It’s a great time to be an entrepreneur. The pace of change is continuing to accelerate and startups all over the world are disrupting industries to make processes more efficient. With this trend, we are seeing an incredible uptick in the diversity of ways to fund a startup.
Previously, an entrepreneur’s choices were limited: bootstrap or raise funding. Raising funding could be done by going to a bank, seeking out the three Fs (family, friends and fools) or raising the money from an external investor such as an angel or a venture capitalist (VC). These options have been analyzed to death so I’ll quickly skip to the newer (and more interesting) models that are starting to take hold.
First off, we’ve seen the advent of crowd-funding sites like Seedrs that allow masses of people to invest in startups that interest them in exchange for equity. (It’s similar to Kickstarter, only the “backer” gets a small equity stake in the startup.)
While there are negatives to this system [1. Usually the crowd funding platform organizing the transaction gets the right to vote on behalf of the masses. While this is less than ideal and likely a turn-off to many experienced angel investors, it’s a small price to pay for the benefit of efficient logistics.] it’s a fantastic alternative for startups and investors. From the perspective of the founder, they can raise money and get some initial market validation. (If they successfully raise funding, they’ll likely have their first customers lined up as well.) From the investor’s perspective, it can be alternative way to dip one’s toe into a new asset class.
After crowd funding, we have the often-fallaciously-interchanged accelerator and incubator models. An accelerator brings in outside teams to support them with mentorships and resources for a finite amount of time in exchange for an often single-digit percentage of equity. This model makes sense for a lot of teams that are already gaining traction but need help navigating their way to product market fit. Additionally, an increasing number of accelerators are starting to specialize in specific industry-verticals that can provide incredibly valuable resources to startups that fall under that umbrella.
An incubator on the other hand develops ideas from the inside and hires an outside team to execute on that idea. If the idea works, the outside team will usually get a portion of equity. If not, the team is sent on their way.
Accelerators and incubators each have their positives and negatives, but it’s important to note that there is very little proof that most accelerators and incubators work. For many of them like YCombinator and TechStars with easy to find track records it’s clear to quantify value, but some of the lesser known programs should be thoroughly researched before committing.
Finally, we come to what I’m going to call the “Startup Foundry” model. (Full Disclosure: I’m an Entrepreneur in Residence at Forward Labs in London where we are using something similar to this model. The opinions in this essay are mine and mine alone, not necessarily that of Forward Labs.)
The Foundry model is similar to an incubator, except that it invests in people instead of ideas. The critical flaw in the normal incubator model is that nobody knows how many iterations through customer discovery and customer development it’s going to take to get to product market fit. Plan A is most often thrown out and it’s usually Plan F or J or Z that ends up working. So the Foundry model brings in entrepreneurs, provides them with the similar support that an incubator or accelerator would provide, but allows the entrepreneur to come up with the idea [2. With some assistance] and to iterate through to profitability.
The Foundry model provides the entrepreneur with equity, all of the resources they need and continuous funding as long as the partners feel the entrepreneur is making documentable and real progress towards a profitable startup – using metrics developed and agreed upon between the partners and the founder. The Foundry assists the entrepreneur with many of the time-consuming activities that don’t always directly contribute to creating a great company, leaving the founder to concentrate on what truly important matters: building a profitable startup.
The founder needs to be disciplined about documenting lessons learned and, if progress is not being made, the idea is scrapped and the entrepreneur finds a new idea where they can leverage the learning from the previous venture. The constant cycle of learning and progressing in the Foundry model is the closest thing to Malcolm Gladwell’s “deliberate practice” that I’ve seen for entrepreneurs in the startup ecosystem.
All of this being said, there are negatives for the entrepreneur and the investors. In the Foundry model, the entrepreneur will have a minority equity stake in the startup, meaning that “success” could end in a substantially different result than if the founder had bootstrapped, and the founder doesn’t have control of the board. This risk can be slightly mitigated by doing due diligence into the organization and questioning past entrepreneurs that they’ve invested in, meeting with the partners and getting a general feel for what their intentions and goals are.
From the investors perspective, the model falls apart if the entrepreneur is not learning. It’s a great vision to say that we’re investing in the person instead of the startup. And if the entrepreneur is actually learning from their mistakes this has a high probability of success. But if the entrepreneur is not gaining an advantage from lessons learned – the model is unlikely to work as the founder will likely continue to make the same mistakes over and over. This makes the selection of entrepreneurs the most critical component for success.
No investment model is perfect for every investor and entrepreneur. Every model has positives and negatives based on a variety of factors such as funding needed, entrepreneur experience, market, idea, etc. If an entrepreneur thinks they can grow organically and aren’t concerned with rapid scaling requirements, bootstrapping may be best. If the entrepreneur has already proven the market but knows that they’ll need capital for scaling and competition, VC might be the most profitable route. Regardless of the stage of the startup, it’s great to see that investors and entrepreneurs alike have access to more alternatives than ever before.
In the upcoming decade, I anticipate an ever-increasing number of Foundry models being formed around the globe as it does an incredible job of aligning the interests of the entrepreneur with the investing entity. A byproduct of this proliferation will be teams of people that can execute with a quiver of past learnings like no model before it.