Imagine you have organ failure and your doctors are focused on lowering your fever - you might feel better for a while, but how long will it keep you alive..?

Global warming is no small symptom in our climate crisis, and the work being done to tackle it by lowering carbon emissions is incredibly important - but it remains a symptom of a much wider and more wicked problem: the systemic degradation of nature.

Ecosystems are our planet’s vital organs. They can take some damage and recover, but if we push them too far they start failing.

Deforesting the Pantanal, the world’s largest tropical wetland region, is equivalent to damaging your kidneys. You may not feel it right away, but everything downstream suffers — fluid retention, toxicity, collapse.

Climate extremes like droughts and floods are not isolated events.

They’re consequences of failing ecosystems due to nature degradation — they carry real costs for investors.

Brazil 2024
While half a million people were displaced by catastrophic floods in Porto Alegre, the Amazon basin experienced one of the worst droughts in its recorded history.

Two extremes, one underlying cause — the collapse of Brazil’s “flying rivers”. These atmospheric rivers — vast corridors of moisture moving from the Pantanal wetlands and Cerrado savannah to the Amazon rainforest — depend on healthy, forested ecosystems to function. When wetlands and savannahs are degraded or cleared for cattle or soy, these ecological pumps break down. Rainfall patterns become erratic.

The result? Drought where there should be water; floods where there should be balance.

The floods alone caused over $15 billion in economic losses.

Investors with exposure to Brazilian infrastructure, agribusiness, real estate, etc. felt it.

So yes, we do have a carbon problem — but the real risk lies deeper.

Protecting a wetland in the Pantanal might not look like a traditional investment — but it could be a smart move to safeguard assets across Brazil.

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The Market Failure Behind The Organ Failure

We’ve been living under a myth that nature is infinite, or rather infinitely self-regenerative.

Many people have come to understand this is not the case, but our financial markets and economic structures haven’t yet caught up with reality.

Take any piece of land or ocean anywhere in the world today and ask a human to make it work for their families, communities, or shareholders. Here are their options:

Hunt & Gather ($31.1 Trillion)

• Clear it to produce food — $5 T (McKinsey)

• Mine it for minerals, metals, sand — $1.9 T (The Business Research Company)

• Log it for timber, charcoal, wood products — $1 T (Grand View Research)

• Build infrastructure, real estate, roads — $15 T (Expert Market Research)

• Extract oil, gas, or fossil fuels — $6.7 T (Kings Research)

• Fish it — $567 B (The Business Research Company)

• Hunt wildlife — $667 B (Coherent Market Insights)

• Pump water — $303 B (Zion Market Research)

Protect & Restore ($244 Billion)

• Ecotourism — $219 B (IMARC Group)

• Land-use carbon credits — $25 B (Global Market insights)

Can you see the problem?

Now - can you see the market opportunity?

Schumpeter taught us that every collapse in the old economy opens space for a new economy.

Every free ride nearing its ends is a market waiting to be built.

Assign value to anything and markets organically grow around it:

• NFTs

• Smooth skin

• Monthly users, clicks and eye balls

• Labubus

• Baseball cards

• Carbon Capture..!

Assign value to ecosystem health and people will intuit and engineer new business models, technologies, professions, laws etc around it.

The Rise of a Nature Economy

We’re at a turning point in history.
Geopolitics are shifting.
AI is rewriting the rules of work and value.
The old systems are cracking.

A revolution is already underway, and given how deeply we depend on nature, it can only play a central role in it.

Once we assign financial value to ecosystems based on their health — not just their extractive potential — we’ll experience the rise of a different sort of nature economy:

• Natural ecosystems on balance sheets as living, productive assets, measured on their overall health.

• Landowners with financial incentives to track, protect, and enhance that health.

• Entire professions that emerge to protect, improve and verify ecological performance.

• Governments designing tax incentives and legislation to reinforce ecosystem health.

• Nature stewards, landowners, and investors rewarded for conserving, protecting and supporting the regeneration of these ecosystems.

If you think I’m crazy, I’m not alone!

There are many of us dedicating our time and investing our capital in the rise of a new nature economy:

• 🌱 The Landbanking Group has raised $11M from four funds and ten family offices to build a “bank for nature.”

• 🌳 The Intrinsic Exchange Group convinced the NYSE to list nature asset companies based solely on ecological attributes — until Republicans blocked it.

• 🌾 Across the U.S., people are “ensuring”, rather than insuring, nature on ensure.app, based on the natural capital value of ecosystems beyond their real estate value through BASIN.

• 🦘 In Australia, an investment banker and founding director of New Forests created InvestConservation to tokenise carbon and biodiversity for conservation finance.

• 🐆 High-net-worth investors from around the world are investing in |XAU’s first nature assets in Brazil, protecting jaguars and hyacinth macaws from extinction.

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Why We Can’t Rely on Carbon

Remember the fax machine? Truly incredible technology that revolutionised the transmission of written documents..!

Pioneer solutions aren’t failures because of their limitations — they’re stepping stones. Bridges into the future.

So, what are the main limitations of today’s carbon markets?

1. Cost and complexity - Carbon projects often require over $200K in feasibility studies and technical documents (PDDs), with timelines stretching months or even years before there’s clarity on whether the project is investable.

2. Perverse Incentives - Carbon standards have tightened to prevent greenwashing, often creating unintended problems: rewarding destruction followed by restoration, while sidelining the conservation of intact ecosystems.

Carbon markets are powerful tools for the restoration of damaged ecosystems that completely fail to support the conservation of the planet’s remaining natural wealth.

They are an essential pivot.
And now it’s time to leap forward — into markets that value the protection of pristine forests and healthy oceans, where carbon can sink.

It’s time to develop Nature Asset Markets.

Nature Asset ≠ Real Estate

To build real markets for nature, we must decouple ecological value from land value.

As long as ecosystems are treated as “real estate”, we’ll remain stuck in short-term profit cycles that undermine long-term value creation.

This split isn’t radical or new. Seeds, crops, trees, and livestock have long appeared on balance sheets as assets, separate from the real estate they stand on.

Natural ecosystems aren’t missing from balance sheets because we lack frameworks.

They are missing because we priced them at zero.

One does not need to own or control land to invest in the protection of its ecology.

That’s why most pioneers in the nature asset space are separating ecological rights from property rights.

Not only does this reflect how natural capital already functions — it also improves liquidity.

Foreign land ownership carries complex colonial baggage for local stewards, as well as practical burdens for investors: regulatory restrictions, title deeds, land transfer taxes → all reducing asset mobility.

Separating ecological rights from land ownership is a win-win: more liquidity for investors, more autonomy for land stewards.

Value Beyond Revenue

Plenty of assets are valued for what they enable rather than what they directly earn — a brand, a reputation, a user base.

Facebook saw value in WhatsApp for the ecosystem it developed and the users it hosted despite little to no revenue at the time - US$19B in value for a company with nearly $140M annual loss.

Others are simply valuable for their intrinsic value, like art or gold.

An asset’s financial value can range from making a company more investible to improving its credit rating.

We see nature the same way.

Wetlands, coral reefs and pristine rainforests are organs of the Earth - regulating water cycles, stabilising the climate, and sustaining both life and the economies built upon them. Vital organs whose protection and conservation have lasting value.

From Free Ride to First-Mover Advantage

But Joana, are you mad? Nobody has ever assigned financial value to nature, it’s never going to happen!

I’ve heard that more than a few times…

You might remember a similar free ride that seemed impossible to end, until it did, not so long ago: slavery.

The end of slavery and apartheid weren’t without challenge and tragedy. Free rides only end at the verge of collapse, by their very definition.

But that does not mean they do not end.

Climate change and biodiversity loss aren’t just “market failures” NGOs and philanthropists can patch up — they are signs of a global system unraveling. A free ride at the edge of collapse.

The assetisation of nature is a global phenomenon that arises from this very collapse - like a phoenix rising from its own ashes.

The death of this free ride, as painful as it will be to all of us, offers the greatest opportunity of our time: the birth of new markets that treat and value nature as the infrastructure that it is.

Let’s not forget — people who were once enslaved, with no rights, no income, and no perceived value, now represent $1.4 trillion in U.S. buying power. That transformation wasn’t easy. But it happened. And it reshaped the world, creating opportunity.

The question is not if, but when nature will be valued.

The sooner we act, the more we can shield our communities and economies from the unraveling ahead.

Invitation To Action

New economies don’t build themselves. Here are three suggestions for you to take action to shape and fuel the New Nature Economy:

1. Markets don’t get built on consensus - they get built on transactions.

Help originate transactions, rather than sustain dependencies. Next time you feel called to donate to a conservation NGO, ask them if you can buy biodiversity credits instead, or pay for nature outcomes.

2. Value is never inherent - it is assigned by people like you and me.

Find a nature asset developer you trust, with assets that protect species close to your heart - Mountain Gorillas, Jaguars, Black Rhinos, Blue Macaws, Orangutans, Kakapos, Great Whites - and make an investment.Whatever happens to your stock portfolio after the AI revolution, one thing’s certain: we’ll still need nature.

3. Capital is the most powerful engine of change in a capitalist world.

Ask the people managing your wealth to assess your exposure to nature and biodiversity loss in the same way Norges Bank does for the people of Norway. Signal in your conversations with the people that make up our financial markets that nature carries double materiality — risk and opportunity.

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About the Author

Joana Picq is a Silicon Valley-seasoned entrepreneur trained in engineering and archetypal psychology, dedicated to putting biodiversity on the balance sheet.

Through her startup IXAU, she weaves together finance, conservation, government, and community governance to structure nature assets that enable nature stewards to raise capital — in ways that benefit ecosystems, custodians and investors.

She believes that behind every financial market is a myth — and that how we value nature depends on the stories we’re willing to rewrite.

Innovative Finance Shares

• Mad Capital is hiring a Portfolio Manager and Director of Credit

• Most Founders Don’t Need VC - Buyback Ventures

• We should own the economy - read and support - Elle Griffin

• Social Entrepreneurship through Acquisition (sETA) - Transform Finance

• Where Are All the Employee Ownership Deals? - Small Capital

References

Clear it to produce food — $5 T (McKinsey)

Mine it for minerals, metals, sand — $1.9 T (The Business Research Company)

Log it for timber, charcoal, wood products — $1 T (Grand View Research)

Build infrastructure, real estate, roads — $15 T (Expert Market Research)

Extract oil, gas, or fossil fuels — $6.7 T (Kings Research)

Fish it — $567 B (The Business Research Company)

Hunt wildlife — $667 B (Coherent Market Insights)

Pump water — $303 B (Zion Market Research)

Ecotourism — $219 B (IMARC Group)

Land-use carbon credits — $25 B (Global Market insights)

The Landbanking Group raises $11M

The Intrinsic Exchange Group’s work with the NYSE to list nature asset companies

BASIN’s valuation models for ensure.app

InvestConservation’s tokenisation of carbon and biodiversity for conservation finance

|XAU’s first nature assets in Brazil

The secret life of the fax machine

$1.4 trillion in U.S. buying power

Norges Bank’s nature and biodiversity disclosures for the people of Norway

Capital nerds are not founders.

And founders are the customer.

And there lies the danger in capital innovation.

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This is what made me so refreshed to complete an innovative deal with Isaac Squires and so excited to share it with this newsletter. It is not often that a founder comes to the investor with capital innovation in mind. Building a company is hard and capital raising is exhausting. It is fair for founders to not want to waste an innovation point on their capital stack. In fact, I think it is investors’ responsibility to innovate in a way that meets founders where they’re at.

Lucky for us, before we ever met, Isaac had already thought deeply about his company, including capital. Having raised and sold a company already, he couldn’t ignore his conclusions for this go around.

This provided a unique occasion to nerd out with the customer - one thoughtful founder. With that, I’ll let Isaac set the stage in his own words:

The Founder Tale

The Journey to Aligning Long-Term Goals with Venture Investment

By Isaac Squires

When we started Human Program, our mission was to build a free, self-paced alternative to classroom education—one that could offer world-class education to students everywhere in the world. It was an ambitious vision, especially given the well-known challenges of ed-tech: difficult monetization, long sales cycles with schools, and, in this case, a core audience in underserved regions where even ad revenue is minimal.

But as experienced entrepreneurs and technologists, we knew what we were signing up for and why it was worth it. We’d worked on projects with clearer business models but less meaningful impact, and we were ready to take on a harder problem with real-world stakes. Confident in our ability to build, we committed fully: bootstrapping from day one, taking no salaries for the first two years, and sustaining ourselves through consulting work and personal capital. It was a demanding path, but one that shaped our culture—scrappy, mission-driven, and unwilling to compromise on access or impact.

Why Venture Investment?

As a seasoned founder, I initially envisioned Human Program as a self-sustaining entity. I wasn’t keen on raising venture capital. Traditional VC models often prioritize liquidity events like acquisitions or IPOs within a decade—timelines that can conflict with a mission-driven, long-term vision like ours. Having experienced this pressure in previous ventures, I wanted to build Human Program with sustainable growth at its core, prioritizing profitability and team agility.

But by 2023, the landscape shifted. The release of GPT-3.5 created an unprecedented acceleration in generative AI, reshaping the ed-tech space. It became clear that to scale quickly and stay competitive, we needed external resources. Our app, Primer, saw rapid user adoption with advertising costs as low as $0.06 per install. Early experiments with a subscription model began showing promise. These signals indicated it was time to amplify our efforts.

Additionally, on a personal level, my wife was ready to step back from her executive role, and I needed to start paying myself a salary. This compounded the urgency to explore funding options.

Finding the Right Partner

Enter Greater Colorado Venture Fund (GCVF). When I met Cory Finney at West Slope Startup Week in Durango, I was struck by the alignment of our philosophies. GCVF’s focus on rural Colorado businesses—often bootstrapped and outside traditional VC pipelines—resonated deeply. Their willingness to experiment with innovative deal structures opened the door to a conversation about what a partnership could look like for Human Program.

After discussions with Cory and his partners, Jamie Finney and Marc Nager, we landed on a hybrid approach that incorporated a revenue share alongside preferred equity. This model solved a critical challenge for us: how to secure investment without compromising our long-term vision or creating undue pressure for a quick exit.

The Revenue Share Structure

The investment structure we arrived at is a reflection of the flexibility and alignment we were fortunate to find with GCVF. Here’s how it works:

• Preferred Equity: GCVF’s $500,000 investment bought them approximately 7.1% of Human Program’s equity at a $7 million post-money valuation. The round also included a 10% employee option pool and other standard rights.

• Revenue Share: Investors receive 5% of our quarterly gross cash revenues (net of app store fees) after a three-year holiday period. This revenue share is split pro-rata among investors and provides a path to returns independent of an exit event.

• Dissolution Option: If investors remain involved for seven years without a liquidity event, they can vote to be bought out, ensuring alignment over the long haul.

This structure offered GCVF and other investors the potential for returns tied to our revenue growth, even in the absence of a traditional exit. For Human Program, it preserved the flexibility to pursue our vision sustainably and the potential to operate the business indefinitely.

Reflections on the Partnership

Choosing to take on venture investment was not a decision I made lightly. But with GCVF, we found partners who understood our unique challenges and were willing to think creatively about solutions. This partnership has provided us with not only capital but also confidence and a safety net as we navigate this next stage of growth.

With the ability to scale operations, accelerate user acquisition, and enhance our product offering, Human Program is poised to make a meaningful impact on education worldwide. And we’re doing it on our terms, with the support of aligned investors who share our belief in building businesses sustainably.

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The Investor Tale

Venture Capital with or Without the Exit

-Jamie Finney

The first thing you should know is that we had never done a deal like this before.

We had completed a few redeemable equity investments before and made a stink about capital innovation. This was enough to pique Isaac’s interest and trust that we’d be willing to hear his needs for non-traditional funding as opposed to simply passing like most investors would.

The design specs we heard from Isaac were:

• His ambition is for a world-changing homerun

• He does not want to be forced to exit

• This round will likely get us to profitability

• The company is already capital efficient and GPT 3.5 was going to amplify that

• Margins are high and likely to remain high

From our perspective, the implications on our structuring were as follows:

• We need to structure in liquidity…

• …without ruling out a later round

• …without ruling out an exit

• …without capping our upside

“I want to be a fund returner for you guys.”

On one of our calls, Isaac asked me what would make this a win for our fund. Isaac started this company to fundamentally affect education globally. Our answer revealed our support for that mission. It also was the truth about the venture fund we raised. I told him we wanted to see a fund-returner.

I asked him how we would measure success for our partnership. He responded the same. Like us, he didn’t see any place for a false tradeoff between impact and returns.

We then walked through the napkin math of a comparable business at unicorn scale. Our revenue share at its scale was surprisingly close to the size of our fund. This is about as scientific as “upside” calculus gets in venture, and it was surprising to see how similar that held up with our structure.

Could we have implemented more radical incentives? Yes. We could have tied our returns to education outcomes. We could create a trust that holds a golden share and votes for the children. However, we’re a generalist venture fund that exists to prove there are high-ambition startups being founded everywhere. Isaac aligned with that. And we align with his global education ambitions.

Docs

At this point, we were ready for deal docs.

This is a daunting moment when you’re doing new deal structuring. Lawyers can run up impressive tabs using only template docs.

After a lot of research and helpful collaboration from Isaac and his lawyer, we agreed that our changes were simple enough that they could be dropped into traditional NVCA docs. This gave us comfort that we’d keep all the rights and protections of any other investment. Moreover, should we need to raise another round, our changes would be obvious to show to a later firm. In reality, if that round comes along, we don’t want to limit our options to capital-innovation-friendly investors. We’re ready to default back to the vanilla venture capital path if it is what is best for the company and our fund. Critically, we trust Isaac’s VC skepticism enough to be sure we will remain aligned with him and his mission.

So what did we add to the docs?

• The revenue share is a preferred dividend.

• After three years, the dividend is default declared quarterly unless the board vetoes.

• The board is Isaac, us, and an independent whom we all respect.

• We participate in common dividends too.

  • As a testament to Isaac’s thoroughness, he felt this was important to ensure if he used dividends as compensation for his team, it would never be at odds with his investors.

All in, this back and forth took us a couple of weeks. It was immensely helpful that Isaac understood the nuances of our agreement and was willing to work with his lawyer to draft them. Our legal reviewed once we had all agreed on a draft. This dynamic was best-case for headaches and cost. All in, this was certainly one of our most expensive deals, but we accomplished way more than similarly priced rounds with more menial back and forths. The total drafting added to the NVCA docs was less than a page.

Implications

Seedstrapping from First Principles

What I love about having taken over a year to get to this writeup is that we were sketching out “seedstrapping” before it was cool.

Not to pat ourselves on the back, but this came before “seedstrapping” was cool. Seed funds hadn’t realized it was cool to be capital efficient yet. The new AI-enabled tech stack was creating capital efficient companies, but the capital stack had not yet responded. Even Indie VC, the instigator capital efficient venture, was still iterating on how to be pro-unicorn, AI, and efficiency all at once. This is what makes being the “rural fund” an advantage. We innovate because founders and fundamentals tell us to. It is nice to have the venture-hype machine working for us for once.

I digress.

Autonomy to Affect Change

I have had countless conversations with impact investors who see companies compromise on their original mission to raise capital. This is Isaac’s fundamental reasoning for wanting to avoid exit-lock-in at the outset.

We can’t say we have avoided that risk forever, but we at least did not make that exit promise in our round. To the extent margins remain and growth continues, we can retain mission autonomy with profit for funding. It has been done and will only happen more and more.

Truly No Exit?

Should an acquirer be able to amplify the company’s impact, we’re open to that. None of us will decline the equity cashout that would entail either. That is why we are normal preferred equity holders and why our ownership is not redeemable.

What if we do need to raise another round?

It is not hard to imagine that we need more funding given the global scale. It could be a Series A. It could be a Series A at Series D stage. We should be ready.

Most likely, we will have to forego our revenue share if this happens. For us, we’re a venture fund that is used to the venture stack playing out. Easy enough. Maybe we’ve even made some money beforehand. Most importantly, we trust Isaac’s values and practicality to weigh this decision productively with the board.

A Parallel Capital Path

I’d be remiss not to mention an obvious best-case later round opportunity.

We are doing our revenue share math based on fund-returning scale. In venture, as rounds continue that math slowly regresses towards PE multiples and timelines (e.g. 3x in 2 years vs. 100x in 10). Why can’t a growth investor also invest on our structure to reach their return targets?

A typical equity round presumes the dilution to existing shareholders is worth the upside bought by the additional capital. Owning 4% of a $100M business is better than 5% of a $50m business (hence why ownership targets are often silly). We can do the same math with our revenue share. We would gladly take 4% of revenues if the final revenue number could grow more than our 20% revenue dilution. This is the same math law firms do when they consider doling out partner shares to their star lawyers and some PE firms use profit sharing rights already. Why can’t there be a parallel capital stack to venture that works off of these cashflow incentives?

Are there downsides? Yes. Are there downsides to the existing venture capital stack? Yes. So why not make both an option?

Conclusion

All in all, we hope Human Program can pave the way for capital-efficient, mission-first companies. Both trends are on the rise and worth amplifying.

We took a minimalist approach to the innovation but think we solved the most immediate, egregious shortcomings of existing venture capital, while still providing venture capital. Success for Isaac is measured in the number of human lives changed by access to education. Success for us is measured in dollars. Most investors are judged by similar metrics as us, so we hope this helps illuminate a path which allows everyone to win.

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…And if you like this post, there is a community call next week (June 17th) where you can hear directly from more Innovative Fund practitioners.

Now let’s dig in:

Why Fund Design Matters in Impact Investing 3.0

Impact investing has come a long way. In the 1.0 era, we worked hard to prove that you could make a financial return and deliver social or environmental impact. The 2.0 phase took us deeper—we standardized impact metrics, tackled uncomfortable questions about power and extraction, and experimented with new models. But for the most part, we still operated within traditional financial structures.

Now, as we step into what I see as the 3.0 era, it’s clear: if we want transformative impact, we have to design for it—intentionally, from the ground up.

At the heart of this is fund design. Because how a fund is designed—its purpose, structure, incentives, governance, and exit strategy—directly shapes who gets funded, what kind of capital they receive, and what kinds of outcomes they’re able (and incentivized) to pursue. A poorly aligned structure can quietly limit the ambition of an entrepreneur or distort their ability to prioritize long-term impact. A well-designed one can unlock impact outcomes we haven’t yet imagined.

The Five Pillars of Radical Fund Design

We’ve been working on a simple but powerful framework to help fund managers align every element of their design with their impact intentions. Here are the five pillars we’re focusing on:

1. Purpose: Designing for Regeneration

A fund’s purpose shows up in its investment thesis, but more importantly, it shapes the types of enterprises it helps build. Impact 3.0 funds are designed to foster regenerative, not extractive, business models.

• Example: The Purpose Fund uses steward ownership to lock in mission over time, ensuring that decision-making power remains with those connected to the company’s purpose. Similarly, New Majority Capital focuses on transitioning businesses to underrepresented founders, embedding equity directly into enterprise ownership.

2. Structure: Rethinking the Box

We can’t solve systemic problems using the same tools that helped create them. Traditional structures—like 10-year closed-end venture funds—are often mismatched for the types of businesses we want to build. Impact 3.0 encourages experimentation across the capital continuum.

• Alternatives: Holding companies, open-ended funds, rolling funds, nonprofit capital vehicles, or blended finance structures.

• Example: Fair Capital Partners uses a permanent capital structure, giving them the long-term flexibility required to support businesses pursuing deep, patient impact.

3. Incentives: Paying for What Matters

Incentives shape behaviour—full stop. If fund managers are only rewarded for financial performance, then that’s what they’ll optimise for. But we can build incentives that reward impact outcomes alongside financial ones.

• Example: Prime Coalition ties fund manager compensation to climate outcomes, including emissions reductions, making it clear that impact is not a side note—it’s the job.

4. Governance: Shifting Power

Fund governance often happens behind closed doors. But if we’re serious about equity, then we have to bring historically excluded voices into decision-making—especially those most affected by investment decisions.

• Example: Citizenfund, a Belgian cooperative, gives every “cooperator” one vote—whether they invest €5 or €5,000. Investment decisions are made collectively, including setting return expectations and exit strategies.

5. Exit: Designing for Continuity

How capital exits matters just as much as how it enters. A rushed or misaligned exit can undo years of impact. Fund managers need to think beyond IPOs or acquisitions—and consider who benefits, who stays, and whether the mission holds.

• Example: Apis & Heritage uses mezzanine debt to transition companies to employee ownership, building wealth for workers and preserving community-rooted businesses over time.

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What Comes Next

We’re seeing a groundswell of innovation in enterprise design—everything from steward ownership to Doughnut Economics-inspired businesses. But these models will stall unless we have the capital structures to match them.

That’s where we come in.

The Innovative Finance Network is bringing together over 500 fund managers, asset owners, academics, and technical experts to reimagine what finance can be. It’s still early, but the momentum is real.

If you’re building (or investing in) the next generation of impact funds—or just curious to learn more—I’d love to have you join us. This work is collective by nature, and it will take all of us.

-Aunnie

Note: this piece was adapted from an article written with Erinch Sahan in Impact Alpha and is based on work from my forthcoming book on alternative fund structures.

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This week, another big steap, or leap possibly, was taken.

Led by Aunnie Patton Powers, the Innovative Finance Initiative is a five year collaboration between practitioners, service providers, ecosystem builders, and anyone who wants to play an active role in bettering our economy.

The initiative itself is informed by input from 400+ starting members. It is designed by those doing the innovating, with an eye towards how to enable more and better innovating. The backing came from by an A-team of funders who saw the need for a concerted community of practice and multi-year horizon.

Here is how Aunnie puts the work ahead:

📚 𝑳𝒆𝒂𝒓𝒏 𝒘𝒉𝒂𝒕 𝒊𝒔 𝒘𝒐𝒓𝒌𝒊𝒏𝒈 (think recoverable grants, redeemable equity, impact linked compensation, impact first capital strategies, steward ownership, impact linked financing and so much more)

👩‍🚀 𝑬𝒙𝒑𝒍𝒐𝒓𝒆 𝒘𝒉𝒂𝒕 𝒊𝒔 𝒑𝒐𝒔𝒔𝒊𝒃𝒍𝒆 (what could alternative exits for impact or innovative islamic finance or secondary markets for community owned real estate, or innovative finance for humanitarian aid look like?)

🏗️ 𝑩𝒖𝒊𝒍𝒅 𝒘𝒉𝒂𝒕 𝒊𝒔 𝒏𝒆𝒆𝒅𝒆𝒅 (what about an AI powered impact expert directory? Or a tool that built alternative term sheets? or a detailed map of innovative fund managers?)

So now what?

» Check it out yourself

» Join the conversation on LinkedIn

Other Innovative Finance News

• Grow America has launched a revenue-based debt fund for Washington, backed by SSBCI funding. This is the first time SSBCI has been deployed for an RBF specific vehicle. Perhaps it is the beginning of filling the debt-equity gap for all 50 states?

• Cracks in PE/VC mean openings for impact investors - by Worthmore. What if “market rate” investors can no longer afford not to be “impact” investors?

• Diversifund targets $100M to invest in regenerative food systems. What could be more inspiring and critical than “landscape scale transformation”?

• Report: Financing the Future: Navigating the Next Generation of Outcomes-Based Financing

NONE of the statistics I care about have appreciably changed in the last decade.

Women founders like me still only receive 2% of venture capital, people of color even less. 2024 is shaping up to be a new low, with Black founders receiving a mere 0.3% of the nearly $80 Billion of venture capital that flowed to start ups in the first half of the year. The money just isn’t moving at the volume and velocity we need. This massive capital access problem persists at every stage of a company’s life all the way to exit, according to a recent McKinsey & CO report:

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Let that sink in: even if an underestimated founder succeeds against the odds to attract funding, on exiting, they are not creating the wealth for themselves that white men do. And, as the McKinsey report helpfully observes:

“It’s also a gap on both sides of the table—only 1.4 percent of the $82 trillion in US assets under management (AUM) is managed by women or BIPOC managers (as of 2021). In general, funds that flow from asset managers match their demographics.”

It was a sober message to deliver to an audience of incredibly talented, motivated and ambitious entrepreneurs at Sloss Tech in Birmingham, AL in June of 2024. While there is an encouraging local investing scene there, the demand for early stage funding way outstrips the local supply, and entrepreneurs in places away from the coasts like Birmingham, AL continue to face the same seemingly insurmountable odds as they did 10 years ago.

And it’s even worse if you are working on any kind of “social purpose” type venture. It’s a little depressing, at my age, to realize that today’s 20 and 30 year old entrepreneurs are launching themselves into this incredibly challenging fundraising environment with the same passion as we did when we were their age, knowing what I know now: the odds are still very much not in their favor.

Innovative finance to the rescue!

So what if venture capital is still systematically stacked against women and founders of color, surely there are alternatives these underestimated founders could tap into?

Indeed there are! Thanks to Jamie Finney and Aunnie Patton Power we have a grammar and playbook for understanding alternatives to venture capital as a source of finance for ambitious and impact minded entrepreneurs. These are real resources for how to approach revenue based and other financing options, how to structure them, what terms to create, and how to drive those conversations as both entrepreneurs and investors.

Furthermore, there has been an encouraging amount of experimentation with those alternatives to venture, and there is a growing number of capital innovators who are building investment funds that are using revenue based strategies, debt, mezzanine structures, real estate, and micro PE to invest in businesses and create wealth in underserved communities like Birmingham, AL.

By all accounts, revenue-based finance writ large is growing globally, and is beginning to turn into a recognizable asset class. There have been some great programs, like the Capital Access Lab of the Kauffman Foundation that invested in the managers of innovative investment funds that were using revenue-based strategies to invest in underestimated founders. Investing in the managers of revenue based investment funds, the Kauffman initiative aimed to promote the growth of emerging funds and create more supply of founder-friendly capital. Typically these were investments of $500,000 into first time funds that were each raising between $5 and $20 million. Not a huge amount of new capital unlocked, but better than a poke in the eye with a sharp stick.

The progress of revenue based finance is an encouraging signal, and it’s worth quoting a recent overview article at length:

“RBF can be structured as a redeemable equity investment, in which the company buys back the investor’s equity as revenue grows over time, or as a revenue-based loan. In either case, an RBF recipient repays the investment as a share of their revenue, typically 2-5%, until an agreed-upon multiple or cap of the principal amount, typically 1.4-2x, is reached.

RBF provides much-needed flexibility for borrowers and investees by tying repayments to cash flows. Moreover, its underwriting is less reliant on existing asset bases for collateral than traditional lending, making it accessible for asset-light businesses. And with an investment exit built into its structure from the beginning via revenue-based repayments, it provides an alternative to the endless march toward higher valuations and an eventual sale required by venture capital.”

Not so fast…

At a gathering hosted by the Kauffman Foundation in early 2020, however, I discovered this incongruity: in talking with the foundation’s chief investment officer, she revealed that the investment side of the house could not participate directly in the Capital Access Lab because she is not able to write checks smaller than 1% of the corpus, or $25 million at the time, given the then size of the total assets under management for the $2.5 billion foundation. Further, she was not allowed to take more than a 10% position in any one fund they invest in. In short, the SMALLEST fund she could invest in was a $250 million fund. At the time, there was no such thing in revenue based finance, and 5 years later I am aware of only a few funds that might fit this bill.

This is not to throw shade on the Kauffman Foundation. They are not the first or last foundation to get caught in the “two pocket problem” – where grant funded initiatives like the Capital Access Lab cannot be fully supported by the investment side of the house due to the constraints of the governing documents and internal rules. If we solved that two-pocket problem and aligned 100% of foundations’ assets with their mission, this could unlock the $1.8 Trillion sitting on US foundations’ balance sheets alone. The Kauffman Foundation dilemma is just a symptom of the structural problem we are facing: the innovative finance vehicles that we need to drive capital to underestimated founders and communities are not maturing quickly enough to absorb the institutional capital that is hamstrung by its internal investment rules. Another way to look at this is that allocators just aren’t getting off their assets quickly enough, and are not rising to the opportunity presented by these innovative emergent fund managers. But more on that in the next section.

So while it is true, that there is now $1.6 Trillion deployed for impact globally, as per the latest GIIN report, it also remains true that the plumbing does not (yet) exist to drive this capital to the most innovative emerging fund managers. Thus, nor does it reach the entrepreneurs they serve. Foundations and family offices that, in theory, should and could be first in line to accelerate innovative finance, are blocked by their own internal logic.

Where are the impact investors?

It’s worth restating the McKinsey & Co insight from above, that “funds that flow from asset managers match their demographics.” In other words, women fund managers invest in women, BIPOC managers in BIPOC entrepreneurs, and so on. If shared lived experience is key to assessing a business idea, white men are reliably investing in white men and the things white men are interested in. I am going to generalize this statement a bit more, and postulate that fund managers who have direct, lived experience with any number of social, economic, and / or environmental issues create innovative vehicles and investment theses informed by those experiences. That’s why, for example, the majority of the members of the Inclusive Capital Collective are employing innovative debt, equity and / or real estate strategies to not just create wealth for themselves and their investors, but their communities too. This takes the form, for example, of community owned commercial or mixed use real estate. Or funds that make equity-like investments in early stage businesses but take debt-like repayment on non-extractive terms. Whomever has the capital under management will drive the outcomes on the ground. And only 2% of all assets are managed by women and people of color.

Investing in more diverse fund managers and innovative investment theses could be hugely catalytic in terms of changing the outcomes we want. For me, these outcomes all fall under the rubric of the Sustainable Development Goals articulated by the United Nations for ensuring a thriving planet for all. In theory, impact investors could play a leading role in achieving the outcomes we want by directing capital into these innovative vehicles.

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We put that theory to the test at SOCAP24, where my company Armillaria partnered with three other members of the Inclusive Capital Collective–New Majority Capital, Roanhorse Consulting and Common Future–to host the Inclusive Capital Exchange. Inspired by the deal rooms that are part of mainstream finance conferences, we invited emerging fund managers who are currently raising funds 1, 2, or 3 and investors who are currently deploying capital into funds to fill out a short form to tell us what they were looking for. We were able to match 7 investors with 42 fund managers (out of over 140 who applied to be there) at an in-person event during SOCAP, and we will be following up to see how much capital flowed as a result.

We asked the investors to confirm that they are in fact able and willing to write checks by the end of the first quarter of 2025, and that simple question to ensure we are not wasting the fund managers’ time was apparently off-putting to some folks. The impact space is famous for people taking a very long time to make investments, and for expecting to be treated with deference to their quirks, theories of change, and frequently confused thinking about financial returns, risk profiles, and measurable impact. We are keeping our fingers crossed that this first Inclusive Capital Exchange will move some real capital, and also plan to host future Exchanges at impact conferences where impact investors, fund managers and entrepreneurs gather.

Reasons for hope

While the Inclusive Capital Exchange experiment plays out, there are some reasons to hope that 2025 could be a turning point for figuring out the impact capital conundrum. And I don’t mean the noise pollution that is the AI hype. Like so many silver bullets and hype technologies before it, AI will not fix this. But that’s a topic for another post.

Instead, what is encouraging to me as we go into 2025 are a number of emerging trends and patterns that I am sensing.

First among them, the rallying cry of systemic investing for social change, a new investment logic that applies systems and complexity thinking to investing and is being embraced by an increasing number of family offices, foundations and private investors. The cynic in me is quick to point out that systemic investing and its cousin, bioregional finance, are new words for old ideas that are long on concepts and intellectual frameworks, and short on actual financing facilities. The impatient pragmatist in me, however, sees this as a welcome sea change in impact investing, which has been notoriously fragmented and has been characterized by overly specific geographic and / or sectoral investment theses rather than taking more integrated approaches to investing in change.

Another welcome development, for the first time in my 10 years building an impact tech company, there appears to be interest from impact investors in underwriting infrastructure technology designed for mobilizing capital, innovations and people for impact. Not in the sense of electronic wallets or other last mile finance solutions, but workhorse technology that makes it easy and efficient to source impact deals, do and share diligence, syndicate, underwrite, monitor and aggregate outcomes across portfolios and investors. Our 2018 report on the missing impact finance infrastructure finally has several family offices actively investigating the issues diagnosed, I am hopeful that we will see real progress this year in data liquidity, interoperability, sovereignty and agency. Incidentally, these are all prerequisites for an eventual ethical deployment of AI for impact finance.

Looking to disrupt the “wealth defense industry” from within, the Wealth Hackers Initiative takes on the very tools, protocols, and behaviors that keep wealth locked up for the few at the expense of people and the planet. The idea is to work with accountants, lawyers, intermediaries, financial modellers and others to create the new tools, norms and practices that align wealth management with the values of the next generation(s) of private wealth holders while we go through what’s been called the greatest wealth transfer - over $80 Trillion passing from the Baby Boomer to their millennial and Gen X heirs. Remember the internal rules of the Kauffman Foundation? Those are the kinds of things that need to be broken and reimagined, and I am looking forward to the first six hacks that we are funding and meeting the intrepid wealth holders who’ll put them to work.

And last, but not least, the Innovative Finance Initiative is an exciting new effort sponsored by The Impact, which is sort of a family office of family offices. The IFI takes an ecosystem approach to popularizing innovative finance structures, creating a community of practice around them, and developing the infrastructure for making it easy and delightful for wealth holders to not just learn with and from each other, but combine and channel their capital to maximum effect. During the soft launch of the initiative in December, I was encouraged by the networks and organizations represented and their commitment to get practical and tactical with each other.

Whether you learn about systemic investing for your own investing practice, or get involved with one or more of the mentioned initiatives and projects, I hope you’ll be part of the push in 2025 to solve the impact capital conundrum.

Innovative Finance Announcements

• Federation of American Scientists sees the Employee Ownership Opportunity

• Dream Job Alert - Dir. of Catalytic Capital, Align Impact

• Highlights from Regenerative Ag, 2024

This is the final chapter of the Information Era - the Knowledge Chapter.

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Playing Information Era economics entails maximization amidst scarcity, only to get undermined by technology. Where Settler’s of Catan would have you “trade, build, settle,” this game was “find, join, learn.” Find the data, join the network, learn the knowledge. Collect those cards in that order and you have the winning trifecta. Then press your advantage for as many hands as you can before technology shares your precious cards with the world at large.

Observing this pattern over history reveals its natural, imminent end - the Knowledge Chapter.

In the 1500s, Christianity’s data card was the bible and its network card was the few priests who had access to the data. Then came the printing press - open source’s original sin. All of a sudden, the masses were free to interpret the data themselves. Amidst the Protestant Reformation that followed, the Catholic Church’s Information Era advantage took a huge hit. As bibles got printed like COVID stimulus, the Vatican’s data and network cards saw hyperinflation. Alternative translations and interpretations of Christianity flourished.

And so the Information Era pattern repeats.

The compass brought a Reformation for the the navigation supremacy of the Portuguese and Venetians. Expedia took travel agents’ booking data and allowed anyone to access it and book themselves.

Clinging to data and network advantages is akin to hoarding Weimar notes in the 1930 while as they get used for kindling for fires in the streets. Zettabytes of data are produced each year. That’s twenty one zeros. Metcalfe’s law states that a network’s strength is equal to n-squared. With 5.5 billion people on the internet, that’s a network strength of 30.25 quadrillion. Centuries of the Information Era’s maximization function has hyper-inflated those cards for good.

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The Vatican didn’t wither away however. The new Protestant upstarts lacked knowledge cards. Catholicism still had centuries of building community, credibility, and churches. Their earned knowledge cards kept them in the game.

So what makes this the last Chapter of the Information Era?

For the first time ever, it is not the just data or network cards going through hyperinflation. It is the knowledge cards too.

Just 3 years into public large language models, we have over a trillion parameters feeding responses. It won’t be long before you might as well give your knowledge cards to the kids outside and join them around the fire.

The first knowledge cards to go - white collar knowledge.

Blue collar knowledge will remain insulated. Electricians go behind drywall. Plumbers go into the crawl space. Artists go into our hearts.

The key is to go where computers can’t go.

White collar knowledge however, it is earned by diving into valuable datasets. Devs master code. Lawyers recall law. Accountants memorize accounting principles. Whether stored in language, logic, or math, they’re all just professions built upon dataset mastery.

LLMs can pass the bar. Write code. And please, any day now, take care of accounting and taxes.

What does this mean for little old finance?

It is nearing time to gather around the fire.

A free market relies on supply, demand, open and equal information, and lots of market actors. Acting with endless data, network nodes, and knowledge, Information Era economics will continue to play out - just without us. Ironically, less humans, the more free the market.

On the sidelines, the fires will be burning. Empty your pockets of those cards you’ve been hoarding. The crowds will appreciate the extra burst of heat. Then, strike up a conversation. This is the post-Information era playbook.

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Chatting around a fire is only half metaphor.

As AI coopts the free market at the scale of zillions, we have 150. This is Dunbar’s number, the maximum number of relationships a human can maintain. It is a number small enough to implore you to strike up a real conversation. Empty your pockets of all of your old cards, share their warmth, and get to know your peers.

That is the post-Information Era playbook.

Lowercase Capital Fund I is regarded as the most successful venture fund in history, turning eight million dollars into a rumored two billion plus. It also foreshadowed how post-Information Era finance work for us lowly humans.

Lowercase’s founder, Chris Sacca, has a JD in law and technology. He took college math years ahead of time. He was flush with Information Era cards, yet they hardly mattered for his famous Fund I success.

Venture capital is worth examining because it has long abandoned ploys of knowledge supremacy. It is not won with algorithms, deal structuring, or any of the common markings of “finance.” It is won by being in the best deals, which means knowing the right people at the right time.

When Uber raised its first round, Sacca had already spent hours in Travis Kalanick’s hot tub. Whether or not they made it into the tub, Sacca’s social circle also included the founders of Kickstarter, Twitter, and more. His Dunbar 150 was chock full of high potential tech founders.

Does this mean the post-Information era game one of schmoozing and raising venture funds? Can LinkedIn handle another “your network is your net worth” post?

I hope not.

For Sacca to turn his hot tub connections into $2B, he had to raise $8M. It helped that he knew a who’s who of tech to invest already. Going forward however, keep in mind, that AI is running the world’s most efficient free market in the background. It is not crazy to say that one function of the agentified markets will be effectively allocating liquidity to all the healthy fireside connectors.

True, Sacca’s law degree and google pedigree helped him stand out for allocation. But in a world where that knowledge is left to the bots, the resume of a Sacca looks a lot different.

Have you ever walked down the street with someone who seems to know all the good stuff happening? They geek out on beer, meaning they know the brewer and all her nifty tricks. The guitarist playing tonight was their old roommate so they never miss a show. They never miss a chance to thank their kid’s teacher for a very human job well done. These are the people who win the post-Information era.

In this next era, appreciating each other becomes a hard skill.

The economy will remain a central tenet of our lives, but monetization will look a lot different. I won’t dare predict the myriad of forms it will take, but I do know where to start.

Will there be capital allocators? Maybe. AI handles all the structuring, paperwork, and spreadsheets. Chances are, “allocating” will sound like the job description of “typist” today. AI and the new free market will handle the numbers and legalese.

There are likely hundreds of other jobs that all boil down to human appreciation, so focus on your humanity.

Gather around the fire. Get in the tub.

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Innovative Finance Announcements

• GPs - Apply for the Catalyze Fellowship

• GPs - Introducing the Catalyze GP Runway Fund

• Getting Off the Alphabet Train

• The Silver Tsunami vs. Climate Change

Next up - exciting guest-posts, case studies, and more

Where fertile soil is deposited, agricultural wisdom collects.

It is soil science meets mechanical know-how meets generations of lessons learned in the fields. Farming is an uncanny local skill that does something profound - puts food on our tables.

In another time, communities with fertile grounds and green thumbs made for full bellies abound.

Today, many ag towns are food deserts.

Hunger is regularly tided by fast food trucked in from far-off slaughterhouses or sugary treats from the gas station. Where the local trade is feeding people, nutrition can be hard to come by.

Anyone who has spent time in an ag town knows that reverence for farmers is not just nostalgia, it is an ode to a uniquely local, mission critical skillset.

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Information Era Economics

This economy is just another version of Settlers of Catan. It has different cards with varying values depending on what phase of the game we are in. The rules are made up. The players are, well, all of us.

For the past 100 years, the game has been about collecting data and network cards.

These cards have been in the game the whole time, but were hard to play. Early network cards meant shaking hands with someone no one else could shake hands with. We have traveled across oceans to find new trade partners and formed a collage of alliances, clubs, and old-guards to make network cards valuable. Similarly, data was primitive. Longitude was once a data card that kingdoms saw as the key to worldwide dominance. England, The Netherlands, and Spain (twice) issued massive rewards to secure this data card. It was a different game back then.

Since the days of discovering longitude, people have flocked to London, NYC, SF, Hong Kong where their data and network cards were more valuable. It was a niche game amongst niche players.

Meanwhile, other cards, like farming, were easier to play. Find prosperous land and apply labor. Crops were not yet datapoints in commodity markets. They were food available for purchase by hungry locals.

The Information Era

An unforeseen telecommunications revolution transformed these cards forever.

First, computing enabled for theoretically limitless data creation. Then, the internet allowed for limitless access to not just data, but network. The opportunities to play data and network cards for profit became infinite.

Guess who’s been collecting these bitcoin-esque cards this whole time? Wall Street and Silicon Valley. Finance and Tech.

A century of collecting data network cards was already lucrative, but more in the bitcoin mid-2010s kind of way. Computers to the power of the internet made the cards Bitcoin 2024 valuable. They are the best in nearly every game worldwide.

As a result, finance and technology have all the leverage in value capture. If carrots are a static $1B market, the carrot farmer is making less than 100 years ago not because their carrots are worse or less desirable, but because finance and tech are just that much more effective at capturing value. That $1B gets doled out by cards played, and tech and finance simply hold the high cards.

This advantage will be the main story of the Information Era. The same players will keep winning with their same data and network cards.

Why?

Data and network cards are best played with a Knowledge card. Thus far, knowledge cards are only attainable by years of playing in data and network games.

Robinhood gave the public the same level of market access as Wall Street. This theoretically opens the game up to everyone.

Meanwhile, Wall Street buys the order book information from Robinhood, making billions off of this data advantage. That is the knowledge cards being played.

If you had order book information from Robinhood, could you arbitrage the markets in the same way? Could you write the SQL to analyze the information? Structure the investments to take advantage? Write the code to automate the trades? Raise the money to hire the people to help with this?

If you answered no to any of the above, you don’t have as many knowledge cards to play. Despite 66% of the world being online, only 0.01% know how to play the data and network card at that level.

Information Era Economics have been far from equally distributed. That begins to change in the final chapter.

The Knowledge Chapter

While the Information Era game remains tilted towards tech and finance, we enter its final chapter - the Knowledge Chapter.

The Gamestop short squeeze was a telling preview.

The data around Gamestop’s outstanding short positions had been publicly available for years, but the knowledge as to how to profit from it remained finite. Come 2020, a Reddit thread surfaced this knowledge and made it actionable (with help from our friend Robinhood) to the masses.

A few hedge funds had their multi-decade lead in the Information Era gam erased. Under the examination of a networked populous, short selling is a fundamentally riskier endeavor.

That was all before AI became available at consumer scale. Now, knowledge cards have been airdropped to everyone who has data and network cards.

This final chapter of the Information Era is only going to last the blink of an eye.

It is essentially, “next hand wins” for the Information Age.

Then comes the next game…

Coming up in the next game

• Our final Knowledge Chapter hands

• Finance and tech, diverge

• Data and network cards go from being Bitcoin to Dogecoin

• Do farmers get a break?

• Your innovative finance announcements (hit reply!)

Today, I'm going to guide you through one of the most critical yet often overlooked barriers: the personal financial challenge faced by emerging fund managers.

The Emerging Manager's Dilemma

Imagine you're a talented individual with a keen eye for promising startups and a passion for fostering innovation. You've angel-invested, crowd-funded, ecosystem-mentored, and learned from masters in the field. Now you've decided to start your own venture capital fund. Exciting, right? But here's the catch: the next big thing can drain your personal resources.

Let's break down the basics:

1. Fundraising Timeline: Typically, it takes 12-18 months to raise a first-time fund. You're working full-time on the fund but not earning any income from it during this period.

2. Fund Costs: Starting a fund incurs significant upfront costs, including legal fees, fundraising expenses, and formation costs. These costs can easily reach six figures.

3. Cost Reimbursement: The fund can reimburse many initial formation and fundraising costs, but only after the first close, which may take over a year.

4. Management Fees: Once the fund is raised, managers typically earn a 2.0-2.5% annual management fee on committed capital.

5. Timing of Income: Management fees don't kick in until after the fund's first close and gradually increase as commitments rise over 12-18 months.

6. GP Commit: General Partners (GPs) are expected to commit their own capital to the fund, typically 1-2% but often more. This is not insignificant.

Now, let's examine the numbers to see how this plays out in reality.

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The Financial Gap: A Case Study

Initial costs

Before the fund’s first close, an emerging manager might face costs like:

• Management company expenses $60,000

• Formation/Fundraise expenses $80,000

Total: $140,000

These costs are typically paid out of pocket and can only be reimbursed after the first close. The manager's living expenses are not included.

Management fees

Assuming a fund size of $8 million with a 2% management fee:

• Annual management fee: $160,000 (less during the first year ramp-up)

• After operational costs (estimated at $104,000): $96,000 available for GP compensation

However, this doesn’t start until after the first close and doesn’t reach that run rate until the entire fund is raised, most likely by year two.

GP commit

If the GP is expected to commit 2% of the fund investment:

• GP Commit: $160,000

Even spread across multiple years, this can be a significant personal investment.

Personal cash flow gap (Y0-Y4)

The above three variables create significant costs prior to income, similar to a startup. Let’s examine the personal impact on the early years of an $8M fund.

Year 0 (Pre-first close):

• Income: $0
  Expenses: - $140,000 (fund startup costs)- $100,000 (living expenses)

• Gap: -$240,000 (remains over $100k after reimbursement at first close)

Year 1 (Post-first close):

• Income: $60,000 (portion of management fees going to the manager)
  Expenses: - $100,000 (living expenses) - $40,000 (GP Commit / 4)

• Gap: -$80,000 (and the remaining unreimbursed $100K+ from Year 0)

Years 2-4 (Investment period)

When management fees are fully flowing, the GP might only take home $56k ($96k minus the $40k GP commitment)—leaving a $44k gap every year. Plus, committing to years of a “salary” that might be $50k-$250k less than market rates in the financial industry.

Totals for the life of the fund

Assuming the fund performs in the upper quartile and creates a 2.5X net return, this cash flow gap persists for 3-5 years until the fund (hopefully) starts generating returns:

Income: $2,604
+ $924k take-home portion of mgmt fees (60k year 1, then 96k/year)
+ $400k return on 2% of committed capital
+ $1,280k for 20% carry (assuming the manager receives all the GP carry)

Cumulative Expenses: $1,331k
- $160k for 2% GP commit and $1,170k living expenses for 11 years

Net Upside: $1,273k ($116k/year), or just shy of 2.0X personally over 11 years (while the LPs net a 2.5X return).

This (very personal) case study illustrates why an emerging fund manager can endure a personal financial gap of hundreds of thousands of dollars in the first few years. That’s a deep hole to self-fund. But more than one LP told me it is simply the cost of entry and an incentive to perform— one suggesting wealth is correlated with talent.

Thinking like this is a significant barrier preventing talented individuals from entering the field, particularly those without substantial wealth.

What could we gain from removing the barrier?

I love this from Gridline:

Emerging managers not only have a smaller share of their income coming from management fees, but they’re also trying to build a personal brand to justify bigger, successive funds. You can only do that with a strong performance.

Emerging managers are grinders, hungry for success the way a young underdog is against a perennial winner in the sports world. This tightly aligns their goals with LPs – a strong return means both the manager and their partners win.

The Impact on Innovation

This financial barrier has far-reaching consequences:

1. Lack of Diversity: Only those with significant wealth or strong networks can afford to become fund managers, limiting diversity in the VC ecosystem.

2. Risk Aversion: GPs under financial strain might make overly cautious investment decisions to protect their personal finances.

3. Missed Opportunities: Talented managers who can't overcome this financial hurdle never get the chance to innovate how to fund startups.

4. GP Blind Spots: A homogeneous group of fund managers may overlook promising companies outside their homogenous networks.

5. LP Blind Spots: Limited partners focused on GP commitment (or existing wealth) may overlook promising fund managers outside their standard view.

6. Asset Class Performance: These small funds will likely include the top-performing funds solving the biggest problems. Funds that focus outside typical innovation hubs outperform. This is a power law play… the domain of emerging managers.

Potential Solutions

Addressing this challenge requires a multi-faceted approach: defining what GPs need, helping LPs understand the challenges and benefits of supporting them, and innovating in the gap:

1. Flexible GP Commit Structures: GP commits could be tied to a percentage of the manager’s net worth instead of a fixed percentage of the fund. “Skin in the game” is dependent on how much skin there is to begin with.

2. Grant Funding/Philanthropic: Specialized funds that can commit to a first close as an anchor to catalyze market-rate LP participation.

   • Offer lower return expectations or junior preference to another capital.

   • Larger checks in the initial close allow the management fee to start at a more sustainable rate and cover more costs earlier for the manager.

3. Early Management Fee Activation: Be flexible with front-loading management fees to align with the fund’s actual expenses.

   • Front-load more management fees into the investment period. Some LPs still oppose this, but most sourcing and selection costs are spent in the investment period.

   • Pull the final year of management fees into the first close to help cover for the time spent raising without pay (before the first close).

4. GP Funding Vehicles: Create specialized financial products to help emerging managers bridge the cash flow gap.

   • Investment in the GP entity or the overall Investment Firm entity.

   • A catalyst fund with forgivable loans to cover the initial cash gap.

   • Creative funding tied to the emerging manager (like GP Runway Fund, Chisos Fund, or SPACE agreement), where the return of capital is tied to the compensation and distributions to the emerging manager.

5. Institutional Support: Established firms and institutions could provide grants or low-interest loans to promising emerging managers for these cash gaps.

Conclusion

Lowering financial barriers for emerging managers can unlock a new wave of innovation in venture capital. This isn't just about making it easier for capital entrepreneurs to start funds—it's about ensuring the best ideas, regardless of origin, can secure funding and change the world.

As an industry, we need to recognize that GP finance IS personal finance – and support the next generation of fund managers. Only then can we honestly say we're fostering innovation at every level of the startup ecosystem.

I’d love to hear how other capital entrepreneurs are solving this cash gap. Who do you know that is addressing this?

(I’m happy to send you the spreadsheet. Just let me know.)

Don’t overthink it.  

The answer is...cash.

Today’s post is by David Silverstein, Founder + CEO at Ned, software for cash flow underwriting.  When it comes to low-hanging fruit for capitalism, David’s tech picks what is already ripe and waiting.

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Cash Flow Lending Drives Today’s Economy, Not Tomorrow’s

The Move to Cash Flow Underwriting: Unlocking Potential

With approximately 31 million businesses in the U.S., and an estimated 10 million underfinanced each year due to credit or collateral challenges, widely adopting cash flow underwriting within lending organizations represents a monumental, once-in-a-century opportunity to release billions into communities and stimulate serious economic growth.   

Outdated Underwriting Methods Challenge Lenders 

Today’s underwriting relies heavily on assessing the borrower’s credit history and collateral. Many small businesses, especially new ones, lack a credit history and sufficient assets to pledge, disqualifying them from traditional capital products. 

This collateral requirement is specifically problematic. Small business owners need to be asset-light today, but lenders still require assets for financing. 

This misalignment leads to time-consuming underwriting, complex creditworthiness analysis, and friction with borrowers. No one wins—lenders struggle and small businesses suffer. 

Cash Flow Underwriting Emerges as a Route Forward

In contrast, cash flow underwriting evaluates a business’s ability to generate revenue and maintain positive cash flow. This approach focuses on the business's performance and potential, rather than its credit history or collateral. 

By embracing cash flow underwriting, lenders can unlock growth and provide financing to solid businesses otherwise excluded from traditional lending. This benefits both lenders and businesses—capital gets deployed and cycles back to the lender, small businesses thrive, and new jobs are created. 

Cash Flow Underwriting In Practice

Let’s take a restaurant that wants to open a new location. The owners pay rent, so they don’t own property, and they lease most equipment. It’s a great business that operates profitably.

The owners need $120,000 to lease a new location, purchase supplies, and hire employees. They shop for a loan at four lenders and get rejected by three. They are in the market for a three-year working capital loan. 

Three lenders say no because the restaurant lacks assets. However, one lender recently implemented a tech-driven cash flow underwriting capability and sees potential in the business’s fundamentals. 

The lender sizes the loan against revenues and notices that the restaurant is seasonal, and that 60% of their revenues come in Spring and Summer, but over time they have cash flow to deliver against repayments. What’s more, the restaurant might even have the ability to pay off early. 

The borrower gets approved after a quick underwriting process because the lender can easily forecast revenues and size the loan appropriately. They even provide the borrower with two options - they can either take a fixed repayment loan or a revenue-based repayment loan, to provide some flexibility given seasonality. Capital is deployed, and the loan is repaid successfully because the lender maintains ongoing cash flow visibility.

Separately, the three lenders that rejected the business realize they missed an opportunity. This begins happening more and more, and they consider making changes to their lending operation.

The Big Picture 

Given the scale of the small business sector in the U.S., the shift to cash flow underwriting holds real promise. With 10 million businesses underfinanced each year, billions can be unlocked for businesses that otherwise struggle to secure financing.

Cash flow underwriting isn’t just helping legacy lenders, it’s making it easier for new lenders to enter the market altogether. 

When it’s cheaper and and more straightforward to underwrite a loan, and faster to deploy dollars, the door opens for those emerging lenders that otherwise might have hung back - tech companies who aspire to finance their SMB customers directly, accelerators or incubators that can finally get their first fund off the ground, the list continues.   

More tech-enabled cash flow lenders means more money available to small businesses. At Ned, we’re seeing customers increase deployment - a lender that developed a capital product for retail-oriented in Tennessee, another that’s built a new, flexible offering for Kansas City businesses. The outcomes are unique and powerful.   

This means there’s more options to move forward and pursue growth for businesses that typically had a harder time. Slightly newer, service-related businesses, those that need to flex to meet inventory requirements, brick and mortar businesses that need to replace equipment or expand. We’ve seen close up how lenders are using cash flow underwriting to meet their customers’ needs, on their terms.  

There’s no doubt that we’ll see new jobs, innovation, and stronger small businesses as the outcome.

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Innovative Finance Announcements + Content

• Energize Colorado is hiring a Community Lending Specialist

• The American Worker Project

• Funding the Funders: Flexible Lending for Capital Entrepreneurs

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As a result, we engineered bigger, more durable crops and pesticides to kill all other crops.  Larger corn stalks and less competition from other plants increased yield.  

Modern farming is rife with lab solutions to field problems.  

Solvers and Their Environment

In reality, the most qualified problem solvers are those facing the problems themselves.

The further the solution is from the problem, the more likely that problem space will find itself learning and relearning this truth.  

The lure of that one genius insight keeps us cooped up in our own heads, behind our computers, or in our laboratories.  We all want to be heroes without getting our hands dirty.  Yet, these places lack the most critical resource for problem solving - real-world insights.  

No solution is perfect, but the odds of a solution creating more problems than it solves decrease when the solution is born of the same environment as the problem itself.  It is all about feedback loops.  The closer you are to the problem, the tighter the feedback loop, the more accurate the solution. 

Every startup wants to be a disruptor.  Pivots are lauded as agile thinking and clever resilience.  This non-attachment may be the ideal way to unlock revenue and growth, but it also results in a lot of problem solvers who are relative tourists in their problem space.  They’re the new neighbors petitioning to cover graffiti with a mural, unaware of the graffiti’s beloved local status.

Our collective strife is born in this slippage between solvers and their environments.  Whether you want to pick on Washington Elites, Wall Street Quants, or Startup Bros, they’re all the same critique - problem solvers from a distance.  They are famous for creating more problems than solutions over the long term. This is how well-meaning, dedicated problem solvers find themselves as “perpetrators of the system.”

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High Finance

High finance is peak “system.”  A systems framework reveals this quickly, surfacing an organism that behaves like cancer.  Once a few cells, or a few bankers, with a novel solution, now has the entire body working to feed and grow it.  It centralizes resources and is ever increasing in size and complexity.

But bemoaning high finance will not solve anything.

Rather, let’s imagine the solution.  

Instead of high finance, we need low finance.

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Low Finance

• Rather than incentives to grow, it preserves incentives to keep small.  

• It does not increase in complexity but refines towards simplicity.  

• It is not an industry of a few, but rather a decentralized function embedded into every organization.  

For any financial innovation, the question is whether its unbounded success will lead to high finance or retain low finance.  At the risk of reading like every other nonprofit website, finance needs grassroots solutions.

A graduate degree in finance is laughable to grassroots finance.  Quants have exceptional skill, but they will need to refashion their trade in low finance.  Increasing assets under management will only be prudent so long as it decentralizes asset managers.  LPs with the ability to scale their operations down in check size and up in reach will far outperform.

Low finance is still finance, it just transforms from a cancer that exists to feed itself to a complex adaptive system.  These types of systems are not new.  We call them healthy ecosystems.

Wisdom On The Ground

The fancy, bigger, better corn fed us well.  

Once we invented endless fields of mutant sized stalks and cobs, the problem shifted to how to use it all.  We invented corn sugar, corn oil, and corn fuel.  It is unfair to point the finger at just corn or corn farmers too.  High finance deemed certain plants “commodities” and farmers did the rational thing - more corn!  

Millions of acres of healthy ecosystem, formerly known as the American Prairie, got overtaken by industry.  

Except this all started with a lab solution thrown at a field problem.

Ironically, yield problems are creeping back into our fields.  As corn and other crops absorbed industries, they also absorbed our aquifers and soil nutrients too.  

There was never a corn yield problem.  There was simply the amount of corn the ecosystem could healthily produce.  And our misunderstanding of this wisdom on the ground.

Innovative Finance Announcements

• Social Capital Partners is hiring a Director of Communications

• Novel Capital closed $15M for its Capital Intelligence platform

• From the Small City Segment: Small Towns, Bigger Games

With that, please meet Dustin Mix.  

I connected with Dustin through his newsletter, The Small City Segment.  As a rural Colorado focused investor, I was struck by how perceptive Dustin’s newsletter was.  By his standard, most of the places I work are not even small cities, yet he was putting words and data to trends which my partners here in Colorado have been circling for years.  For me, that’s the tell of good writing.

Dustin lives in South Bend, Indiana, a city of 100,000 with a growing reputation as a rust belt revitalization story.  All too often, funds get raised with an interesting thesis, only to go chase the same deals as everyone else.  In contrast, Invanti, the fund and studio that Dustin cofounded, exists to actually solve problems for small cities.  This ambitious focus yet grounded approach made me fall in love with his newsletter and way of thinking.

My favorite piece of his - Grow or Die is Wrong - is the perfect example of this.  While I had sneaking suspicions of growth prerogatives, Dustin crunched the numbers to find an important insight - growth is not synonymous with community health.  Not only does he reject a common economic development norm, but he dives into what communities should be focusing on, quality of life and entrepreneurship.

This leads us to today’s post by Dustin:

Investing For a Place

Immediately after I finished graduate school, I moved to Léogâne, Haiti, a city of about 60,000 people 25km to the west of the capital, Port-au-Prince. I had spent three years in two master degree programs exploring new residential housing models in the wake of the 2010 earthquake. My faculty advisors and I had a design we felt might work, so off I went to see if we could implement it with local labor, materials, and partners. 

After being there for a few weeks, I met Paul. Paul and his brother were generational residents of Léogâne and had built a small collection of companies and on-going concerns, including a construction firm. He had spent most of his childhood and college in the US, so while my Kreyol language skills were still developing, he made getting things done much easier. 

I pitched Paul on our design and construction process and he was immediately in. We learned a lot from each other over the coming two years and built some homes that are still standing today.

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Paul was all-in on Haiti and all-in on Léogâne. He didn’t say yes to our project because I painted an irresistible opportunity. He said yes because, three years after the earthquake, he was scouting the world for new ideas that could make him more comfortable, as a builder, that his homes could stand up to earthquakes and hurricanes. But he was also a businessman, so it couldn’t just be interesting. It required the potential to become a sustainable enterprise. 

It took me a while to understand the sprawling nature of Paul and his brother’s investments. A construction business, small hotel, gravel business, gas station, cherry farm, motorcycle imports - the list goes on. This is nothing to say of how they invested outside of their businesses - supporting the local Rara festival, building clean water wells - this list goes on. And they weren’t alone. I attended a few local rotary meetings and everyone in attendance was doing the same thing.

I learned a lot from Paul and his brother while I lived in Haiti. A decade later, I’m still learning from them. And after 10 months of exploring small cities, one of their most profound lessons has come to the surface. 

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Investing For a Place, not just From a Place

I have a simple definition of economic development: to improve the quality of life for residents. 

Too often, I think this gets conflated with a strategy of economic development, namely helping local entrepreneurs start new businesses to create new and good-paying jobs. Better paying jobs are certainly one way to improve the quality of life - it gives people more options and opportunities - but it isn’t the only way. 

My definition also includes innovations that make a higher quality of life more accessible. 

Put another way, if you think about a person’s income statement, you can increase revenue or decrease expenses to put more money in their pockets. The best case is doing both. Increasing the amount of discretionary money increases what they are free to do - both now and in the future.  

What does this look like practically? 

It means expanding the purview of local capital from only investing in startups that come from this place to also investing in startups that are for this place. 

Instead of only advertising, 

‘We are investing $500k checks into companies that headquarter here.’

you’d also advertise things like, 

‘We are investing $500k checks into companies that can reduce the cost of housing, solve our lead paint problem, increase access to transportation for employment, or solve the prenatal care gap.’ 

Cities can just as easily request what startups solve as they can where startups locate. There is value in startups building products and services that improve housing, transportation, education, job access, financial health, and a myriad of other things. That is true even if that company is not physically located in your city. Sometimes innovations that come from the outside can do things that are a struggle locally. Local capital should not arbitrarily shut those out from its investing universe because of the mailing address of the company headquarters. Sure, we may not get the job creation benefits or the tax revenue, but those aren’t the end-all, be-all. 

The goal is improving quality of life. Expanding from a strictly “from” capital strategy to include a “for” strategy can increase our ability to do so. 

What are the advantages of including a “for this place” investment strategy?

1. Capital as Advocacy

Investing early in solutions allows your community to shape what a company ultimately builds. Companies are not predetermined machines, they are path dependent and if customers in your city are early adopters, that will show up in what is built and prioritized. This strategy turns local problems into opportunities. If local capital backs a compelling solution to a local problem that also happens to affect other communities, your community can actually see returns for having catalyzed it. 

2. Independent of Local Deal Flow

Many cities are trying to figure out their innovation and entrepreneurship ecosystems. They are nascent, small, and still looking for their identity. This can make traditional place-based investing hard at times because the deal flow is just not there yet. Adding a “for” strategy is independent of ecosystem maturity - you can start regardless of the robustness of current “from” supply.

3. Expands the Investing Universe

Piggybacking on the last point, the number of companies that may be building products and services that can improve your community is most likely much larger than those coming from your community. This wider net means more opportunities to see interesting, high-quality companies that can both serve your community and deliver returns.

4. A Bigger Tent

This strategy allows you to get more people involved. You’re not only engaging people in the entrepreneurship community, you’re also bringing together people who are problem experts and partners who understand your community's challenges and may spend little or no time in the traditional entrepreneurial ecosystem. 

5. Local Networks are Powerful

Local networks are valuable to both the founders and the investors. Founders get access to potential customers and partners at an early-stage. Investors get access to local expertise that can improve their due diligence and investment decisions. And if an investment and pilots do happen, both win.

6. “Traveling Salesman” & Intercity Connectivity Benefits

The connectivity of small cities is powerful for new ideas, businesses, and innovations. When you become an investor in an external company that serves your community, you’ve added a new node for your city. New connections are made, new ideas are shared, and the dynamism of your city increases. 

Examples in the Wild

Examples abound for the “from” model of investing - city-specific funds and accelerators (see Buffalo, Birmingham), state-backed funds (e.g., Elevate Ventures in Indiana), and national firms with geographic theses (Rise of the Rest). Some of these only invest in companies from their communities, others also invest in companies that want to move to their communities. Most are still young experiments - a decade old at the most. 

The hard part about the firms with hard requirements around where the company locates is that it becomes a zero-sum game, turning the old smokestack chasing game into a techstack chasing one. 

Layering on a “for” strategy lets you play a positive-sum game. Startups aspire to serve customers in more than one city, and if you’re an investor as well as a customer, you’re fully aligned with that. It allows cities to collaborate with each other, rather than compete in a race to the bottom on incentives, funding, and amenities. And in an age where it’s hard to even define what a “headquarters” means for many companies, it takes some pressure off.

There are bright spots of organizations that are leaning into the idea of investing for a place. Blue Ridge Labs in NYC explicitly goes after the earliest stages of this, running what looks a lot like a venture studio, focused on solving problems for New Yorkers. The Ohio Impact Fund is putting from and for together, investing in Ohio-based companies that make Ohio a better place to live. The Urban Innovation Fund is investing to improve urban cities writ large. 

There is a lot of room for more “for” strategies. They don’t all have to be the same. They don’t have to preclude or replace a “from” strategy. They are just another tool to pursue the ultimate goal. 

All In

We have the luxury of sitting down and writing long-form newsletter posts about these distinctions. At the extremes, in places like Léogâne and for people like Paul and his brother, this is a silly nuance to name. Of course you’d invest in both “for” and “from”. There is no time for these debates - there are problems to be solved, jobs to be created, communities to build.

In my research for the new podcast project I’m working on, I came across this quote about Wheeling, WV back in the early 19th century:

There are less boundaries between local economic development and local investing than we artificially create. Often they have a simple shared goal - improving livelihoods. Before we had frameworks, models, and entire institutions dedicated to the practice, we just had problems and problem solvers. Leaders like Paul and his brother.

We don’t have to wait for things to improve in our cities. Sometimes this means building things ourselves. Other times, it means scouring the world for innovations that can make our cities better. There will be some convincing, negotiating, and things that don’t work out. But there is a world of possibility in a small mindset shift of considering ourselves not just from a place - but also for a place. 

» Check out more of Dustin’s writings at

Innovative Finance Quick Hits

• VC Include Announces 2024 Cohort for Fellowship for Impact Fund I Managers

• Dirt Capital’s 10 Year Impact Report

• Webinar: Do you need to deploy capital for Indigenous communities?

When the seeds of companies turn to blossoms, any entrepreneurial ecosystem will want to organize capital.  

It is a logical step. Invest money, accelerate businesses, reap rewards, reinvest proceeds. If done right, a capital ecosystem kicks of a virtuous flywheel.

So where is that capital to kickstart the flywheel?

The community inventories its members and discovers plenty of potential investors amongst its ranks (note to self - save accreditation rule rant for another newsletter). 

The angel group initiative begins.

With emphatic community buy-in, a selfless community leader pours themselves into this effort. They’ll fundraise for the events, practice the pitches, schedule lunch after lunch to recruit more investors, build a website.  All the pieces will get put into place.

Come “launch, they’ll have a roster of enthusiastic investors excited to knight the community’s next great company. Companies start pitching. Asks go out.

And then what happens?  

Nothing.  

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At least in terms of real results - capital flowing into companies.

Meanwhile, the community’s single most precious asset, founder time, got squandered.  They built investor funnels, practiced their pitches, scheduled lunch after lunch.  Local funding is often the most aligned, so founders often prioritize raising with the new angels-to-be.

And then “something comes up.”  Over and over and over again.

99% of angel investors have other priorities, be that their own companies, their family, or just playing golf 100 times per year.  That is okay; it is just the nature of commitments and being busy.  

At best, the checks are smaller and slower than anyone expected. At worst, and all too often, no checks get written.

The community’s momentum and credibility will take a hit.

Angel investors are an important component of a healthy capital ecosystem.  They are not going to be the spark.

To Be Fair…

There are plenty of angel investors who step up. This is the devil’s advocate talking (from experience).  

I’ve seen individual investors make game-changing connections, lead boards, and most importantly, step up and write checks.  They are absolute champions for founders and the community (you know who you are). 

They are the exception.

On the whole, angels are great funding followers and ecosystem amplifiers, not leaders.  And that is okay.  In fact, it is great.

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If you want to kickstart your capital ecosystem, start a fund.

One entity with one leader deploying capital will create more momentum for your capital ecosystem.  

Community leaders are the most invested yet underappreciated players in most capital ecosystems.  They’re likely already doing a lot of this work anyways - mentor connections, events, email updates, things VCs call “value-add” on their site.  Now, they have a way to monetize and amplify their tireless efforts.

Early stage investing is not a matter of consensus anyways.  Even for the companies which don’t get funding, the time gained from one swift “no” from a fund compared to ten slow angel “nos” is priceless.   

While writing checks is not business building, it sets the tone for others to join.

So where should the fund capital come from?

The short answer - wherever possible. There is SSBCI, state programs, economic development organizations, foundations. These are likely the anchor checks.

That said, the ideal answer - as many of your community’s angels as possible.

While every angel intends to write all the checks, attend all the events, review all the decks, and mentor all the companies, they’ll appreciate someone else stepping up to do this work.  In fact, they’ll do it better if they are already invested via the fund.

From there, the community leader, now a GP, is tasked with creating lower bars for angels to clear to get involved in an already happening capital ecosystem.  

Oh, and the door is always open for an extra check from the extra excited angel on every fifth deal that resonates and fits with their experience and schedule.  In fact, after a few of these, coinvestment gets normalized.  All of a sudden, the angels are talking to each other about their investments.  They start to feel the social pressure of chipping in.  

And all of a sudden, they start writing more checks, even into companies the fund doesn’t back. They meet on their own.  They meet founders and introduce the fund to them.

And just like that, ironically, the angel group is born.

Is raising a fund harder than getting a few checks written here and there?  Yes.  Does starting a fund introduce many of the downfalls of venture?  If you’re not careful (carefully reading this newsletter that is!). Is there room for innovation to do a fund right?  Tons.

These are all solvable problems.  

Despite the critiques, starting the capital ecosystem with a fund is the fastest way to get capital flowing.  From there, people will want to be a part of the progress.  

Even better, start an innovative, flexible fund.  By doing so from the start, you become the standard bearer of your community’s capital norms.

Innovative Finance Quick Hits

• Accion is hiring an Associate

• Amkan Ventures shows you can have a $10M Fund of Fund

• How a humanitarian organization is catalyzing capital

Sam was a solo act for a few years.  It paid the bills, but demand eventually grew beyond what he could personally service.  As a result, he hired another plumber, taking a personal pay cut to do so.  

For a while, that hire seemed like a crazy idea.  Sam had to hustle to make sure there was enough work to keep them both busy.   His paycheck came last–after his employee’s, servicing the work truck, some local advertising, replacing the toolkit.  Some months, Sam’s pay was a fraction of his employee’s.  Others, it was zero.

Year after year, local plumbing demand outpaced Sam’s team, so he hired and grew.  Sam the plumber was now also a one-man hiring, marketing, customer support, and finance department. 

Each time a new plumber was added to the team, Sam weighed whether the new plumber was likely to unlock enough business to pay for their wages or salary.  

If he got this wrong, despite being over a decade into a successful business, he would occasionally forego his own salary or take on extra jobs himself as free labor for the company.  

If he was right, Sam gave himself a share of the profits.

This balancing act happened for decades on end.

Eventually, particularly in the last ten years, it has all started to pay off.  

His large, longtime client-base became a predictable revenue generator.  He built a stable team of ten and rarely markets himself thanks to loyal clients.  It is an efficient six to seven figure revenue generating machine.

For Sam, as the business grew more efficient, he took home more of the profits.  Sacrificing his own pay to grow the business eventually netted him a lucrative income stream.  It was a laborious, occasionally even harrowing, few decades, but Sam is now comfortable, if not well-off.  

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The Crashing Tsunami

Sam’s journey is a stereotypical droplet of the “Silver Tsunami.”  Here’s a quick primer on this phenomenon:

• 2.3M Baby-Boomer-owned businesses

• Employ 25 million people in America

• Less than half have succession plans

In short, Baby boomers own a ton of businesses, employ a ton of people, and have become the wealthiest generation in human history doing so. This is the single largest wealth transfer in the history of humankind – estimated $53TR to be exact. 

Proactively dealing with this wealth transfer is a societal priority.  Legacies, nest eggs, and the future of our economy are on the line.

I have ideas.

A Frenzy for Lucrative Faucets

The Sams of the Baby Boomer generation built six and seven figure faucets and a lot of them will continue to work for years to come.

Realistically, much of this wealth has been taken home and stored away.  It got invested into stocks, real estate, college funds, and more.  A lot of this is getting written into wills for the next generation.  That said, make no mistake, the vast majority of it came from these businesses.  It all started as dollar of revenue or asset/equity appreciation in these small businesses.  Silver Tsunami businesses are the crux of this wealth transfer.

There is a frenzy under way to capture the wealth from these faucets.  This is the trillion dollar tsunami that is crashing as we speak.

So what do we do?  

The free market is already doing the obvious thing.  Money and talent are flowing in to secure these wealth generating machines.  For example, an earlier newsletter highlighted the search fund opportunity, a micro-asset class (for now) of business-owners-to-be, backed by investors, buying up the stable and profitable Baby Boomer businesses.  This is just one of an ever-expanding variety of business models addressing the Silver Tsunami.  

That said, keeping a bevy of decades-long profitable business profitable is not the interesting opportunity.  

We can leave it to the MBAs to weigh the pros and cons of search funds, hold cos, tech disruption, and whatever other solutions arise.  The opportunity is too vast for any single solution to be the right response, as opposed to “all of them” being the right response, anyways.  

More importantly, if there was ever a moment of transition from historical economy to future economy, this is it.  

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Capturing Dollars vs. Creating Value

In Sam’s era, dollars were used to assess value creation.  I’ll even concede that this was a “good enough” measure for the time.  Through business creation, the Sams of the world created more wealth than the world has ever seen.  It was such an effective playbook that we let it run for decades.  Hard work and persistence translated into business creation which created wealth for the business builders.  This wealth was fine proxy for the value we got as a society from these businesses.  It is an amazing time to be alive, and this is a large reason why.   

What the old economy didn’t account for, is that Sam is getting old and wants to be done working. 

It also didn’t fully account for the massive subsidies the old economy was built off of.  Likely unbeknownst to him, Sam rode the financial tailwinds of subsidized capitalism.  Yes, there was government subsidy - mortgage rates, social security that will actually be there at retirement), healthcare and education before they became unaffordable hot messes.  There was also environmental subsidy.  Sam didn’t have to account for his business’s footrpint, nor did his suppliers.  His customers didn’t have to care about water waste (yet).  The old economy relies on unaccounted for subsidy from all directions.

Sam’s playbook may have been the best we had at the time, but that time is running out and those subsidies are becoming debts.  

We should be demanding that the successors of the Silver Tsunami work off of a new playbook.  

They don’t have to.  

The Silver Tsunami is by default a value capture opportunity.  That is why everyone is clamoring to find how to fit their solutions onto annual six figure faucets like Sam’s?

Occasionally, the next in line to that faucet is a longtime employee who was a part of Sam’s journey.  Or maybe another local outfit wants to buy Sam’s business and customer base?  Perhaps Sam even has a kid lined up to inherit the family business and carry on his legacy?

However, given the scale of the tsunami, hundreds of thousands of times over, a bright-eyed grad student will do the simple math, pitch PE backers, and step into Sam’s six figure job without ever having to turn a wrench, let alone sacrifice to keep the team fed first.  

Some successions will seem worthy, some will seem privileged.  We will neither grasp all the nuance nor judge it fairly.  In fact, let’s accept that the vast majority of successors will be mainly be collecting cush paychecks thanks to their ideal positioning below these faucets.  Lamenting others’ wealth is counterproductive. 

While Sam may have worked decades to build an income stream, his successor likely will not.  That doesn’t mean his successor didn't’ earn the right to inherit the fruits of Sam’s labor fair and square.  

However, after the faucet has been captured, we should demand value creation.  

Sam’s value creation happened over the course of decades.  He built a plumbing business which served his community.  The old playbook rewarded him according to the rules of the game.

Sam’s successor is capturing a fantastic income stream from day one, dodging decades of hard work in the process.  They owe it to Sam to continue to grow the business’s value to its community, though this time in the future, less subsidized economy.

Sure, that may mean improving on Sam’s plumbing business.  Our future economy will still require plumbing.  

However, as every politician will repeat, “small businesses are the backbone of our economy.”

Transitioning to our future economy requires we flex this backbone to ditch our inherited subsidies:

• Take the silver tsunami cash-printing machine and make it a cash sharing machine.  Employee owned businesses outperform their peers anyways. Start redistributing those profits as the first step in growing revenue.

• Are there processes of the old business which could be more resource efficient?  Doing more with less means making more while spending less.  

• Could impact-linked compensation become a norm?  Is it a matter of retraining our future business owners or applying pressure as communities on our local business owners?

These are my top of mind actions for business beyond subsidized capitalism.  You can fill them in with your own too.  They require finding a larger reason to exist than simply collecting a paycheck. 

When done right, they are competitive advantages and a larger reason to exist.  Discovering this overlap is the once-in-humankind opportunity. It won’t be easy, but that is how the Silver Tsunami goes from a value capture to a value creation phenomenon.

The compensation to create is already taken care of.  You can thank Sam for that.

Innovative Finance Jobs and More

• Raven Indigenous Capital Partners is hiring a Senior Impact Associate

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• So, You’re Thinking of Investing in Regenerative Food Systems…

Equity does not price its capital.  Depending on the exit, it could pay out nothing, if the company fails, or infinite amounts in grand-slam exit.  

So what should founders and investors make of the return cap in many innovative term sheets?

There could be a 1.5x, or a 3x, or even a 10x.  Is this the cost of capital?

It depends.

If the investment is debt, then yes.  A 2x revenue based loan will only ever cost 2x.  The lender underwrote the deal to get a 2x.  Some revenue based loans have lower multiples to incentivize early repayment, but by and large, the cost of capital is exactly as advertised.

If the investment is risk capital, such as redeemable equity or a convertible note paired with a revenue/profit share, then the return cap is a fallback.  Why?

Risk capital is not a game of assessing risk.  Risk in new markets or early stage companies is impossible to quantify and capture in a price.  As a result, risk capital is not a matter of underwriting a single deal but rather bundling a batch of deals and letting the cards fall as they may.  Unlike underwriting debt, the higher order task is not risk assessment or avoiding defaults at all.  It is all about capturing winners in a batch.  

So what is the return cap with risk capital term sheets?  It is a price should a company not turn out to be an outsized winner.  If the equity position is not on track to become a great multiple, the return cap offers a release valve, allowing the investor and founder to remain aligned as they shoot for a modest multiple comparatively.  

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It is critical for investors and founders to understand if the return cap is the price of capital (innovative debt) or is the fallback price (today’s innovative risk capital).  

For founders, this mistake is a windfall at first.  When cheaper debt is not available, more expensive “whatever type of capital” will do.  They do not plan to take on burdensome debt, but the return cap often ends up feeling expensive.  As a result, the equity has no prospects of converting or getting purchased in an exit.  The revenue share kicks in and a debt-like tailspin ensues.  

This is most common with equity-sensitive founders.  Hoping to retain full cap table control, they raise this hybrid structure and anticipate paying it off just like a loan.  When real risk wins out, they are stuck with an obligation they can’t service.  The correct funding was risk capital, designed to tolerate failure.   

When investors make this mistake, they fail to optimize for picking upside.

The multiple, or return cap, gets seen as a continuation of debt’s pricing.  “If a bank offers 10% and a revenue based lender’s 1.5x usually nets out to 15%, I can just price my startup capital at 2x and aim for 20% IRR/interest.”  The investor thinks they are tippy-toeing near the edge of what is underwritable when in fact they’re deep off the banks of making a bundle of risk capital bets.  The result is a portfolio with risk capital-like failure rates and debt-like returns on the deal-level.  Lacking a mechanism to capture upside and make up for the failures, the portfolio looks like the disastrous underwriting that it was.

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This pricing misconception must be dispelled for innovative finance terms that scale.  

At the deal level, this causes years of misaligned founder-investor partnerships.  One level up, GPs end up with real risk and no upside to make up for it. At the macro level, investors see mediocre returns and head for the hills.

The key to avoiding these misconceptions is simple: ask questions. Portfolio strategy is an essential conversation in the investor-founder dating process. Funding creates obligations, so both parties should be clear about what obligations they see being created and the pressures that will come with them.

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💰🛫 » Funding the Runway: Addressing Cash Flow Challenges for Emerging Investment Fund Managers with Sonam Velani, David Lynn, Michael Belles & moderated by Margot Kane

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Some choose top-line revenue.  Not accounting for any holiday period on payments, as soon as the company has paying customers, payments start to investors.  This also preempts any other expenses for the business, ensuring the returns are not manipulated by padded company expenses.

Others use profit (often via net income), the far other end of the income statement.  On one hand, this is pure alignment with profitability.  Investors only get returns once a sustainable business has been built.  On the other hand, all other annual expenses get doled out before profit and therefore investor payments.  Profitability can get delayed or avoided for reasons valid and not.  

Lastly, there is a group which takes profit, then adds back in founder/exec compensation, and shares from that sum.  It aims for profit alignment, but also addresses the most tempting expense, founder comp.  

I can see arguments for each of these and don’t anticipate reaching the single prescriptive solution.  Each investor has their own reasons for doing these, specific to their focus, thesis, style of partnership, etc etc.  For terms that scale, I think the goal is to make selecting one relatively straightforward for any funding situation.

I see two main places where I anticipate return variable thinking to evolve:

• Think of the Return Variable as a Preference.  The distinction between common and preferred shares is widely understood and standardized in use.  The return variable functions much like common vs. preferred, dictating the order of payout on the income statement instead of cap table.  Revenue is the “most preferred”, as it derives returns before the company can use any of that revenue for its own expenses.  Profits are essentially common stock preference, if not even below, where investors wait in line for returns alongside common shareholders, after all expenses and budgeted salaries.  Thinking about these as a parallel to common vs. preferred may expedite their standardization.

• Profit sharing gets a lot of crap for how easy it is to manipulate.  However, so long as it is paired with long investor-lock-in, what company can sustain manipulating its way out of profit for years on end?  A lot has to go wrong in the investor-company relationship for a successful, profitable company to continue to hide profits to avoid investor repayment for the better part of a decade, which is the length of ride most risk capital investors are used to signing up for.  Why orient around this level of paranoia?  Or am I naive?

• Is there opportunity for the return variable to shift based on triggers?  This could prevent negative ones, like hiding profits early on, and reward positive ones, like performance milestones.

• The most commonly used return variable is gross revenue.  I think this makes sense for simplicity and this will continue to be the case.  That doesn’t mean it should be blindly adopted in lieu of thinking through the options more critically.

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More Perspectives:

Tyler Tringas, Calm Company Fund - investor utilizing (pioneering really) the use of Founder Earnings

One of our primary goals at Calm Company Fund was to be able to invest confidently in a profit-sharing vehicle while allowing the founder(s) to retain board control. If investors are only entitled to a share of traditionally declared dividends, and the founders have full board control, then investors are exposed to the risk that founders simply increase their compensation to the point where the company is no longer profitable. The heavy-handed way to resolve this for investors to take board control and have the right to approve "fair" founder compensation packages. But this is unnecessary for many businesses.

Founder Earnings directly mitigates this risk by aggregating all the cashflow in the business that could be allocated to the founders—actual founder compensation + net income—and using that as the baseline for calculating the Shared Earnings obligation to investors. This lets founders make their own optimal/tax-advantaged decisions on how to actually allocate those dollars between salary, dividends, or reinvestment, while ensuring that investors are automatically entitled to their fair share. 

>>>Learn more about Calm Company Fund and their terms here.

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Ines Schiller, Vyld - steward-owned startup founder who raised a profit share based seed round

One of the main reasons for us to go for profit instead of rev. share was that at the point where we had to come up with the terms, we felt we did not have a robust enough model to predict the revenues in relation to the overall company development that we could make sure a rev share would not accidentally blocking us at some point. The second and very basic reason was that we are pre-revenue and as a R&D heavy company we will stay like this for some time. The last point is more a philosophical one but in our interpretation of steward ownership the repayments for investors should only be based on profit as these are the additional worth that is created by the company while fulfilling its mission and therefor can be shared without sacrificing our profit-for-purpose principle. 

>>>Learn more about Vyld’s seed round here

What is your take?

Hit Reply so we can incorporate your expertise in future newsletters.

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• Raven Indigenous Foundation is hiring for Analyst/Strategy/Engagement

• Trust Neighborhoods is hiring a Director of Finance

The next few newsletters will be mini-newsletters (by our wordy standards) and focus on specific early-stage finance terms and how they can or can not scale in current form.

The early-stage focus is not because other areas of finance have an already acceptable status quo.  Rather, every single business starts as an “early-stage” company and has to go through one-way valves to receive early-stage financing.  If the goal is to plumb our economy to better outcomes, these valves see the most flow and are therefore the first place where businesses get routed away from those outcomes.  We are starting as upstream as possible.

Read the next few newsletters as problems to be solved, opportunities for the taking, playbooks to be copied, and questions waiting for expert answers (possibly even your expert answers).  

Let’s use this newsletter as a space to discover terms that scale.

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• Novel Capital is hiring a Credit Analyst

• Common Trust is hiring a Content Marketing/Design Specialist and PR + Events Manager

Tiger invested in 288 deals, and bloodbath conditions contributed to a record-breaking $23 billion in venture deployed in 2022.

Today, the bloodbath has been replaced by something worse, a mess.

The founders and investors remaining are forced to work tirelessly to find soft and not-so-soft landings. Meanwhile, the top mess-maker, Tiger, has effectively closed up its venture capital practice.

While their strategy shook up VC’s stagnant corner of finance, the bloodbath and subsequent mess were not progress. In a society largely underwhelmed by finance, Tiger was not a breath of fresh air.

This Innovative Finance community aims to provide that breath of fresh air. If we don’t let Tiger’s tactics suck all the air out of the room, that is.

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A Bloodbath Becomes a Mess

The key to Tiger’s strategy was simple - offer the very best terms. Their speed was notorious, normalizing deals done in weekends instead of weeks, was a function of the primary strategy - offer the highest valuation to every founder every time. High valuations, or rather cheap capital, won them the most deals. That is how they scaled from an occasional growth-round investor to $12.7B VC practice overnight.

Cheap terms led to Tiger’s entire VC arm scaling back down to zero overnight. For now, the returns are not there. The mess is.

No one champions Tiger as a “non-extractive” investor or pioneer of “regenerative” investing.

So, why is innovative finance at risk of repeating the same mistake?

Existential Problems vs. Marketing

There are valid reasons to price capital lower than the market-rate.  We need investors willing to push outside of the constraints of market-rate. Price discovery of impact is necessary to break out of the subsidized capitalism dilemma. Some problems are acute and fixable with capital too. Inventing an investment model may be distracting when the return of a fixed problem might just be enough. We need funders willing to accept concessionary, or zero, monetary returns to tackle acute, solvable societal problems.

• $1M to revive neighborhood restaurants ravaged by a flood? Screw finance. We’ll talk about flood prevention later. Let’s revive.

• $2M to provide household solar lights to an off-grid region in need? Concessionary returns or not – let there be light.

• $3M to replant 50 hectares of clearcut forest?

Not so fast.

Restore the forest only for as long as the residents value the trees over the income associated with cutting them down for palm oil. This is called the Poverty Degradation Trap. It is an example of focusing on the acute problem and overlooking the necessary systematic fix.

Innovative finance (in my view) is after systematic fixes.

Cheap capital is not innovative.

What happens when cheap capital is invested in systematic issues?

Occasionally a bloodbath, but inevitably, a mess.

Cheap capital is effective, lazy marketing.

The premise should sound familiar - it is the Myth of Greed.

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At first, helpful lines are drawn.

Predatory lending is real. Definitions make it easier to spot predatory lending, where the underlying goal of the loan is not payback, but default. Lives get ruined by a thirst for profit. Predatory terms are possible with any capital product.

As tales of predatory investment practices spread, the counter-positioning is irresistible. Investors start portraying all of finance as predatory, cementing this fear in founders’ minds as they go to raise capital. Quickly, all investor marketing starts to sound the same. Everyone piles on to promote finance as a whole as predatory and then competes with who can portray themselves as the founder-friendliest?

Well, what is the founder-friendliest?

Every financial model suggests it is the cheapest capital.

The better terms, the more cash. The more cash, the more likely a you are to pay employees, make rent, feed your family. Moreover, the higher valuation, albeit only a theoretical number, the more validated you feel for years of hard work. No one should be chastised for survival decision-making.

In Tiger’s case, they even skipped the “founder-friendly” marketing phase and went straight to “cheapest” (aka largest check and highest valuation). This won them a spot on a record numbers of cap tables.

All too often, funders make the same mistake. They see the effectiveness of cheap capital and offer a mission-aligned cherry on top. They conflate financial innovation with price, standing up a market of unnecessarily concessionary capital.

Founders rightly flock.

The acute problem, a single company in need of a certain amount of capital, gets solved. The systematic problem, scalable terms to enable more financial pathways in our economy, remains unaddressed. Even worse, it may take a step back.

Investors market their cost of capital via the Myth of Greed, conflating innovative finance with cheaper finance. Previously helpful definitions, such as predatory, start getting misconstrued into labels. The pitch goes, “if you are a founder in [xyz enlightened industry], you deserve cheaper capital. Choose us, instead of the rest of finance, which is predatory.”

This divides finance around subjects which we all seem to agree upon. We all want a healthy environment, distributed opportunity, and a high standard of dignity and rights for all. Nobody gets in business to fight these things. However, cheaper capital gets sold as the enlightened capital. The rest of finance is greedy.

This division is poisonous for society and puts a ceiling on progress.

The Tiger mess has deterred billions from flowing towards early-stage tech. Cheaper terms result in cheaper returns. Void of returns, thousands of people are living through recaps, layoffs, and career crises. This is financial pain and human pain. It turns capital and people away.

As for Tiger, they may have captured the next NVIDIA, which will pay for their own mess and then some. Meanwhile, early-stage tech as a whole will further fracture into winners and losers. Repairing this damage will take years.

Tiger is an extreme example, but this pattern plays out in any industry with suboptimal returns. Early-stage tech is one thing, but what happens when an entire industry refutes returns?

No new capital flows in and underlying systematic issues remain unphased.

The entire budget for fixing an issue becomes the sum of the line items it can win from government and philanthropies. All the Rockefellers in the world can not underwrite the systematic transformations needed in shared ownership and climate.

There is no singular fix for systematic issues. The best we can do is enable as many of us as possible to pursue what we each see as progress.  This respects everyone’s unique version of the future and maximizes our chances at the best collective future possible.  We need to shift our $85 trillion dollar economic system to work on these problems.

This requires returns.

Returns require terms that scale.

Here lies the challenge for innovative finance.

Terms that scale are not cheap terms, they are new economic plumbing.

If finance is a means, innovative finance is the task of maximizing ends we actually want. We may not be able to agree on what the future should look like, but we can create financing that is maximally compatible with a range of futures we would like.

Terms that scale are terms which the economy at large can embrace without compromise.

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…Part III will discuss innovative finance terms themselves – where they currently scale and where they do not…

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Squander?  Yes, permanently relegated to small ball.  It is a future where our corner of finance is still referred to as “alternative”, only doing a handful of deals per year.  They’ll remain bespoke and misunderstood.  Our AUM will remain a fraction of a fraction of the rest of “traditional” finance, which will serve the same underwhelming role in society as it does right now.

We never found terms that scale.

I would like to talk about terms that scale - the pieces of today’s innovative term sheets which do and don’t have legs.  We could explore the solutions from other corners of finance - already solved problems waiting to be borrowed.

But first, we must dispose of the myth of greed.

And to do that, we must talk about survival.

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Everybody Gasps

Falling into the Arctic Ocean is always an acute, survival situation.  Falling into the Pacific is too…sometimes.  Whether the water is a deadly Arctic -1.8 degrees Celsius (28.8 F), or a balmy equatorial 70, we all react the same.  We gasp.  

It is an involuntary reaction.  The body has signaled that it is in danger and the mind proceeds to act accordingly.

Before you have even bobbed back above the surface, you start looking for lifelines.  Your lungs cycle in and out furiously.  Your heart races.  Your brain is frantic.  Your life depends on finding this lifeline quickly.

This is a problem.  Though instinctual, it is the wrong way to go about falling into the water 100% of the time.

The first issue is misdiagnosed survival.  The water is aqua blue.  You’re in the tropics.  You’re actually wearing a life jacket.  There is a waterslide.  And a camera.  Wait, you’re on an ad for Carnival Cruises!

Your body has started this chain reaction and totally forgotten the reality of the situation.  Luckily, you will figure that out soon enough and, hopefully, remember to smile in time to get the shot.  

Forgive yourself for that momentary panic - it was your biology, not you.  No biggie.

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What if it actually is survival?  

It is the Arctic Ocean.  You’re fishing for crab on the Deadliest Catch when your foot got caught in a rope and you got yanked overboard.  A cold water submersion is a serious situation.  Survival is a matter of mere moments.  

This presents the same issue from another, colder angle - your survival instinct is still wrong.  Your livelihood now depends on overcoming your biological instincts.

First, you have one minute to relax and control your breathing.  If you don’t, you will begin to hyperventilate, likely ingesting water in the process.  Moreover, as your heart starts to race, when combined with the abrupt cold, an imminent and unrecoverable heart attack nears.  Calm yourself!!

If you do survive the first minute, your limbs are only of use to you for another minute or two.  That is your narrow window to find a lifeline.  First, your fingers will be unable to grab for safety.  Then your limbs will stop altogether as your body shunts, prioritizing blood flow to your core and you'll sink like a rock.  

Yet, none of this matters if you don’t relax and control your breathing in the first place. 

Even if the situation is survival, and not misdiagnosed survival, your best course of action is to defy your biological instincts.   Accept the initial, unavoidable gasp.  Ignore the rush of adrenalin.  Mute the brainstem’s screams for a lifeline.  

Act like it is not survival.  Take some slow breaths.  

Now, you are more likely to do the next right thing, whether that is to smile or grab the lifeline your crewmates have thrown your way.

The Myth of Greed

Unlike an unexpected plunge into water, greed happens on dry land, or from the safety of the boat.  

Greed is a judgment made by those who never had to contend with that initial gasp.  

From the safety of the boat, or retrospect, the best action seems obvious.  You see the helpless soul in the water and think - Calm down - the rescuer’s throw bag practically hit you.  Now hurry up and grab it you fool.

Why would someone do anything else?  Why do people make short-minded decisions that so clearly sacrifice their long-term best interests?  Or even worse - my long-term best interests?

From the safety of the boat, it is easy to overlook the fact that once we feel that initial gasp in our chest, every single one of us thinks we are drowning.  There is no time to invoke the haves and have-nots, let alone act on such a conspiracy.  

Survival has no room for greed.  The myth of greed forgets this and blames people for their faulty survival decision-making and the suboptimal outcomes that ensue.

As the myth of greed propagates, it divides us.

Those who fall in water and, due to their biology, flail, are demonized.  They are greedy.  They are the enemy of our shared future.  If we can just identify these pathetic, greedy people and remove them from power, where would we be?

Even worse, we watch people from the “good team,” fall into the water which reinforces the myth.  Thrust into survival mode, they act brashly and in self-interest.  Their instincts fail them, just as ours would if we fell into the water.

Having watched another soul succumb to the waters of greed, we start to assume the danger is the water, not us.  Understandably, we recognize that the only way not to get wet is to critique from the dry safe shores.  We refuse to deal anywhere near the water and criticize those who do.  The teams get created - wet vs. dry, greedy vs. generous, good vs. evil.

Once again, our instinct is dead wrong.

To diffuse the myth of greed, we need more people in the water more often, together.  

This can not be practiced from the safety of the boat and is best done with others.

Practice feeling the shock.  Accept the gasp.  Take a few deep breaths.  See what is going on?

Cortisol and adrenaline pumps through our veins, whether or not we are actually in danger.  It may just be a chilly day in the water.  It may only be our ego that is screaming for a rescue.   It may be deadly cold. Act swiftly and effectively.  Prioritize your safety.  Feed your family.  Stand for your rights.  Survive.  Survive.  Survive.  Breath.

Saving your own life, it turns out, is the least interesting outcome from this training.  Being able to recognize just how often you are not in danger, that the water is not actually that cold, likely has bigger consequences.  

Without our survival on the line, more paths forward present themselves.  Our future selves, communities, environment, you name it, all stand to benefit from us realizing that we are safe.

Lastly, the largest benefit of collective coldwater training?  

Compassion.  Having felt the gasp ourselves, we will find compassion, heartbreakingly, for the fact that most of the time, we are all just trying to survive.  This explains why it is so damn hard to move things forward.  Why some people seem like they are fighting the future we seem to all agree on.  

It turns out, we have all been on the same team this whole time.  

Sure, some are more dry than others.  

Resist the urge to delineate new teams.  Rather, the task is to welcome everyone into the water.  

Gasp together.  Offer a life jacket.  Take some slow breaths.

Free of the myth of greed, and no matter the temperature, the water becomes less scary.  The key is to practice.  

Keep jumping in.  Keep gasping.  

And then, calmly, keep breathing.

Try it now.

From Survival to Finance

Against all odds, this brings us to innovative finance.  

I worry innovative finance is at risk of falling for the myth of greed.  

It is all too easy to forget what is really happening.  There is a deal, and in that deal, there are two or more people, sitting on different sides of a table, gasping for air. 

If we miss this, we will get stuck playing small ball.  Innovative finance will simply be code for “terms that do not scale.”

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Stay tuned for Part II - Terms That Do Not Scale

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The efficiency frontier represents an optimal diversification of portfolios and only applies indirectly to individual investments. 

However, it's possible to move the efficiency frontier by choosing a portfolio of companies that each have a broader range of achievable outcomes— effectively producing more non-zero outcomes with the same initial risk.

For most venture capital investors, every seed check relies on a future check at a higher valuation. Then, founders make decisions and navigate the paths from idea to product-market fit to scaling, backed by that seed check...

Which still relies on someone else's later (and bigger) check.

This “next round” risk is not mitigated as the company increasingly spends to grow.

Will later-stage investors agree on what progress looks like?
Or who is the best team?
Or how to value the company?
Or have funds ready to deploy in the first place? 

If any of these are a “no” despite progress made since the seed round, that next check may not exist.

This is an existential risk. Seed-stage venture capital is too often built on a foundation of an existential risk – no later-stage capital. 

This risk increases exponentially for those who choose to scale first and survive second. Every dollar of cash burn increases the need for a larger check from a smaller pool of potential investors– to overcome an ever-higher mountain of deficits.

What increases the risk of getting later capital?

• “Hot” sectors cool down

• Valuations stagnate or drop

• Timelines extend due to external events or a necessary pivot

What reduces the risk of getting later capital?

• Business model that only needs one funding round to sustain high growth

• More customers, revenues, and margins

• Market with multiple large, competing potential acquirers (versus a monopoly)

• Investors that can accept multiple liquidity options (IPO, acquisition, PE, ESOP)

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Opting Out

We see signs of seed investors taking this existential risk seriously, as it is ultimately their problem, and good founders recognize this.

Indie VC announcement
@jefielding - https://twitter.com/jefielding/status/1744147266355478782
How Capital Efficiency Leads to Major Growth 
Capital Efficient Growth with Zoom and Veva 
Capital Efficient Businesses - Elad Gil
Edison Partners’ Kelly Ford Buckley on capital-efficient investing in underserved markets
Capital Efficiency is the new VC filter for startups
Can Unicorns Overcome Their Big Losses? It Depends
Capital Efficient Company list

Like any VC trend, you can bet some of this is trend-chasing, just like VR, AR, Metaverse, AI, delivery drones, smart homes, wearables, or SPACs.

But let me show you how founders can truly take this existential risk off their backs (and investors can still earn a great return). 

Alongside a small but mighty cohort of investors, we've been doing it for a couple of years at Capacity Capital. This is the real nuts and bolts of how this works so founders can spot the signal (truly profit-aligned investors) from the noise (pattern-matching investors chasing shiny objects - or rather, shiny projections).

Optimizing the Outcome

Consider five scenarios illustrating what this means for the founder and investor.

Every high-growth company has a distribution of potential outcomes, from zero to IPO.  The optimal funding mix can't be determined beforehand, yet founders often pour layer after layer of equity. This is unnecessarily dilutive for both parties and can cause misalignment if the eventual outcome strays, as most do, even slightly from the speculative grand slam that was originally pitched. Optionality (and autonomy) is critical to optimizing financial outcomes for founders and investors.

Before I show you numbers and scenarios, let's clarify what we want to invest in.

To maximize both survival and outlier success, we look for founders intent around:

• building sustainable growth (via bootstrapping tactics and profitability) and;

• using targeted venture capital to remove the constraints of profitability when there is an inflection point.

Upon identifying those founders, we want to see enough initial investment to define and solve the right problem, reach profitability, and create more options. We seek an inflection point that requires venture capital but as few rounds as possible.

This results in less dilution for both the founders and the early investors, creating far more choices of viable exit scenarios. A massive exit or IPO isn’t required to “return the fund” — but it doesn’t remove that path.

To make this work, founders must focus on first principles: 

• find customers and compounding revenue

• build a product informed by customers and delivered by a great team

• manage with fiscal and business model discipline

The result? Fewer failures, more wins with a higher probability of overall success.

Scenarios

To get specific, we will invest $200k for rights to 10% of a company, of which 9% can be redeemed for 3X. (Redeemable Equity).

This is one of the deal structures we use, but the same principles can also work for other flexible deal structures:

• Revenue-based debt finance with additional warrants

• Profit share with an equity kicker

• Right to profits or distributions with some kind of upside tied to equity

Now, let’s play out the post-investment scenarios:

A - Series A, Scale, Exit
B - Grow into later Series A, Scale, Exit
C - No Additional Raise, Scale, Exit
D - No Additional Raise, Grow, No Exit
E - No Additional Raise, No Exit, Incomplete Redemption

A - Series A to Exit

“Plan A” is my hope for every company we invest in. Our round helps them confirm product market fit, scalability, and profitability - fundamentals that a Series A will help scale.  If it makes sense, we may continue to raise VC through the whole alphabet, but capital-efficient businesses require less dilutive capital to scale quickly.

Post Investment Equity: Raise a single $2M investment round in 12-18 months

Post Investment Path: Become break-even or better; operationalize scaling to create options - capital efficient enough to make additional venture rounds optional

Founder Upside: Multiple paths. Less pressure to dilute further unless necessary.

Investor Upside: For the investor, the likelihood of a win goes up. Higher multiples are possible at lower exit values creating a wider range of acceptable exit prices.

Upside Risk: Return scenarios depend fully on the acquisition price, but the fundamentals instilled greatly reduce the risk of a zero.

B - Later Series A to Exit 

Post Investment Equity: A significant raise is planned post-break-even. A raise can be also be delayed for unplanned reasons: misalignment with the next valuation, a pivot to an inflection point takes longer than planned, in which case, valuation would suffer.

Post Investment Path: Build and grow a capital-efficient business model before raising a large round. Find sustainable revenue growth prior to the first raise.

Founder Upside: Some redemption of investors' equity rights reduces founder dilution, resulting in greater ownership at exit.

Investor Upside: If higher revenues and capital efficiency are achieved, that can lead to higher valuations than a faster raise. Even with some equity redeemed, the markup can be higher. (Comparable to dilution that would have occurred from additional rounds.)

Upside Risk: Redemptions create some liquidity pre-markup, and the remaining ownership returns depend on the acquisition price.

C - No Series A to Exit

Post Investment Equity: None

Post Investment Path: Break-even to profitable. Maintain cash-efficient growth only needing non-dilutive operational capital on the path to an exit.

Founder Upside: More redemption of investors' equity rights further reduces founder dilution, increasing ownership at exit.

Investor Upside: In a situation that typically leaves an investor near “zombie-land”. Potential for an early small multiple while maintaining an upside in a future exit.

Upside Risk: Liquidity from the redemption of equity rights takes some risk off the table prior to exit.

D - No Additional Raise, No Exit

Post Investment Equity: None

Post Investment Path: Break-even to profitable. Operational capital only.

Founder Upside: Max redemption of investors' equity rights, lowest dilution

Investor Upside: Potential for a small multiple even without a future exit.

Upside Risk: The timeline for an exit is likely to extend, but as long as the company doesn’t die there is a good probability of return multiple (not just a return of capital).

This is expected for the middle third of a portfolio. Better probability of 3X (instead of 0-1X).

E - No Additional Raise, No Exit, Incomplete Redemption

Post Investment Equity: None

Post Investment Path: Failure prior to raise, redemption, or exit

Founder Upside: Max redemption of investors' equity rights, lowest dilution

Investor Upside: Still potential for some returns prior to failure with temporary success

Upside Risk: If the business model never works, there is no return of capital.

To see these scenarios together:

Instead of the typically binary VC outcome, A or the low end of D/E, there are multiple legitimate outcomes for both founders and investors. We also see more reliable paths to VC-competitive returns and higher probabilities for life-changing outcomes for founders. (I’ll save probabilities for a later post)

NOTE: We roughly follow the expected multiple from Seed to Series A for our structured redemption multiple (3X). The average multiple from Seed to Series A has ranged anywhere from 2X to 4X over the past 15 years, so at this point, 3X is reasonable. (I highly recommend Nnamdi’s post on this) The multiple keeps us on par with other seed funds, except we are now talking about DPI rather than existentially riskier TVPI markups. The outcomes are similar whether the eventual return is from the Seed to A equity markup or the multiple through redemption of equity rights. 

Less Risk = More Actual Winners (not only investors)

Founders Win

Founders with only a single significant funding round experience far less dilution and retain more control. Delaying significant fundraising until proven scalability and profitability means equity costs less, increasing their personal take-home.

Celebrating minimal fundraising over maximum raising reflects today's reality: $200,000 now stretches further than $2M did a decade ago, thanks to low-cost tools (lo/no-code, AI). Yet, average seed-stage funding has quintupled in a decade, with fewer deals. Follow-on fundraising has become more challenging and risky.

Prioritizing profitability doesn’t decrease the upside– it creates more options, reduces risk, and allows time to reach the next inflection point.

Successful examples include Microsoft and Adobe, which were profitable within a year. This may explain part of why Microsoft has also jumped into investing in a mix of revenues and equity.

Communities Win

A balanced approach retains more companies (and talent) locally and validates the importance of funders and incubators working in smaller innovation hubs.

For communities (like mine in Chattanooga), it’s key to nurture diverse fast-growth business paths, regardless of the funding. Over-focusing on multi-round venture capital neglects broader startup needs and can harm smaller communities.

Venture-funded startups, while newsworthy, are rare (1 in 100) and, even when successful, can lead to more talent leaving town after a successful acquisition.

It's critical for local ecosystems to focus on supporting all fast-growing companies… along multiple growth paths… by providing more optionality and autonomy.

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Innovative Finance Community Announcements

• VYLD releases a case study on its profit share in collaboration with Purpose

• Access Ventures is accepting applicants for its AV Fellowship (ages 22-30)

Their recent work cracks open the massive opportunity for innovative finance, particularly revenue-based finance (RBF), leveraging the existing, robust infrastructure of Community Development Financial Institutions (CDFIs) across the US.  

You can also find the full whitepaper here: The State of Revenue-Based Financing & CDFIs

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Innovative Capital for Small Businesses: The Rise of Revenue Based Financing

By Bruce Katz, Michael Belles and Bryan Fike

Since we launched the Innovative Finance Playbook in November 2022, Catalyze and the Nowak Metro Finance Lab have been assessing Revenue Based Financing, or RBF, as a tool to help address the capital gaps and deficiencies laid bare by the COVID pandemic; namely, the 83% of entrepreneurs who do not access to traditional bank debt and venture capital. We recently released a report sharing our findings entitled "The State of Revenue Based Financing and CDFIs.”

The report, informed by Catalyze’s peer group of 10 mission-driven lenders piloting RBF in their portfolios, provides a practical guide for CDFIs and other mission-driven capital providers to develop RBF products. It explores an emerging spectrum of RBF providers, addresses challenges, and offers resources for RBF implementation, all contextualized with case studies of real RBF deals.

Despite the pandemic’s disruptive dynamics, the traditional capital product paradigm has seen little change for decades. Our current capital product landscape – a binary between debt and equity – has put far too many entrepreneurs who cannot access traditional capital between a rock and a hard place, choosing between bootstrapping their businesses with no outside capital at all or relying on unsavory capital products that are inordinately expensive at best, and outright predatory at worst.

Remedying these deficiencies will require capital products, like RBF, which are fit to purpose, provide much-needed flexibility, and offer pathways to sustainable growth. CDFIs – long touted for their ability to serve otherwise hard-to-reach firms – must play a leading role in accelerating the adoption of RBF.

A growing movement to fill a glaring gap

Conventional debt and equity products have left a major gap in the small business capital market. Debt, traditionally in the form of term loans, typically comes with a fixed repayment schedule and requires collateral – cash or a physical asset – for approval. While these loans are familiar and consistent, their relative rigidity and asset-based underwriting can make them unattainable for many firms. Equity from outside investors, typically in the form of venture capital, provides flexible capital for growing firms, but is dilutive (i.e., requires the entrepreneur to give up an ownership stake in the company) and can place firms on a never-ending cycle of increasing valuations that is frequently unrealistic. The VC model can be a good fit for asset-light, tech enabled firms, but is typically not an option for the rest.

RBF can help to fill that gap. RBF can be structured as a redeemable equity investment, in which the company buys back the investor’s equity as revenue grows over time, or as a revenue-based loan. In either case, an RBF recipient repays the investment as a share of their revenue, typically 2-5%, until an agreed-upon multiple or cap of the principal amount, typically 1.4-2x, is reached.

RBF provides much-needed flexibility for borrowers and investees by tying repayments to cash flows. Moreover, its underwriting is less reliant on existing asset bases for collateral than traditional lending, making it accessible for asset-light businesses. And with an investment exit built into its structure from the beginning via revenue-based repayments, it provides an alternative to the endless march toward higher valuations and an eventual sale required by venture capital.

Collectively, these features can help RBF make capital more accessible to a wider array of firms than traditional lending and investing products. Seasonal businesses with fluctuating cash flows, asset-light businesses, and growing firms that are not on a venture capital-like trajectory can all benefit.  

Industry reports value the global RBF market at $2.8 billion as of 2022, with the U.S. representing a relatively small share. With a few noteworthy exceptions, CDFIs have historically not been part of that market. In recent years, however, RBF has gained momentum among a group of leading CDFIs. Today, Catalyze estimates that approximately 20 CDFIs provide RBF, with more potentially interested going forward. 

Catalyze’s peer group of 10 CDFIs and mission-driven lenders captured a snapshot of this evolving market. The group explored RBF strategies and shared best practices on topics like technical assistance, portfolio construction, underwriting, and fundraising. Peer group members who disclosed portfolio data have completed at least 49 deals totaling $4,640,000 as of August 2023, with an expected 145 deals and a budget of $15,690,000 by 2024.

Emerging RBF market segments

With the increased prevalence of RBF and broad range of approaches represented within the peer group, we now have a clearer idea of the various types of RBF in the market, allowing distinctions between lender-like and investor-like RBF. The spectrum demonstrates how RBF can be suitable for a range of business types and uses and come with a range of return expectations.

Lender-like RBF closely aligns with term lending, relying on historical cash flows for underwriting. It tends to favor conservative practices like credit score assessments and tax return reviews. Lender-like RBF offers versatility in the use of funds, provides minimal grace periods, and often considers assets for collateral. While it is more conservative than other forms of RBF, it generally comes with expanded risk tolerance over traditional term loans.  

One CDFI member of the peer group used the lender-like RBF approach to help a coffee shop client out of a precarious financial position. With little collateral and an average credit score, the business owner turned to a merchant cash advance (“MCA”) to pay for a $30,000 espresso machine. The MCA’s demands on the business’ cash flows – 15% of all sales – constrained the company’s growth instead of fueling it. A CDFI offered the business an RBF loan to refinance the MCA – underwritten in part based on strong historical financials and margins – in which the business agreed to repay 1.25x the principal amount via a 6% monthly revenue share. The new loan has proven far more sustainable for the business, which is now on a sustainable path to repayment.

More equity investor-like RBF can fund growth-oriented plans without requiring the rapid revenue growth typical in venture capital. It requires high-touch pre- and post-investment support and, given its orientation towards growth, often includes grace periods at the outset. It is more speculative in nature, addressing gaps in high-risk, early-stage growth funding. Accordingly, it is generally more expensive than lender-like RBF. 

In one case, a husband-and-wife team recently transitioned their home-based welding hobby into a full-fledged business. With comfortable margins and growing demand for their services, the company quickly needed to expand to a larger facility with more sophisticated equipment. The couple’s personal assets provided insufficient collateral and the company lacked historical financials due to its young age, making a more traditional debt product difficult to access. Based on the company’s business acumen, strong growth prospects, and technical expertise, a local capital provider offered a $32,000 revenue-based investment with a 1.28x cap and 6% monthly revenue share.

In between the two is a hybrid model, incorporating elements of investor-like processes while retaining term loan underwriting policies. It's apt for contract- and project-based businesses, allowing CDFIs to finance ventures based on secure future revenues to reduce risk. Recipient businesses may lack the collateral or credit score required for a traditional loan but have a robust pipeline of future revenues from contracts or purchase orders. While growth remains the focus for this type of RBF provider, the approach also offers moderate downside protection.

As RBF has grown in popularity and developed a reputation for entrepreneur friendliness, however, providers of less savory products – MCAs in particular – have sought to capitalize on it. RBF and MCAs share some characteristics, namely an up-front influx of capital with future repayments based on cashflows. But there are significant differences between the two. MCAs draw repayments daily or weekly, are intended to be repaid within a very short time period (less than one year), may require confessions of judgments, and can lead to vicious debt cycles. RBF is typically longer-term capital to fuel growth over three to five years. Repayments are monthly (not daily or weekly) based on a negotiated revenue share, and capital is often paired with hands-on business support.

Going forward

The paper should inform CDFIs, policymakers, and business support organizations looking to expand access to capital by adding RBF to their capital toolkits. While RBF is still in a nascent stage among CDFIs, four signals will indicate progress towards a more mature market as its uptake accelerates.

New metrics: Lenders and policymakers must understand the outcomes of RBF as a financial product, especially relative to the status quo options of term lending and VC. Mission-driven lenders see RBF as a tool to achieve additional impact outcomes – primarily, expanded access to capital – beyond returns-oriented objectives. Outcomes to track as RBF use increases include accessibility for different demographic groups, availability of capital for firms that otherwise may not qualify for more traditional products, and the growth and financial health of recipient businesses.

Increased clarity and industry standards: There is currently no clear guidance on tax and accounting treatment for RBF, leaving it in something of a gray area. Our report details how RBF practitioners are dealing with this uncertainty in varying ways. Further, existing fair lending and borrower protection standards rely heavily on APR tests to determine whether a product is borrower-friendly or usurious. Given RBF’s more flexible repayment structure and lack of a standard APR, it does not fit well within such standards. Updated and more definitive guidance on both areas can help accelerate RBF adoption. 

Continued innovation from an array of leading organizations across domains: Catalyze’s peer group demonstrated how RBF lenders and intermediaries have innovated to use the RBF approach in distinct ways. We expect to see continued innovation from early-mover CDFIs as they increasingly use RBF. 

Support functions like legal and accounting support and technology will provide critical market infrastructure to move RBF into the mainstream. Law firms like RPCK Rastegar Panchal, accounting firms like Dark Horse CPAs, and technology platforms like Ned have proven to be invaluable for leading-edge RBF providers. We expect continued maturation in these functions with time and increased RBF volume. 

Additional support from capital providers to help test and codify RBF: Philanthropy has been an important player in capitalizing RBF initiatives. Members of the peer group have received support from organizations like the Kauffman Foundation, Common Future, Boston Children’s Hospital, and the Colorado Health Foundation, among others. Publicly-supported small business programs can also increase capital availability. In the State Small Business Credit Initiative, for instance, Washington state’s Revenue Based Loan program and Business Oregon’s Royalty Fund can serve as early test cases of RBF’s applicability. 

Small businesses play an indisputably significant role in the U.S. economy, but our capital product landscape has failed to serve far too many of them. Increased adoption, innovation, and maturation of RBF among mission-driven capital providers can provide an additional tool to help fill this long-standing product gap.  

Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Bryan Fike is a Research Officer at the Nowak Lab. Michael Belles is a Co-Founder and Innovative Finance Manager at Catalyze

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