Investing Without Zombies


The results of an investment (in an early-stage startup) depend not only on the success of that startup, but also on the form of the investment.

A sophisticated investor is going to be nodding right now, thinking about liquidation preferences and other common add-on’s to equity investments. But at the same time, those sophisticated investors likely have a majority of their investments in a state where they are worth somewhere between nothing and a 1x return.  A state often called a “zombie” investment.

The root cause of “living dead” investments is not the high failure rate of startups.  Failure leads to truly dead companies.  These zombies are not only still running, but earning revenues or even profits.

The actual root cause is the traditional structure of equity investments.  Take a step back and look at the assumptions of such deals:

  • Investors buy P% of the startup for $X
  • The entrepreneur uses $X to earn $R
  • If $R is sufficiently large, an acquirer buys the company, returning the investor $10X

This is the basic formula for success as an Angel or venture capitalist.  The problem is that successful investors only see this story play out 1 out of every 10 investments, plus 2 investments with a $5X return, a few more with a $1X return, and 4 or 5 that are total losses.  Unsuccessful investors never see the $10X, and without that, have a loss across their portfolio.

I look at this and wonder why the investment structure is optimized for the least likely case, rather than the most likely case.  Is there not an alternate investment form that boosts the returns of the majority of deals above $1X?

Traditionally, the only other form of investment is debt.  It works for homes, cars, Fortune 500’s and the U.S. Treasury, but traditional debt does not provide enough reward for the risk of early-stage investments.  When debt terms are adjusted for investors, the results are too much risk for entrepreneurs.

Looking around the fringes of the financial world, I found a structure that does work.  Revenue-based financing (a.k.a. Royalty-based financing).  This comes in a variety of forms, but in general it works like this:

  • Investors provide $X
  • Entrepreneurs use $X to earn $R
  • Investors receive Z% of $R, until a total of $2X-$4X is returned

The two main variables here are the percent of revenue (Z%) and multiple of return.  Typically the revenue-share is 3%-9% of “top-line revenues”, a metric that is easy to define and compute.  The multiple is commonly $2X for growth-stage investments, and $3X-$4X for early-stage.

This basic structure provides a few benefits for investors.  First, it provides a built-in “exit”, one that doesn’t wait until the entrepreneur has build up enough value to either attract an acquirer or launch an IPO.  Second, it aligns investor interest and entrepreneurs, earn revenues.  Third, it makes no assumptions about when the revenues will arrive, nor requires negotiation on when to issue dividends.  Fourth, it leaves the company management free to operate in whatever manner they please, e.g. management worries about growth vs. profits.  Fifth, it eliminates “zombies” as either companies are alive and earning revenues, or dead (or soon dead) earning nothing.

In short, it provides a reasonable payment for the use of investor capital, while providing a relatively high IRR (with a big boost of that IRR due to the quicker repayments vs. equity).  Plus this structure boots the odds of at least a $1X return, as the investee begins repayments as soon as revenues are earned.

The drawback?  The upside of the investments are capped.  If the structure asks for $4X, then the maximum return is $4X.  However, there are multiple fixes for this issue: tack on some warrants, or toss in some traditional equity.  Do something that adds back in some of the upside.

I discovered this structure while researching the business model for Fledge.  Fledge, in addition to a business accelerator, is also an investment fund, one that targets “conscious” companies, a market with few exits and few comparables.  Fledge uses RBF for its investments, roughly as described above, and so far after 19 such deals, we think it’s not only the right structure for impact investing, but a potential fix for the broken venture capital market everywhere.


Seattle Investing Group Models How to Start Your Own Fund

IMG_0011-1Last fall, the Seattle Impact Investing Group launched a unique collaboration through a Local Food Fund. The group brought together ten impact investors, both experienced and new to the field.  After three months of reviewing applications and business pitches, the fund agreed to invest $50,000 in each of three businesses: Viva Farms, a farm incubator in Skagit County; Better Bean, an innovative bean company in Multnomah County, Oregon; and Cattle Producers of Washington, a cooperative meat processing facility in Lincoln County. The Better Bean investment has been made and the fund is currently working through the details of the other two deals.

Elise Lufkin acted as manager of the fund and recently sat down with Slow Money NW to share their experience with starting their own fund.

First, why are you excited to do this work here in Seattle?

Seattle is becoming recognized as a leader in impact investment. Funds and firms are locating here because of the large impact investor community. National funds are starting to make Seattle a stop on their fundraising tours. Impact Hub has also brought a lot of entrepreneurial energy and buzz around social enterprise. All of these players are helping to creating a virtuous feedback loop that is helping everyone succeed. We are excited to play a small part in that.

This fund marked an evolution of Seattle Impact Investing Group. Why did you decide to evolve?

Originally we were a group of impact investors that got together to discuss our investments and provide support on due diligence. Members began to informally co-invest in deals and eventually a desire evolved to invest together more formally. We wanted to learn by doing together, with the understanding that none of us knew everything. A fund became a vehicle to drive ourselves to push our learning and hold each other accountable.

What were your shared goals for the project?

A healthy local food system is important to each of us, so it became the focus of the fund. Beyond strengthening our relationships through shared experiences, we wanted to create a model that others could take and customize for their own goals, hopefully improving it! While the fund is not about making the most money possible, financial returns are important if the companies we invest in are to be successful long term. It was clear for us that this project was not a philanthropic one.

We too hope that others will be inspired to start their own funds. So, how did you decide on the amount of money each person invested?

We wanted an amount that would be large enough so that people would come to the meetings but small enough so that if we lose everything people can still pay their mortgages. In hindsight, I don’t think it was the size of the investment that kept folks coming to the meetings, but rather their commitment to the shared goals.

Each investor originally pitched in $11,000, $10,000 to be invested in the business and $1,000 to cover the administration of the fund over its 10 year life span. In the end, each business needed a full $50,000 to be successful so each investor pitched in an additional $5,000.                                                                                                                

Beyond the financial commitment, what was the time each member agreed to meet?

We met in person every week for at least two hours, sometimes three. From the beginning it was clear that this was going to be about showing up. It was a big commitment and people took it seriously. We had a one-month period in which we accepted applications and then three months to whittle down the applicant pool. We started with 39 applicants and selected 17 to interview over the phone. The 8 semi-finalists were given the opportunity to pitch the group in person and then the final 3 businesses were selected for deep diligence. In the end, the finalists had to be agreed upon by all investors.

Was reaching that consensus difficult?

Not really. We worked hard to ensure that everyone was heard, and we relied on the opinions of the members who were most familiar with the particular investment we were discussing. To move discussion forward we used a system of post-its as votes. Each person got a set number of post-its and was told to distribute them as they chose among the companies we were discussing. This allowed us to quickly eliminate the companies that no one was interested in, so we could spend more time on the ones still in contention.

Additionally, everyone in the group respected the opinions of the others, which made our discussions very productive.

What criteria did you use to guide the conversations?

We wanted companies that would be successful so we looked for the things all angel investors want – a good idea and the ability to execute on it. In addition to being financially sound, we were looking for companies who are providing a key piece of infrastructure in our regional food system. Each of the businesses we selected is doing that in an exciting way. And lastly, the size of our investment needed to be suitable to their needs.

How did you determine how to structure the financing?

Each deal is structured on a case-by-case basis, based on what makes most sense for the business and the entrepreneur. One of the loans is a basic loan with reasonable interest, one is an equity play and the other is a revenue-based loan. We worked with each of the businesses to come to those decisions.

What is your involvement in the businesses moving forward? Are you providing any ongoing business advising or support?

Each business that received an investment has someone from the fund that is checking in with them on a regular basis to see how the business is doing and to provide advice as needed.

There’s buzz that this fund catalyzed a lot more than the $150,000 invested through the LLC. 

Yes, all told the fund catalyzed investments of $1.5 million. This included monies directed by SIIG members to companies that didn’t make it to the final round and additional investments made to the selected companies beyond the $50,000 they received through the LLC.

So, will you be doing another fund soon?

Yes, we are exploring the possibility. We do not yet know what the focus will be. It may be food again, though it may be something else.

What would you do differently in the next round?

There was a healthy tension between giving companies the time and attention they deserved and the need to move forward in the three-month time frame we committed to. Ideally we’d slow the process down, though as we are volunteers, it’s hard for people to commit more time than they did. We would love to be able to spend as much time on the businesses we won’t be investing in as those we will. This would ensure better feedback to the business and would help us solidify our understanding of the system and where our money can be best invested.

Who should reach people reach out to if they want to learn more about starting their own fund?

For more information on the group or to access the materials that we developed, reach out to Ammen Jordan at

EDITORS NOTE: The Seattle Impact Investing Group is currently researching investment opportunities that provide, through a fund structure, both social and/or environmental impact, and current yield. To learn more go here:

Why Does SMNW only do Accredited Investor Only meetings?

To date Slow Money NW has been one of the most sure successful regional chapters in the national Slow Money efforts. Part of that success is because we have have tried to ensure that our efforts were legal and targeted towards what businesses and investors said they needed. Since opening its doors our  in 2010, we have provided business development assistance to 40 WA and OR based businesses and successfully helped 7 businesses secure investments of  about $5  million. We now have a track record that is attracting financial contributions to do more work, but not yet enough to do all that we want to do.

Gearing up for another accredited investor meeting is always fun and challenging because on the one hand we are directly connecting investors with businesses, and on the other hand excluding people who are not accredited investors. The fun and excitement comes from knowing that good people have good businesses worth hearing, and that good people want to help and invest in good businesses working to grow our regional food economy.

There are two federal legal restrictions on public access to private business investment opportunities: that investors be aware of the risks and resilient to the potential losses; and that we only invite investors with whom we have an existing relationship.

First, accred-only events are exclusionary. The SEC has a clear definition of who is, and therefore who is not, an accredited investor. The quick and simplified reason for these classifications basically dates back to the 1920’s when ‘snake oil’ salesman sold uninformed investors items that sounded really good but cost people their life savings, their retirement, their homes. Rules were set in place during the Depression to make sure that people who invested directly in private businesses (compared to public stock exchange listed companies and mutual funds) understood the risks and could afford to make them. Second, violations of these restrictions include public announcement of the investment opportunities, such as posting the details of the companies presenting on our web site. This is why you do not see our current presentation meetings on our website, and why it is only seen through our direct email invitation. For more information about who may receive invitations and attend events, please contact us directly.

For those that do not meet the SEC definition above, and do not have an existing relationship with Slow Money NW, and want to help transform the regional food system, see our post Beyond Accredited Investor Options on ways that you can get involved. Thanks for your patience as we build out what we have started and continue to create innovative, safe, and legal opportunities for people to connect to the businesses we all want to grow.

Beyond Accredited Investor Options

As we work to balance our limited resources and the regulatory maze for connecting investors and businesses we wanted to list a few of the options that are present and emerging.

The recent JOBS Act has proposed making it easier to to crowdfund investments, and hopefully those rules will come out next year. But don’t hold your breath too long since this means that government has to successfully regulate snake oil salesmen, and the agency charged with doing so, The Financial Industry Regulatory Authority, or FINRA, does not really want to; would you? At least there is progress towards this need, but some reports suggest it may become more complicated.

There are basically four structures out there that do allow some pooling of ‘investors’ and friends to build relationships and figure out how to align investments and donations. 

Investment Clubs are a structure that the SEC recognizes. Any one can participate to learn how to invest and sometimes pool funds towards investments. SMNW wants to build out one or a series of investment clubs in the region. We feel the best way is to help organize people in to groups around topics they want to explore. What is needed are funds to hire someone to organize these efforts; or some Uber Volunteer who wants to work with SMNW to take on this idea. We have 1,000 people on our listserv that would love to know more. If you are interested in helping these efforts please let us know!

Direct Public Offerings, or DPOs, allow businesses a limited but more direct raise from any investor(s). A previous presenter Farm Power raised funds in WA and OR this way via the related SCOR offering structure.  There are current efforts to highlight DPOs as a key vehicle in the growth of regional economies, with Jenny Kassan of Cutting Edge Capital helping lead the way. Portland’s Springboard Innovations is coordinating the launch of ChangeXChangeNW, one of the first attempts to create a local stock exchange. They have a Nov 7th forum in Portland for more information.

A Local Investment Opportunity Network is an innovative structure first developed in Port Townsend, WA. LIONs are catching on around the country because they make sense and people want to do more of them. Just search on the term to see the growth of this idea. The trick is that the SEC has not yet reviewed them as legal and safe, but they are now paying attention and auditing at least one network to determine if what they are doing is safe and legal. I will hold my breath on this one as this could set a precedent for how FINRA structures crowdfunding regs.

Online crowdfunding sites like Kickstarter and Indiegogo are great as contribution vehicles. While they are not technically an investment they have helped various businesses raise significant capital.

Slow Money is in the process of rolling out two innovations focused specifically on food and farming. The Soil Trust is just coming online and is working to aggregate donations for use in investments. Look for more info as this really comes online. A new kid on the block is Credibles, also connected to Slow Money, that uses prepayments of goods instead of contributions; basically a gift card model to have people prepurchase product and get more back than they submitted. For example, if you prepay for product from a business with $500 you will get maybe $550 of product. In Seattle this is how Rover’s funded it restaurant expansion, but without a standardized website. If you are interested in this please let us know as we are looking for a group of companies in our neighborhoods who may want to use this model.

Press Coverage of Farmer Reserve Fund

Sample of coverage from Grist’s online site

We definitely struck a chord with our Farmer Reserve Fund when we launched it last month.  With limited distribution, we received numerous requests for interviews and many groups are interested in replicating this success.  Check out the articles published so far, and if you’re interested in covering the topic, or learning how to create a program like this in your area, please contact Japhet Koteen.

Farmer Reserve Fund Launched

Santiago Lozano (right) with his approved operating line of credit secured by the Farmer Reserve  Fund standing next to  Grow Food’s Executive Director, Ethan Schaffer, and NCCU loan officer, Carolina Chavez

Thanks to all the great work from our friends at North Coast Credit Union (NCCU) and Viva Farms, and with the generous support of our social impact investors, we have officially launched our Farmer Reserve Fund to help beginning farmers grow their businesses.  This is the first piece of our food and farm microfinance effort as we work to make it easier for local agriculture producers to grow their businesses. The first Farmer Reserve Fund loan was made through North Coast last Friday to a strawberry farmer named Santiago Lozano.  A second loan  closed on Monday to Nelida Martinez, a vegetable producer. 

Slow Money NW developed the loan loss reserve fund as a way to fill a gap in financial services  available to small-scale farmers and to meet the interest of regional investors seeking to support sustainable agriculture most effectively.  Slow Money NW, a project of the non-profit Grow Food, did not want to administer the loans so it looked to partner with a regional lending institution. “We wanted to build on existing infrastructure in the community, and deliver services efficiently by building relationships, rather than reinventing the wheel — the reserve fund structure through North Coast is a perfect match.” said Japhet Koteen, Slow Money NW’s Project Manager.  

As a co-operative credit union, NCCU doesn’t take big risks with their depositor’s money, but they desired to help farmers in their community. Charitable donations from two local impact investors were used to establish the reserve fund to reduce the risk for the credit union.  Viva Farms provides an additional layer of due diligence for the fund by screening their student pool for the best potential financing candidates.

The Farmer Reserve Fund is a win for the credit union which puts its deposits to work in their community, and a win for the investors that donated the reserve funds since each dollar they put into the fund means up to five dollars available to lend out to beginning farmers. The farmers also see immediate benefits. “It is very difficult for new growers to access credit, “said Lozano. “ I will reserve some of my line of credit to cover any emergencies that come up. The rest I will use to pay my harvest crew before I get paid for sales.” Martinez says the loan is allowing her to grow her young business. “Thanks to this program, it’s much easier for new farmers like myself to get a loan and keep moving forward. We’re very thankful for the extra help in realizing our dreams.”  

Learn more about the Farmer Reserve Fund here.

Summer Update

It’s been a busy summer for the Slow Money NW management committee. We’d like to share a little about what we’ve been working on since we last connected.

Needing an investment is quite different than being ready to present a business and manage investor expectations. Slow Money NW (SMNW) has been working hard in a few fronts to find businesses ready for investment, and matching them with the best next step.

SMNW has spent the last year tightening the expectations and reality of what an all-volunteer organization can accomplish. We have participated in many phone, email, and physical meetings surrounding the notions of connecting food and farm businesses to interested investors. This work culminates towards two main avenues of engagement.

Existing Food and Farm Businesses
This past year SMNW has fielded numerous queries from established businesses seeking investment. We spend time with each business to find out more about their needs, who they have already approached and with what success, read the business plan and financials, then suggest and align them to the best next step. For some this means connecting them with one of the banks, credit unions, or other investment companies we know; for others this means connecting them to what we know call Angel Professionals who help them tighten up their plans and financials; for some this has meant suggesting some more thought and time be spent on the business plan and to contact us again when they have answered the known questions. Our Oct 10th Food and Farm Investor Network Meeting is the visible portion of this work and represents what we feel are companies who are ready to present to investors. We hope you will attend!

New Farmer/Businesses
From the USDA Ag Census, through major media outlets to CSAs and farmers markets you will see the recurring theme that younger people are (finally!) attracted to farming. With this growth comes a need to identify and engage the best ideas and businesses for our future farming generations. But all of this innovation comes at high risk, especially when you combine new farmers with new ideas. SMNW continues to work in this space by researching and meeting with various established regional lending institutions to explain the need and opportunity, and to create a solid network of lenders interested in engaging in this space. Some lenders, like the NW Farm Credit Services, have established new farmer loan programs that we can help by making noise (like this posting). Others have expressed strong interest if some entity can provide loan guarantees. To this end, SMNW is in the planning stage with local lending institutions to develop a vehicle used to provide guarantees so that existing lenders can do more of their work on our mission. This is a classic win-win: the institution gets new business and SMNW does not have to manage loans. If you’re interested in the concept or have expertise to lend, please contact us.

Revenue Based Financing

A Seattle group, Revenue Loan, highlights an innovative method for financing where the return occurs from the revenue gains. While their focus is on tech development, the financial model can be used with food enterprise development.

What is Revenue Based Financing?
Revenue Based Financing (Revenue Based Finance) is a new way for promising early-stage companies to finance the growth of their business. In a nutshell, Revenue Based Financing is a special kind of loan. Instead of requiring a business to pay a fixed amount and over a fixed amount of time (i.e. think of your typical bank loan), a RBF loan entitles the lender to a fixed percentage of gross revenues, “capped” at a multiple of invested capital (typically 3 – 5x). Revenue Based Finance lenders trade steeper default, timing and rate of return risk for richer potential returns than those offered by traditional business lending (i.e. banks).

How does Revenue Based Financing work?
Here’s a hypothetical example:
Tom is the CEO of a promising Software as a Service (SaaS) business. He’s built the business with no outside capital and is operating close to breakeven. He sees an opportunity to ramp up sales by investing in business development. He doesn’t have enough cash in the bank to make this happen.

Most banks won’t lend to a company like Tom’s because his isn’t an asset-intensive business. Tom doesn’t want to raise venture capital because he doesn’t want the dilution and he isn’t sure his business has the potential to scale as quickly or or as big as most VCs would expect.

Tom learns about Revenue Based Financing. He lines up a group of angel investors willing to invest $500,000 for a royalty rate of 10% of gross revenues. The royalty payments don’t begin for a year – giving him time to invest and build the business – and have a 3x cap (limiting Tom’s total royalty payout to a maximum of $1.5 million).

With the help of this additional capital, Tom builds a profitable small business with revenues of $3 million a year — and still owns 100% of the equity. The investors get their 3x return paid back over 5 years — without having to force Tom to sell his company or buy their shares. In this scenario, everyone wins.

The innovation here lies in bringing the Revenue Based Finance approach to riskier, earlier-stage investing, while receiving the expected return in the form of cash flows. The fact is, most well-run businesses look more like the firm in this example – growing, profitable, but not a shoot-the-moon success – than like the Google and rocket rides that the traditional venture industry is geared around.

This seems a great tool to use when dealing with growth stage food enterprises, those with an established track record that are looking for expansion capital.