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Earnest Capital is now the Calm Company Fund
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Private: Investment Strategy

Written By:
Tyler Tringas
September 18, 2018

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Market Overview

In the last 10-15 years bootstrapped, internet-enabled, technology businesses have grown into a thriving market driven by two main themes:

  • Dramatic reductions in the upfront cost to launch a software or technology business on the internet. Beginning with Amazon AWS allowing incredibly low cost, easily scalable servers, and continuing with an expanding universe of SaaS platform tools like Heroku, Stripe, Cloudflare, Intercom, etc. Products like Shopify have exploded the number of niche e-commerce businesses and WordPress, Substack, Patreon have opened new avenues for profitable content businesses. It has become possible for a single founder or small team to build and launch a working minimum viable product (MVP) and acquire paying customers with no upfront capital.
  • Backlash to the venture capital and the Silicon Valley approach to startups. The venture-funded world of technology startups dominates the news and culture but many talented entrepreneurs and developers reject the ideas of growth at all costs, the binary choice between building a billion dollar business and flaming out, 70+ hour work weeks and businesses without profits or a sustainable business model. Communities like MicroConf, Indiehackers, and the Dynamite Circle are filled with entrepreneurs building internet-enabled, profitable, sustainable businesses. The appeal of this kind of business is growing enormously along with the number of new businesses in the space.

The word “bootstrapped” narrowly means a business built without outside capital, but it has come to represent a culture of entrepreneurship that explicitly rejects many aspects of the venture-backed startup culture.

Specifically bootstrapped entrepreneurs reject:

  • Forcing founders to push for billion-dollar exits no matter the risk
  • Founders losing control of their personal life and company destiny due to multiple rounds of investment
  • A culture of workaholics and a lack of diversity
  • Valuing paper valuations over real businesses with sustainable sources of profits and competitive advantage
  • Forcing employees to live in expensive cities

Bootstrappers by contrast:

  • Prefer profits over paper valuations and hype
  • Avoid moonshots and prefer a much higher probability of success
  • Value longevity and viability of a business over growth at all costs
  • Balance business growth with founder, employee, and customer happiness
  • Prefer remote and flexible teams

Bootstrappers don’t raise capital because there are no aligned capital options for them.

Most capital options for tech entrepreneurs have either been (1) a terrible fit for their business like bank loans and credit cards or (2) traditional venture capital, rejected for the reasons above. Thus “bootstrapper” founders frequently conflate the values of this particular approach to entrepreneurship with never taking outside capital. This is a market failure and our opportunity.

The right fund with appropriately creative financial products could offer capital and back these businesses and persuade them that capital can be an effective tool for their business without compromising these values.

These businesses are a strong investment opportunity

Broadly there are four main types of businesses in this space in decreasing order of focus for the Calm Company Fund: 

  1. Software as a Service (SaaS): which is sold on a monthly/annual subscription basis
  2. Information Products: ebooks, online courses & screencasts ideally bundled into a membership product.
  3. Niche E-commerce: hyper-targeted e-commerce businesses ideally with a key innovation that limits inventory requirements
  4. Content & Media: Independent media, websites, and newsletters with a recurring monthly membership or patronage model.

These businesses are frequently bootstrapped but offer very strong investment economics for the following reasons:

  • Recurring revenue products. Most of these businesses are transitioning to recurring revenue business models which provides predictability and de-risks revenue forecasts.
  • Low overhead and near-zero marginal cost. Most of the businesses run remote teams with no office space. The primary costs are employees and other software platforms which are paid monthly and scale nicely with the business. This means there is typically little to no overhead, zero marginal costs and no lumpy investment costs. This allows founders to optimize nicely between investing in growth and reaping profits at a granular level.
  • Dominate niches. The internet enables these businesses to serve the entire world as a potential customer base. Because of their low overhead and costs, theses businesses can be very successful and profitable even with a comparably small audience. Thus innumerable niches, too small to be targeted effectively by the largest companies, can be a suitable base for a profitable business
  • Maker-Founders with strong track records. Because the time and energy required to launch a product has been dropping so precipitously, many current founders have a long track record of building and launching functional products. Execution risk is substantially lower than elsewhere.

Investment Thesis

The Calm Company Fund will make three kinds of investments outlined below. They are presented in order of the expected size of investment but Thesis 2 will be the focus of this fund.

Thesis 1 – Incubate: Enabling a broader spectrum of founders to go full-time on their products

Even as the model of bootstrapping a software business has become perceived to be less risky and more widely known, there are still a huge number of potential founders with the skills to build profitable software businesses that are unable to make the leap into working on their products full-time. Specifically, some of the most common obstacles are:

  • Family and other dependents and obligations.
  • Mortgages, student loans, and other financial liabilities
  • Under-privileged background, lack of family wealth and support, risk in reentry to the job market if the business fails

An incubator-sized amount of capital ($25-100k) could allow founder(s) to work full-time on a pre-product-market-fit business.

Thesis 2 – Accelerate: Early-stage growth capital experienced founders in competitive markets

Experienced and talented founders are increasingly finding that the software market is no longer a blue ocean. Many niche markets have several competitors and there is an increasing interest in the idea of growth capital for businesses that might have stayed bootstrapped 5-10 years ago. Even ardent bootstrappers are beginning to realize the value of a capital infusion shortly after early product-market-fit to outrun competitors and accelerate customer acquisition and scaling.

An accelerator-sized investment ($100-250k) structured in a way that aligned the fund with the goal of a profitable independent business would be increasingly attractive to top-tier founders.

Thesis 3 – Diversify: Enable founders of profitable businesses to “take chips off the table”

Founders of successful profitable software businesses currently have very few options to diversify their personal finances while retaining some upside in the business they built. The primary model is a full sale of the business via a small number of niche brokers. The pool of capital available for sale is mature but still relatively small and there are almost no options to sell a portion of the business to “take some chips off the table.” Finally, the market lacks a go-to financing structure for an outside investor to buy a portion of the business and be paid back primarily through profit-sharing versus a liquidity event.

As the first big waves of successful bootstrapped businesses start to hit years 5-10 of operation, founders will increasingly want to liquidate a portion of their businesses to (a) diversify their personal finances which are heavily concentrated in one business (b) fund significant life events like a house, college tuition, etc. An investment option ranging from $250k-$1m+ would generate returns from immediate participation in profits.

Investment Structure

The Calm Company Fund will use an investment structure aligned with founders’ goals and businesses who ultimately aim to become sustainable and profitable while offering competitive risk-adjusted returns.

Goals

  • Allow founder to grow the business sustainably
  • Incentivize profitable businesses and allow investors to participate in profits
  • Avoid incentives to force a liquidity event or follow-on investments.
  • Explicitly acknowledge the founder’s livelihood, family obligation, “life outside business”
  • Build in options to participate in rocket ships
  • Sensible structures that maximize founder optionality
  • Be “patient capital” — no promise of hyper-growth or paper returns to LPs

Structure details

  • Fund participates in profit share
  • Founders pay themselves a salary up to a cap (negotiated, but based on a simple formula) any profits above that are considered dividends
  • Fund claims 15-30% share of dividends with a lifetime cap of 3-4x invested capital.
  • Fund has a discounted option for equity stake in the event of (1) a significant funding event or (2) sale of the company.
  • Option is reduced over time by dividend payments but does not reduce to 0% so that fund retains some upside in the event of catching a rocketship.

Examples

Fund invests $200k in Thesis 2 company.

Over next 5 years fund receives $700k (3.5x) in dividends.

Dividend share ceases.

Fund retains a minimum 2% in options on the business.

Fund invest $75k in Thesis 1 company.

Initially has equity option for 15% of business.

In years 2-3 fund is paid back $100k of dividends (of $300k total cap). Implied ownership stake is “paid down” to 10%

In year 4 business is sold for $1.5m. Option converts and Fund receives $150k (10% of sale).

Fund invests $100k in Thesis 1 company.

Product hits early product-market-fit and raises a seed round at $2m pre.

The investment converts at 20% discount: $100k / ($2m * 80%) = 6.25%

No further profit-share.

Fund Structure

Target fund size

$5-10m deployed over 3-4 years.

By Founders for Founders

The Calm Company Fund is primarily raising capital directly from successful founders and, in rare cases, funds managed by previous founders and operators.

Everything from the risk/return profile, to the language we use, will be optimized and aligned with founders long-term interests.

Goals of the operating structure

  • Simple legal structure.
  • Minimize fund overhead (remote team, streamlined operation)

Incubator/Accelerator Value-adds

Fund 1 will begin testing the cost-benefits of various value-adds such as:

  • Coaching, mentoring, guest lectures
  • Cohort networking (dedicated Slack or forum for portfolio companies)
  • Clarity/coaching on future exit opportunities
  • Dedicated resources for common services: legal, accounting, HR, payroll

A key component of a true accelerator is creating a defined investment offering with clear terms that many founders/businesses can apply for. At this stage, EC Fund 1 will optimize for learning exactly what that ideal early-stage investment structure is for the target market. If the opportunity presents it self, we may carve out a chunk of the fund for a batched accelerator pending further research.

Additional Fund Principles

Diversifying & Expanding the entrepreneurial ecosystem

There’s not a ton of diversity among successful founders of bootstrapped startups. One thing I think the world of venture capital is making good progress on is starting to acknowledge privilege and a structural lack of diversity and providing more opportunities for founders who don’t fit the typical stereotype. I’m not saying they’re great at it, but all it takes is a few dedicated funds or committed VCs to decide they want to fund more women, more people of color, more people in a different age bracket or from a different part of the world and it happens. The bootstrapped startup world doesn’t have those kinds of mechanisms and I think it is to it’s detriment.

Clear decision-making & feedback

One of the worst things about the VC world is the way that they will never ever give you a clear: No. They always want to maintain the option to invest later, or jump on a round if another VC decides to lead it, so every pitch that doesn’t end in “Yes” will end with some form of open-ended feedback or critique. I hated that so much, if you’re not going to invest, just tell me and give me some clear reasoning. We will always give founders (who request it… sometimes it makes sense for both parties to have an open-ended discussion) a clear decision in 14 days with our honest feedback.

Optimized for Learning

This fund will be breaking new ground in many different ways. Pursuing multiple theses at once and maximizing flexibility in the first fund will lay the groundwork to scale successful investments in the future. This fund structure will all significant experimentation which could substantially de-risk a more structured incubator, accelerator, startup studio or larger follow-on funds.

Lean, Remote, Flexible

Build the fund like the businesses it works with. Remote-friendly, flexible, lean, transparent.

Comparables, Competitors

Part of the opportunity is that there are very few comparable or competitors in this space.

Risks to Mitigate

“Don’t take on venture risk for debt returns” – Bryce from Indie.vc

Adverse Selection.  It’s possible the best entrepreneurs in this space are hustling without capital and only second-tier founders would end up taking the money. Not likely, but a risk to pay attention to.

Bootstrapper culture backlash. A large subset of bootstrapper culture has become quasi-religious about not taking capital at all. A commitment to be transparent and to engage with the community with be essential.

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