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Updated February 11, 2023Aunnie Patton Power (Impact Finance Pro, University of Oxford)
Not all startups need or should seek venture capital funding; instead, the majority of businesses shouldn’t buy into the fast-scaling and exit-focused VC rhythm. In her research and writing, Aunnie Patton Power has focused on all the alternatives out there, many of which can further enable diversity in the ecosystem. From venture debt to equity-based finance, Aunnie shares concrete ideas of what other sources of funding startups can resort to in a detailed sneak peek of her recent book, Adventure Finance.
Interviewed July 2021
Erika Brodnock (EB): You recently published* Adventure Finance, a comprehensive guide and casebook on how companies can raise financing outside of the traditional venture capital model. Why did you write the book?
Aunnie Patton Power (APP): Realistically, venture capital does not work for 99% of businesses, and particularly businesses that are founded with any definition of diversity. One reason is this need for exponential growth, which is not sustainable. Specifically, it is the need for VCs to perceive the possibility of exponential growth.
In my experience working with startups and VCs for the last 13 years, I’ve seen that women and other people who have been underestimated in their own lives are less likely to have the hubris to be able to talk about becoming the next Facebook. They are coming into business models with much more realistic scenarios for how they are going to grow a business. That is not what VCs are looking to hear. They will not find a $50M market interesting. Nor would they support someone planning to build a company to address a need for a niche population that the VCs never interacted with. There is also the exit piece, which is about needing to grow to a point to sell. Not all founders are interested in selling their business. Even if they are willing to sell parts of it, they are not interested in being up against an artificial deadline of seven to eight years, depending on what the VC fund looks like. VC was designed for tech-enabled, asset-light, highly scalable companies, which has morphed into the only type of risk capital that is available for early-stage businesses.
Most early-stage businesses are not these types of companies, and they do not get funded. The market failure is that VC is risk capital; risk capital is not venture capital equity. There are so many more options. People think they should close a business instead of questioning whether the capital is right or not. It is a chicken and egg conundrum around the industry, where you need funders who can do different types of financing and you need founders who understand different types of financing, what they need, and what will be best for them. You also must consider the element of society and communities. How are we designing funding systems and enterprises that are creating value for communities outside of the small number of funders and founders who benefit from venture capital?
Johannes Lenhard (JL): How are alternative funding mechanisms and practices accelerating the openness of the industry? Are they changing the availability of funding towards people who are overlooked? What plays the biggest role?
APP: It is a combination of the process and the product. You can have an inclusive product that works for a lot of founders. However, if you do not have an inclusive process, then you are not going to be able to attract the deals. In addition, if you have the most inclusive process in the world, and you are using a product that is not going to work for these diverse founders you have pulled into this process, you will also not get to the end goal. It is about designing how you find, source, and diligence deals, as well as how you structure them, to be able to really embed inclusivity and diversity. How do you bring in deals? How would you think about the merits of those deals? How do you decide to fund them? What type of structure do you offer them? It is not just about being a venture capital fund that can offer venture debt now, nor hiring a Black analyst or a Latina associate. It is about, what are founders feeling when they walk through the door? Are you providing a product that makes sense for what they want to build?
I work a lot with female founders. They want an investor who offers them the type of investment they need and the type of support they need. That is not necessarily forthcoming from traditional VCs. For example, in regard to structured exits, one thinks about, how do you continue to own this company? How do you repurchase this equity? How does the founder maintain a lion’s share or a large percentage of the ownership? There is a shift from the funder’s perspective around portfolio construction that is not betting on one to two businesses with the rest failing. By shifting that portfolio construction to having a higher hit rate from a returns perspective and having more liquidity earlier on in the process, you can invest in companies that are going into markets that do not require exponential growth. You are able to then work with companies that have normal growth expectations for companies that are risky and are looking for this type of upside. You can still provide very similar IRRs [internal rates of return], but you are able to engage with these companies. Adopting a portfolio construction is one piece of it, but it is also important to figure out how you go out and find deals from creating sourcing opportunities, use peer-based decision making, make sure that your ICs [investment committees] are diverse, or make sure that your scouts are diverse. All of those different pieces coming together is where I see the early-stage funding becoming genuinely interested in diversity and not at a superficial level.
EB: What are the key benefits of that for the founders themselves, especially those who have been traditionally overlooked?
APP: This is exciting. If you can help founders hold on to more of their business longer, you can create or expand the ownership base. You can think about employee ownership, and even community ownership; we can focus on wealth creation for more than just a couple people. We can use structures such as redeemable equity, where the founders can repurchase the shares, and then they themselves will hold more of that wealth. If they create something over time, then they will have more of that wealth.
Taking it further, you can have founders purchasing shares and employees owning them. With this employee ownership scheme, employees are incentivized to continue to create value in this company. Now you have wealth creation, not just at the top. This creates opportunity. From the other side, with crowdfunding and other types of large, distributed ownership, there is also an opportunity for more retail investors and individuals who feel locked out of the traditional VC market or startup market. You can start to imagine products that allow a larger set of individuals at the company side to participate in wealth creation, as well as a larger set of individuals at the investor side. We are prying it open from both sides. There is opportunity to build companies that are sustainable and that are integrated into communities. By doing so, you have better staff, a more incentivized workforce, better ties to communities, and better ideas about what communities need.
EB: This also opens the gamut to solving the problems that most need to be solved and that are not currently being solved.
APP: This has so many layers and it takes both the process and the product. It is not just about funding a few more underrepresented founders. It is about critically thinking and asking, what does this capital allocation look like? What are these business models from the wealth creation and accumulation perspective? We have looked more at changing people from beneficiaries to producers and consumers, but have not yet made that last jump from producers and consumers to wealth creators.
JL: Crowdfunding can have a radical potential when it comes to providing a different type of funding to startups. Is this something that can benefit stakeholders who have been overlooked and unable to participate?
APP: Calling it crowdfunding undersells it. I like to say crowdsourcing or community-driven finance. Crowdfunding can sound like preordering a shoe. Community-driven financing is going to be incredibly powerful. Thinking about investing, one of the most powerful structures are platforms (e.g., AngelList) that allow traditional investors to do the due diligence pre-screen, and then put them up for a co-investment by individual investors. This is powerful because it is not just relying on viral social media. If you can have co-investment opportunities, beyond just equity, and allow individuals to invest small amounts of money into a diverse portfolio, you are investing in regenerative agriculture. There are so many ways to do civilian community ownership schemes. Local communities can borrow from financial institutions and then turn that into a source of dividend income down the line.
We have always just assumed that masses cannot do it. We need to revisit those assumptions. Companies can be owned by employees and be able to utilize their employees and larger community to be able to attract capital that is engaged with that company. There are many ways in which we can think about how the resources that communities have must help small businesses and developments, beyond just money. We underestimate that opportunity.
EB: Everyone wants equity finance, but debt financing is usually not an option for digital businesses because they lack the required security assets. How has that changed, and what are the key factors that will make a debt journey successful for an entrepreneur? How suitable is that for historically overlooked founders?
APP: We need to understand exactly what we need to fund, then we need to be able to assign the right types of debt to it. Three different types of debt stand out as options that should be in most founders’ toolkits.
The first is trade finance: supply chain financing, invoice factoring, or purchase order factoring. These are increasingly facilitated by FinTechs. What they allow you to do is to access working capital, which is terrible to fund with equity, because you are trading ownership in your business for short-term capital needs. Instead, you can use your customers or FinTechs to facilitate payments from your customers. It is short-term expensive financing, but it can be incredibly valuable, particularly for companies that are asset light now.
Revenue-based financing is the next step. It is a complement to traditional equity and more and more VCs will start using it. It also pushes companies to create revenues. By focusing on the internal financing and then monetizing that for growth, revenue-based financing has a lot of opportunities. It is a relatively short-term option, but then we can look at mezzanine financing, particularly for SMEs [small and medium-sized enterprises], which few organizations understand how to do. We need more of them. It has small amounts of collateral, but it also has a fixed interest rate with a profit share. Those three tools are starting to be more accessible, but they are for very specific cases.
Specificity is a bonus for founders, and founders need to better understand their needs as an entrepreneur, as opposed to going on raising an equity round, and then figuring out what to do with the money. We have seen that go wrong so many times. They need a better understanding of the type of capital that fits for the specific type of spend, and then go out and search for that. This is where debt becomes interesting, because that can be customized very specifically. There are even asset-based financing options that are starting to be much more attractive for SMEs, which are often developed by FinTechs and specialist institutions, as opposed to traditional banks. All of those are very tailor-made to the type of spend or the type of assets that you are funding, which creates more discipline.
EB: Having funding alternatives is great and it will allow many companies to raise money that would not have been possible otherwise. But, does it democratize access to big money? I mean, do you think that any of the alternatives are going to fund the next Amazons and Googles? Or are we saying that we are going to carve out a new way because the old way is not working, but the old way will continue, and white males will be over there getting VC funding while women and other diverse entrepreneurs will get smaller pots?
APP: This is a good question. Do we want more Facebooks and Amazons? I do not think we do.
We do not need a separate type of capital for underrepresented founders. We need to redesign our system. VC still has a place. More of those founders need to be women and underrepresented. I live in South Africa, where there has been a big push for Black Economic Empowerment. Yet if you create three Black billionaires, there are still 50 million people that are suffering. I do not think there should be billionaires, and I work with billionaires. Billionaires should not be part of how society works.
There is room, however, to make female founders and underrepresented founders create big companies. I do not see those as mutually exclusive. There should not be an A and B track. We do not want it to be white guys running VC funds continuing to do what they want, and we create options for everyone else. This will unfortunately continue for a while. We are still going to be polluting and destroying the environment, even though we know we need to save it. Funds need to start walking the walk around diversity. Businesses should be founded by the people who have the good ideas—and not just [the ones who] look like a specific type of founder.