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Too Small For Venture? SEALs And Early-Stage Investment Firms Offer Financing, Although Options Still Limited

Illustration of founder dropping a rocket coin into piggy bank

Although there may be a romanticism about bootstrapping that long-dreamed about startup, the fact is even after all the credit cards are maxed out, you likely will still need money.

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However, if monthly recurring revenue is only at a few thousand dollars, options on raising funds can be quite limited.

“There has been a proliferation of different financial products” to help startups, said Tyler Tringas, general partner and founder of Earnest Capital. “But it’s not until you are seeing about $50,000 that those start to become accessible.”

SEALs come ashore

That’s one of the reasons Earnest Capital started devising about two years ago what is commonly known as shared-earning agreements — or SEALs for short (yes, the “L” is just added on).

A SEAL is like an equity investment, but one where the company has the ability to buy back most of the stake it sold some time down the line. Earnest Capital started to blog about the idea of SEALs in late 2018, and since then, Tringas estimates, the company has done about 30 deals.

In such an agreement, a firm like Earnest will write a check  — about $200,000 on average — to a startup. Typically, the startup has revenue of anywhere between a few thousand dollars a month and a couple million dollars a year, Tringas said. The company then can pay that money back over time at a 3-to-1 ratio, typically, to buy back two-thirds of the ownership stake the firm took.

An example would be a company receiving a $100,000 check from Earnest for a 9 percent stake. Over time, the company could pay back $300,000 and get a 6 percent stake back. If the startup decides to raise venture capital, the deal basically turns into a simple agreement for future equity — or a SAFE — and Earnest keeps its ownership stake.

The whole idea behind the SEAL is “first check, last check,” Tringas said, as Earnest does not look to invest in succeeding venture rounds if there are any. Instead, the firm is giving startups that do not have access to debt or revenue-based financing because their revenue is too low, a chance to bring in meaningful money to do things such as hire a salesperson.

“If you are less than $50,000 a month and you can only get 1x or 2x your MRR, that just isn’t going to move the needle much,” he said.

Options limited

While the idea of SEALs may sound intriguing, Tringas said he really only is aware of his firm doing them. He admits that due to their newness there are some unknowns about this type of agreement — such as how taxes are structured — that once determined could make such deals more attractive to more investment firms.

In the meantime, Tringas sees limited options for startups with nascent recurring revenue numbers. Even as venture debt, SAFEs and MRR-based and revenue-based all have gained more attention, those options may not help early-stage startups.

Although he remains optimistic with new non-dilutive financing vehicles — such as debt, SAFEs and MRR-based and revenue-based — gaining more attention, as well as companies such as Lighter Capital, Founderpath and Pipe offering alternatives to venture, he sees little opportunities for bootstrapped companies just starting out or trying to gain market traction.

“I think all these new things are prompting people to take a look,” he said. “But depending on where you are on the ladder, you may not have a lot of options.

Those options became even more limited last week when closed up quietly.

The idea of was to invest in young startups not looking for vast amounts of money —  and explore “the need for funding options that sit between bank loans and blitzscaling,” the firm’s goodbye post said.

In the post, said part of its issues involved losing around 80 percent of its limited partner base — possibly due to being unimpressed with fewer follow-on rounds and fewer markups than more traditional VC funding.

That same problem has undoubtedly affected others. Tringas said limited partners are weighing returns against the opportunity cost of possibly putting that money in a large VC fund. That has made it difficult to raise money from many, as his firm has mainly relied on individual investors.

“Will the LPs do something like this?” he said. “That is the biggest obstacle.”

Others in the industry also are seeing the lack of limited partner participation becoming a problem.

TinySeed, an accelerator designed for early-stage SaaS founders, typically writes checks starting at $120,000 for the first founder and $60,000 per additional founder. It looks at companies with MRR starting at around $500, and receives dividends if founders take more salary beyond the allotted cap. The firm does not do SEALs, but rather more straight-forward equity investments — usually taking 10 percent to 12 percent equity in the company — in very small, young SaaS startups that may be too small to attract the attention of VCs.

“A lot of companies fall into this realm,” said Tracy Osborn, a principal and the program director at TinySeed. “They are successful companies not recognized by VCs. We are trying to fill that gap of really early-stage investment.”

The firm is closing its second fund, but with SEC regulations that limit those types of funds to a maximum of 99 accredited investors, it can be difficult to raise tens of millions of dollars without participation from LPs, she said.

Increasing interest

Despite those issues, TinySeed has invested in around 40 companies since launching in 2019, and is trying to eventually invest in 100 post-launch, post-revenue companies a year, Osborn said.

Although she admits many companies seek to follow the traditional venture capital route, she does see a growing interest from entrepreneurs looking for alternatives and ways to keep ownership.

“There definitely is more information out there on how to keep control of your company, and more interest,” she added.

However, the question remains if that interest will turn into more choices for early-stage founders.

“I hope there are more options,” Tringas said. “The opportunity is enormous.”

Illustration: Dom Guzman

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