstrapped, Profitable & Proud were a portfolio company, it would be a top decile fund.
Bryce: And at the end of the day, that’s, that’s, that’s what we want to do. We, we don’t want to limit entrepreneurs upside or ambition. But we also want to be pragmatic about it as well. We want to recognize that some of these things don’t fit the hyper growth raising every 12 to 18 months in category, you know, in VR, in AI, or whatever it is that VCs are really excited about these days. Some of them just take time, they take nurturing. And, and they, their businesses would be shakier, less well equipped to scale if they’re on that kind of VC treadmill. And so I think for us we hold ourselves to the same return benchmark that any other VC fund holds theirselves to. We just, rather than focusing on valuations and amounts of money raised and so much of that that’s kind of been hard-coded into entrepreneurship right now as a way to measure what someone’s ambition is. We want to support entrepreneurs on their terms. And we want to recognize that, you know, our fund size and structure is one that lends itself to a multiplicity of return scenarios. And that as long as we can support entrepreneurs in building what it is they’ve set out to build and allowing them to have the impact on themselves, their employees, their families, and the world, if we can support them in doing that and put them in a position and focus them and putting them in a position where they aren’t relying on anybody but themselves and their customers, that’s a pretty solid foundation to build a business on. And we think from an investment standpoint, it’s an amazing place to be able to, to find returns. And, you know, I think that venture often loves the idea that returns are found where other people aren’t looking or fishing in ponds where other people aren’t. And, you know, we’re just, we’re finding our own pond here. We want, we’re just fishing over here quietly, trying to find people and, and products and ideas that resonate with ours. And, and I think if we can do that and can help support founders in doing that, that the returns will follow from there.
Nick: Well, based on your comments, it seems that not only will you compete in the absolute return sense in the IRRs but you also introduce a little liquidity here that you never hear about in venture capital and has become a, a big challenge for LPs and other investors. But with your model it seems like you’re getting some sense of liquidity during the investment timeframe that others won’t.
Bryce: That’s, you know, that’s the hope. I mean, we’re, you know, we’re, we’re still deep in the experimental stages of this. But that’s the hope, right? The reality is if as we model our fund, if 20% of the companies we fund return just on distributions, that returns the whole fund. That means all of those equity options we have and, you know, a portfolio of say 50 to 60 companies, that’s all gravy, that’s all upside. The, the, the returns could come from, you know, those cash distributions and we’d be perfectly happy if that were the case.
Nick: So why don’t you think anyone else in the venture community has employed a similar strategy to what you’re doing?
Bryce: They’re a lot smarter than I am probably. I’m still open to
Nick: I appreciate the humility.
Bryce: It might be a really bad idea and everybody else is.., but you know, it’s been interesting. I mean, last year everybody looked at me and was like dude why are you doing, why are you doing it, why would you want to back these kinds of companies? And this year they’re coming back and saying like ah ok I get it, I get why you’re doing this. And, you know, I think that, that goes back even, you know, there are so many parallels to the early seed stage stuff, where, you know, when we went to talk to VCs which in their early days as seed, VCs were 80+ percent of our deal flow, right, was coming from VCs. And it would come to them because we would go and we’d say look, you’re taking meetings all day long with great entrepreneurs. During the day, during these meetings, you’re going to find people and you’re going to say look, this is just too early for us. Like you just need another year, you need a little bit of cash to make a, you know, to prove out a few things, and then, you know, then you’ll be ready for us, right?
Bryce: And so, seed investors benefitted wildly when VCs weren’t making seed investments. And we benefitted from the idea that there were things that were just too early for for VCs, right? And now I get to have those same conversations, but the conversation is look, if you sit in these meetings all day, you’re hearing great entrepreneurs, and all day long most of the time you’re thinking this isn’t a billion dollar company. When you have that thought or idea, those are the people we want to talk to, right?And there’s an, it’s, it’s been interesting for them to start connecting those dots on what are the parallels between seed investing? Who’s the fit for us? Why this might not be a crazy idea? And why there might be a lot of things that could generate outsized returns that they just simply can’t invest in because it doesn’t look like a billion dollar company.
Bryce: It doesn’t look like it has a monopoly potential. And so, I think that creates a unique opportunity space first. But I think they’re also really wedded to an existing business model. There’s just a lot of incentives that are baked into the whole stack of venture from, you know, from the firm to the GP to the, to the LPs. You know, there’s a diabolical word I use or term I use, which is called the entrepreneurial industrial complex. But there really is. There’s a lot of, there’s a lot of parts that are moving and incentives that are in place for people to not really change up how they’ve been doing business. And I think that created the seed opportunity 10 years ago. And, you know, my hope is that at least for the next 3 to 5 years that that same inertia problem allows us to, to create an opportunity space for us and for entrepreneurs. And then when it’s obvious, we’re going to be happy to, to share it. But I mean it’s already happening. I mean, I still field several calls a week and a bunch of emails a week from people who are looking to use our terms, that want to understand how they can implement #Indie VCs style of investing into their current firms. If we’re open to co-investing in V2 so that they can get a better feel for, you know, the types of companies and the return profile of them. And, you know, look, we’re all for it. Like the more different styles of investment that are available to entrepreneurs, I, I think , I think that’s a great opportunity. And so we’re, we’re not being prejudiced about it. We’re publishing everything we’re learning, we’re publishing our term sheets. We would love to see more and more people investing this way. I just think the incentives are in place and the structures are in place that make it really difficult for a lot of VCs to shift to this style of investing. And I’m very much open to the idea that this style of investing is just not a good way to do it. And, and that, you know, over the long term , you know, they, they may be right and I may have, may have fools bet on, on, you know, betting the future of our firm around it.
Nick: I doubt it. And I bet you’ll have your answer sooner than, than most funds do. But,
Bryce: I hope, well I appreciate that.
Nick: #Bryce, if we could cover any topic related to startups or venture, what topic do you think should be addressed and who would you like to hear speak about it?
Bryce: Oh man. Who would I be most be interested in talking to? I think that, I think #Aileen Lee would be fascinating.
Bryce: I think that if you could get #Jerry Collona to stop coaching and talk about his experience of VC and how that has shaped him, I think it would be, I love #Jerry, he’s, he’s been one of my great mentors and he’s carved out a really powerful niche for himself. But, you know, #Jerry is so humble and understated. And you, you know, I think very few people know what a powerhouse of an investor he was. And I, I think if you could get him to open up and talk about that, I, that would be an amazing conversation. #Craig Shapiro of #Collaborative Fund, I think that team is really, really pushing the envelope, and I think you’re going to see them push the envelope in terms of investing and investing styles. Who else, I don’t know, is that helpful? I mean,
Nick: Yes, it’s a, it’s a great list. So #Bryce, what startup investor has inspired and influenced you most and why?
Bryce: Startup investor who’s influenced me most…probably, this happens all the time but it happens for a good reason, and that’s probably #Fred Wilson. You know, when we were starting #OATV in 2005, my partner #Mark and I were in New York and we met up with #Brad and #Fred right as they were finishing their fund. And despite them being wildly successful now and that fund being, you know, probably in the hall of fame in terms of total returns, they, they just got their teeth kicked in while they were trying to get that fund up and going. And, you know, so we had this kind of shared camaraderie and history together. You know, #Fred has been a co-investor with us in a lot of things. He’s been a sounding board for me as I’ve made some pretty counter intuitive and challenging decisions in my own career. He was one of the very first people early on when I talked to him about #Indie VC. He was the first person to tell me it was a terrible idea. He was the, one of the first people to write me a cheque as an LP. And, you know, he just had a tremendous influence on me shaping my thinking and just even though we don’t hang out a ton, the time we do spend together and the interaction we have I would say had a huge impact.
Nick: And then finally, what’s the best for listeners to connect with you?
Bryce: Oh man. I am, I’m on #Twitter. I was looking up early on to even though we didn’t get to invest in #Twitter, I at least got the handle or the username @Bryce
Bryce: I’m @Bryce on, on #Twitter. I occasionally write and I would like to write more, you know, I’m a pretty sporadic blogger at bryce.vc . You can follow my family of ventures on #Instagram. I’m also @bryce on #Instagram. Another big miss but for very different reasons. And then I’m okay on email, I’m not great on it, so I won’t say like hey everybody if you send me an email I’ll reply. But if you send me an email, I’ll see it and if it’s interesting I might reply. So I’m just email@example.com and that’s b-r-y-c-e.
Nick: Awesome. Well I’ve been admiring you for a long time #Bryce. I’m also someone who has a brother who’s the smart one in the family. So, you’re not alone in that regard. But that, thanks so much for sharing the time and, and going deep on #Indie VC today.
Bryce: Anytime, #Nick. Thanks. It’s been great getting to know you as well.
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