Saturday, December 09, 2006

Commission Venture Investing:
A feedback loop for seed stage funding

I was turning wrenches with my partner Dave recently as we worked to get a recycler out the door. Normally I’m on the road peddling these devices, and it was nice to have the face time with my friend and fellow warrior.

In reminiscing about our start, Dave reminded me that 8 years ago we’d each invested a grand total of $3,000 to start our business. We now have customers on 6 continents, meaningful international awards, and a rocking business model.

The current big push for starting up enterprises typically begins with business models that require you to search for outside capital through formal business funding channels right out of the gate.

This isn't necessarily the only path to follow. Many great enterprises were created around business models that didn’t start with formal investment funding. They were started with savings or with small investments from family or friends.

My recommendation to friends starting enterprises is that it's smart to start small if you can. Start part time if you need to. There’s no shame in this at all (I put up a post about starting part time dated 5/10/05). Try to do it with your own money first. If you can’t cover all of it and if the sums are modest, you can consider small investments from people who know you. This is not the time for you and your enterprise to be courting strangers. Your seed investor(s) should only come from people who know and like you. Many start ups need more formal funding avenues. But many more do not.

If you follow this route, I’m going to suggest a method for creating sustainable investment transactions for early stagers. I call it commission venture investing. The start up model offered by commission venturing begins the repayments to your investors immediately in the form of commissions from every transaction. This creates wonderful built in feedback loops for all involved.

Diving headlong into the outside funding game is very time consuming, full of dead ends, and you can easily end up with people in your shorts you may not want there.

You’re not a bad entrepreneur if you think you can start without jumping right into the formal funding rounds. Don't accept the premise that you have to go after outside angel investors, venture capital, or state and federal grants to start an enterprise. Go try out your ideas. Test your solutions in the real world first. Learn your story. Learn to tell your story.

Get out there and make the many mistakes awaiting you. Celebrate the small victories. These will help craft the destiny of your new enterprise. Time and small scale failures are immeasurably wonderful gifts to give yourself and your start up. The creative serendipity arising from mistakes can be the most productive moments of your enterprise life. More valuable information can be learned from the gleanings of what went wrong than can ever come from happy-dancing around what went right.

However, it’s MUCH harder to work through these valuable mistakes and small victories after you’ve entered the formal business funding rounds.

If you don't have enough funds available to start, family and friends can be considered as seed funders, but only if you approach this process very carefully. The end result should be first and foremost, that after the transaction has run its course, you're still family and friends. Full transparency and full disclosure with your seed stage funders. If you can’t operate this way, stay away from your family and friends, because you don't deserve them.

Creating new enterprises with family or friends involved is an opportunity that requires strict discipline to work. Commission venture investing, with its built in immediate feedback loops, offers a scalable model that can benefit all involved.

Rather than promising repayment of the funding from profits to be earned at some future point (if your model pans out), start the payback from the first sale. By this I mean paying out an agreed upon percent of monthly revenue, not profit. Repay your funder(s) with a percent every month’s sales until everyone is made whole.

Your funder(s) see immediate results, even if small. It’s also good for your start up. Commission venture investing requires that you have a firm understanding of all your costs. If the investment payback requires that you charge more, good. At the start of your enterprise, you should be charging more anyway, I promise. Might as well include their repayment portion and get it over with. Even if your enterprise achieves toasthood, your funder(s) will have been repaid in some measure. If you make it through this investment round and everyone is paid back, you’ll be operating at a higher profitability level.

Your accounting responsibilities will require that you operate in full transparency with your funder(s). Your books will be managed by a Certified Public Accountant who is also your in house ethics committee and the core of your financial marketing program. Any intelligent investor will want the authentifications provided by a CPA.

There is also an important side benefit for the larger economy as well. Many people want to invest in entrepreneurship and innovation, but don’t feel they can for various reasons. Commission venturing allows all of us to participate down to the micro level. Funder side, enterprise side. All of it at the appropriate scale for everyone involved.

Nobel Laureate Mohammad Yunas of the Grameen Bank has shown that the micro loans his organization makes creates many wonderful sustainable enterprises. Most important, those loans are paid back at rates far better than typical bank loans.

One of the main reasons is the feedback loops Mr. Yunas and The Grameen Bank build into their loan process. Often the recipients have no experience with economics at any level, so peer involvement becomes important for all involved.

In commission venturing, I see a similar feedback loop, except appropriate for the scale of the economics involved. The funder(s) have full access to your transparent books. They get regular feedback (payments) on the progress of their investment. They want you to succeed, and you’ll be working hard and smart to do so. You will also come out of your seed stage rounds with a far less complicated ownership structure that traditional venture investment models would have created.

This is not a Luddite screed against the more formal venture capital routes. On the contrary. As your enterprise grows into the 21st century, you’ll most likely need the outside resources of angels, venture folks, development orgs, etc. When you get to that level you’ll need to have documented that you have the discipline and the track record needed to execute at the next tier. By demonstrating that you’ve ventured through the seed stage with documented, successful results, you’re earning your eBay stars, and are capable of taking the next steps.

The start up game is changing fundamentally, with over the top positive news for entrepreneurs and the economies we operate in. Many terrific new support programs are now available with more appearing daily it seems.

However, don’t consider that you are shut out of the game if you can’t muster the personal or professional resources needed to start your enterprise with institutional investors. That path is important but over-hyped for many of us.

Commission venture investing can offer a more valuable scale and a more manageable model for seed stage start ups. It creates trust, and it creates returns for your funder(s) from the first transactions. It’s exciting and helpful for all involved. It invigorates the process with a sense of ownership and pride in the enterprise that makes for a great feedback loop. It also requires good discipline from you and all your business processes, especially accounting. I think commission venture investing can evolve into a new form of early stage seed funding that will benefit everyone, from the smallest ventures and the smallest investors right up through global economies.

Don’t be intimidated by the jargon of professionals talking about entrepreneurship. Their approach can quickly intimidate anyone new to the game.

Fire up your dream. Find a problem to fix and build your enterprise around your solutions.

With good planning, you can start your enterprise your way. Kitchen tables, notebooks, pencils (with LOTS of erasers) and all the low tech, small money solutions you can muster are perfectly valid tools for launching your enterprise.

Commission venture investing can work for start ups and small investors alike, especially at the early seed stages.

Go get ‘em, friend.

Mohammed Yunas, 2006 Nobel Peace Prize winner and the wonderful Grameen Bank. You can check threir loan and payback info right from their home page. My kind of transparency. My kind of heroes.


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bad credit car loans said...

It is certainly understandable why those promoting startup investing would want to find as many sources as possible. But once you go down the road with any governmental entity as a partner, you will likely regret it. Plus, where is the budget for this? City of Seattle, King County, State of WA--all are essentially broke and cannot keep the commitments they already have in terms of transportation, public safety, education, etc.

Payday loans said...

Yes, we need more local seed investments to funnel more later stage investments, but I'm not sure if there are 100 companies in this city who can realize that potential if we don't have a stronger support system beyond financing to nuture them. Techstars is great (or so I hear) for the handful of companies that participate, but beyond that there is a big void.