A new wave of Alternative VCs are emerging who are using creative investing structures with some of the upside of traditional VC, but some of the downside protection of debt. Many are reporting that they’re seeing a more diverse pool of applicants than traditional equity VCs… even though virtually none have a particular focus on women or underrepresented founders. In addition, their portfolios look far more diverse than VC industry norms. I’ve been a traditional equity VC for close to a decade, and I’m now researching new business models in venture capital. I have been impressed by how these venture capitalists are accomplishing a major social impact goal…without even trying to.
By Alternative VC, I mean Revenue-Based Finance, Flexible VC, and other new models of VC designed to better align incentives between investors and founders.
This essay is part of a series on alternative VC:
I: Revenue-Based Finance: a new option for founders who care about control
II: Who are the major Revenue-Based Finance VCs?
III: Why are Alternative VCs investing in so many women and underrepresented founders?
IV: Should your new VC fund use Revenue-Based Finance?
V: Should you raise venture capital from a traditional equity VC, Flexible VC, or a Revenue-Based Finance VC?
VI: Revenue-Based Investing: State of the Industry 2020
VII: Flexible VC, a new model for early-stage capital-efficient growth companies
VIII: The Leading Flexible VCs, with structures between equity, debt, and Revenue-Based Finance
I contacted every Alternative VC investor I could identify, and learned:
- John Borchers, Co-founder and Managing Partner of Decathlon Capital, reports that “37% of our portfolio companies would be considered ‘impact’ qualified companies. This includes companies that would meet most institutional definitions for impact investing (women, minority, and veteran owned/run businesses, including LMI (“Low to Moderate Income”) and CRA (“Community Reinvestment Act”) qualified companies. … While we do lots of work in these areas due to the attractive opportunity set, we are not an impact investor, and impact qualification is not a criterion that we use in evaluating or funding companies. On an organic basis, 13% of our portfolio companies are women-owned or run businesses, while 19% of the companies we work with are minority-owned or run. When you look at the composition of the entire founding or executive teams, the number of companies with either a woman or minority in management jumps even higher and is north of 50%.”
- Indie.VC reports, “…50% of the teams we’ve funded are led by female founders and nearly 20% are led by black founders.”
- Lighter Capital reports that they’ve funded companies in 30 states, including well established startup hubs and less mature ecosystems.
- According to Derek Manuge, CEO of Corl, in the past 12 months, 500+ companies have applied to Corl for funding. Of the ones who received capital, “30% were led by women, and 40% were led by executives of non-Caucasian or of mixed ethnic origin.”
- Feenix Partners reports that “35% of our portfolio companies have either a female or minority (non-Caucasian) CEO or Owner.”
- Michelle Romanow, co-founder and CEO of Clearbanc, says that “We have funded eight times more women than the venture capital industry average – probably because we’re not doing meetings, which is an amazing accomplishment, and that’s not because we do different sourcing or anything else. It was just because we looked at data.”
- Founders First Capital is the only RBF VC I’ve identified with a specific focus on underrepresented founders. Kim Folsom, Co-Founder, reports that as of August 2019, Founders First’s portfolio was 80% women and 55% women of color; 70% people of color; 20% military veterans; and 71% located in low/moderate income areas. 85% of their companies have under $1m in annual revenues. I can also announce exclusively that according to Kim Folsom, “Founders First Capital Partner (F1stcp) has just secured a $100M credit facility commitment from a major institutional impact investor. This positions F1stcp to be the largest revenue-based investor platform addressing the funding gap for service-based, small businesses led by underserved and underrepresented founders.”
By contrast, according to PitchBook Data, since the beginning of 2016, companies with women founders have received only 4.4% of venture capital deals. Those companies have garnered only about 2% of all capital invested. This is despite the fact that the data says that in fact you’re better off investing in women. Paul Graham observes, “many suspect that venture capital firms are biased against female founders. This would be easy to detect: among their portfolio companies, do startups with female founders outperform those without? A couple months ago, one VC firm (almost certainly unintentionally) published a study showing bias of this type. First Round Capital found that among its portfolio companies, startups with female founders outperformed those without by 63%.”
Why are Alternative VC investors investing disproportionately in women & underrepresented founders, and vice versa: why do these founders approach Alternative VC investors?
I’d argue it’s not that Alternative VC is so unbiased and attractive; it’s that traditional equity VC is biased structurally against some women and underrepresented founders.
The Boston Consulting Group and MassChallenge, a US-based global network of accelerators, partnered to study why “women-owned startups are a better bet”. Through their analysis and interviews, BCG identified three primary reasons why female founders are less likely to receive VC funds. The study used multivariate regression analysis to control for education levels and pitch quality to conclude that gender was a statistically significant factor. I argue that these 3 reasons are much less applicable for Alternative VC investors than for conventional VCs.
- Less need for a belief in breakthrough technology. From the study: “More than men, women founders and their presentations are subject to challenges and pushback. For example, more women report being asked during their presentations to establish that they understand basic technical knowledge. And often, investors simply presume that the women founders don’t have that knowledge.” However, companies with a focus on early profitability are less likely to require an investor to believe in complex, hard-to-predict new technology which is hard to diligence. Instead, the company can pitch itself based on a credible financial projection.
- Realistic projections. “Male founders are more likely to make bold projections and assumptions in their pitches,” BCG observes, while, “Women, by contrast, are generally more conservative in their projections and may simply be asking for less than men.” However, to raise Alternative VC a woman founder does not need to promise a valuation of $1 billion within 5 years. Rent the Runway co-founder and CEO Jennifer Hyman said in a recent interview with CNBC’s Julia Boorstin, “I haven’t been given the permission or privilege to lose a billion every quarter…I’ve had to bring my company towards profitability…”
- Concentration in consumer/branded products startups. BCG reports that, “Many male investors have little familiarity with the products and services that women-founded businesses market to other women”—especially in categories such as childcare or beauty. However, Alternative VC investors report that they see a lot of proposals for ecommerce and consumer packaged goods geared to mothers. Meghan Cross Breeden, Cofounder of Amplifyher Ventures, observes, “Personal customer attachment shouldn’t be a factor in investing; the early investors in Snapchat and Facebook weren’t the Gen Z target demo. Rather, I would imagine that one explanation of women garnering rev-share modes of financing is the prevalence of women-led companies in the consumer/branded goods field, which systemically is more tangible and revenue driven. Therefore, there’s more revenue to share – as opposed to the typical venture business, which requires capital upfront before a J curve of growth.”
Traditional equity VCs are looking for high-risk, high-reward, “swing for the fences” models. The founders of such companies inherently are taking financial risk, reputational risk, and career risk. Paul Graham, co-founder of Y Combinator, said, “few successful founders grew up desperately poor.” Ricky Yean, a serial founder, agrees: “building and sustaining a company that is “designed to grow fast” is especially hard if you grew up desperately poor”.
Most of the founders of the paradigmatic VC home runs were privileged: male, cisgender, well-educated, from affluent families, etc. Think Bill Gates and Mark Zuckerberg. That privilege makes it easier for them to take very high risk. The average person, worried about students loans and long term employability, quite rationally is less likely to take the huge risk of founding a company. It’s far safer to just get a job.
Chadd Hunt, Director, HiGro GROUP, said, “As a minority-led private equity firm, we experience the same dynamic that other diverse and women founders face. That is, the need to show a higher bar than our counterparts who may not be diverse and/or women-owned. The preference for revenue is the output of two distinct messages: (1) This is evidence that I am good enough and / or (2) I am good enough so I will build my own and generate revenue, rather than continuing to face the challenge of overcoming biased hurdles.”
Investors who back diverse teams can win much higher returns than the industry norm. Both Alternative VC investors and the founders they back will hopefully benefit from this pattern.
For further reading
Bullish on indie.vc: Why its new funding model may just find product-market fit with female founders
The Weaponization of Diversity: Why the great majority of entrepreneurs come from privileged backgrounds
Why are venture capitalists (76% white men) ignoring the future?
Getting Rid of Gender Bias in Venture Capital
Gender diversity as a driver of sustainable profitability
Companies with more female executives make more money—here’s why
Why women-run startups produce more revenue
Diversity In Venture Capital: In the U.S., It May Be Getting Worse
I contributed this as a guest article on Techcrunch. Note that none of the lawyers quoted or I are rendering legal advice in this article, and you should not rely on our counsel herein for your own decisions. I am not a lawyer. Thanks to the experts quoted for their thoughtful feedback.
