[manfredo]

In short: this author is endorsing a funding model focused on low initial investment and faster profitability. The benefits key benefits are that this funding model results in more women and minorities getting funding, as well as higher rate of companies surviving (10% vs. 44% [1]). The former is good, but probably isn't sufficient to motivate most investors. The latter doesn't necessarily translate into better returns on investment. Throughout this whole piece I was looking for a comparison on the net return on investment of the traditional VC model and this Indie.vc model. This comparison is never done. A high-risk high-reward investment model may still produce higher rates of returns than a low-risk low-return model.

Right now we're seeing a trend of larger companies taking an ever larger piece of the market share, and the total number of firms decreasing. While encouraging founders to form smaller companies with shorter time to profitability undoubtedly results in more companies surviving 3, 5, and 7 years after founding, that's not what we're optimizing for. An investment strategy with high rates of failure, but producing larger companies with those few successes is still yields the potential for larger overall returns.

1. What does it mean by 10% vs. 44% of companies surviving? Presumably it means that 10% of traditionally funded companies exist X years after founding versus 44% of Indie.vc founded companies. But this is a strange metric to give without specifying how many years we're talking about.

[adamgravitis]

"In short: this author is endorsing a funding model focused on low initial investment and faster profitability."

-> so basically, Canadian "venture" capital. They don't even want to talk to you unless profitability is there or within a few months. So, basically, it distills to a barely riskier than usual bank loan, except you pay the loan with equity.

[Hongwei]

A cause or symptom (I'm not sure about causality here) is that the Business Development Bank of Canada (BDC) directly funds most private Canadian VCs. VCs now have public money as part of their LP base, with some strings attached. Most of these strings (eg. don't waste taxpayer money doing anything unethical or overly negligent) will nudge VCs to be more conservative. Plus, the VCs are guaranteed 20%+ of their 2% carry from BDC taking up that much of every fund and don't need to swing for the fences to make a good income.

[nicholascamera]

I live in Montreal and intend to do a consumer oriented software startup. I would like to better understand what I would be getting into starting up here, vs. applying to YC. Can you suggest resources for understanding Canadian startup landscape, funding etc.?

Perceived Pros:

- Many STEM grads

- Gaming and AI industry, 2+ top AI schools

- Relatively little competition for engineering talent compared to SV

- Many engineers who are barred entry to US based on country of origin

- Easier work visas (to be confirmed)

- Free healthcare and other social services, and less violence

Perceived Cons:

- Cultural lack of ambition, entrepreneurial dreaming.

- Excessive reliance on government subsidy (the government is the customer)

- Risk averse VC

- Shallow bench of experienced operators to mentor, invest, and manage

- Brain drain to SV of best talent

- Higher taxes

[jariel]

Remember in the SV costs are astronomical, so there's a kind of buy-in threshold necessary which won't make sense for most companies.

Shopify is a perfect company for Canada - they are not making 'tech for other techies' and don't require all the best devs in the world. It took a while to get going, so costs needed to be lower. They can make some income early on, thus 'proving the model'.

There is a reason that the nations top social network started at Harvard, which has an elite status among young people. There's a reason that Snap was started by an attractive young man from Cali, from a the top school in Cali. Glossier, a 'makeup company' is actually, truly a 'social network', and there's a reason it was founded by an ex-model/reality TV star with deep connections in LA/NYC.

On the technical side, there's a reason that certain companies really need to be in the Valley as well.

So if your business needs to be in the Valley, it might make sense to do that, but if it's a 2cnd-tier kind of thing, not something the FAANGS would ever look at, and doesn't require the best technical talent in the world, than you can do it other places.

Montreal a tier 2 cities, Ottawa/Vancouver, not really tier 2, Toronto is probably a solid tier 2. FYI that is actually not bad considering tons of American cities are not tier 2 either. Chicago, Toronto's 'twin' really might not even be Tier 2, there is a weird lack of entrepreneurial activity there for its relative size and power.

Montreal has cheap prices, decent AI grads, stable economy, supportive government, weak VC but the top could of firms are fine places to go for smaller up to round A, and if your business fits well into Quebec's strategy, following rounds can be supported by Desjardins and nationalist players.

Also, Porn.

[a13n]

Purely anecdotal, but having lived in Canada for 5+ years now, I'd definitely say Canadians tend to be more averse to risk.

[loceng]

Arguably there are less Canadian VCs available locally as well, and therefore they can get away with offering worse conditions.

[troughway]

>Canadian "venture" capital.

I love this. I wish it were a thing, "The Canadian Model".

[vkou]

The Canadian model for business isn't all that great.

It doesn't do a great job of serving the country's social needs, and it also doesn't do a great job of producing competitive businesses.

There's a fair number of public funds that get funneled into unproductive firms through things like innovation grants, and there's a lot of protectionism for incompetent incumbents. All of this seems to enrich a small class of elites, at the expense of the public purse. Most Canadians just shrug their shoulders at all this, and move on with life.

[nickff]

Ballard Power being a classic example of this, though there are many.

[airstrike]

Can you share more on how this applies to Ballard Power? It's a name that just came up on my radar this weekend and I was planning on doing research on them, so thought I'd ask in case you have something specific to share

[nickff]

Ballard's been getting government grants and subsidies for over 20 years, and produced very little in terms of saleable product on the other end. They make fuel cells and related products, but their business model seems to be mostly taking government and investor money, and using it to produce units which they 'sell' at below-cost to companies trying to look green by 'testing' alternative fuels.

[bcrl]

Canadian banks are incredibly risk averse, and programs like CSBFP have so many strings attached that make it almost useless for certain sectors. Trying to fund infrastructure (rural FTTH) has been an exercise in futility with most Canadian banks. 75-85% loan to value ratio on fibre builds makes no sense considering the assets have 30+ years of life after being paid off in 3-4 years. But hey, we love real estate!

[munk-a]

As a Vancouver-side Canadian I must say that the support for tech up here is pretty poor in a large part due to the labour laws being gutted by EA. Providing information on OT policies and OT compensation is one of the first rounds of questions you can expect to receive during hiring.

On the other hand - Canadian business expenses are still quite high, but quite a bit lower than US business expenses. Healthcare and cost of living are huge factors in labour costs.

[WalterBright]

> public funds that get funneled into unproductive firms

If they were productive firms, they wouldn't need government money. This is why free markets work better, because free markets allocate resources to the most productive uses.

[markdown]

> productive uses.

You misspelled profitable.

[WalterBright]

The role of government in a free market is to make profitable and productive congruent.

[leesalminen]

I think both worlds can exist. You can have the "traditional" VCs going for the high-risk, high-reward model. And you can also have "new" VCs going for low-risk, medium-reward.

As an anecdote, in 2014 we looked for ~$250k investment. We had a business model that realistically took us to ~$5mm/year revenue in 5 years. We pitched various "traditional" VCs. The overwhelming feedback we got was that nobody doubted our team, the product, or the model. The problem was that the returns weren't big enough. The product was niche and could never become an "Uber" without really stretching the imagination. In the end, we found an angel investor in our space. We indeed did turn that $250k into $5mm/year revenue in 5 years and sold the company for 8 digits.

[molsongolden]

> We pitched various "traditional" VCs. The overwhelming feedback we got was that nobody doubted our team, the product, or the model. The problem was that the returns weren't big enough.

Sahil @ Gumroad has talked about this in good detail. The VC idea that "yes, your business/idea is/will be profitable but you shouldn't waste your time making money when you could be working on changing the world"

The "changing the world" business will also hopefully be profitable and make money down the road but they are looking for outsized returns from a market disrupting unicorn.

--

Regarding the "new VCs" concept. Alex Danco and others have discussed this and the funding model ceases to be VC when it is low-risk, medium-reward.

It's possible that many areas of tech are maturing to a point where VC will no longer be the optimal funding model, outside of high innovation specialties. As the industry matures, there are many businesses that might provide stable returns and have a risk profile that is different from that of the unicorn VC-startup. These businesses might be better served by debt funding and a debt-based investment vehicle/product might attract more investors and allow for greater de-centralization of tech funding.

Linking Alex's blog post below instead of rambling in this comment.

https://alexdanco.com/2020/02/07/debt-is-coming/

[epicureanideal]

Is there any existing term for "funding for business that will never be a unicorn but can clearly become profitable and provide good returns"? Is there an equivalent of VC for "lifestyle businesses"?

If not, if someone can establish a term it'll be easier to talk about this.

[teej]

There’s tons of existing finance infrastructure for this already, it just doesn’t reach tech. Small business loans, traditional banks, franchisors, local business investor groups, etc all facilitate these sorts of businesses today.

They just don’t do tech. This is because their risk models are built on 30+ years of priors and the financing is very often business sector specific. Tech is too much of an unknown for this model.

[grumple]

Are you saying banks won't provide loans to small tech businesses, but they will to things like restaurants?

[molsongolden]

Differentiating between "small tech businesses" and VC-style startup tech might be useful here.

There are many tech businesses that can and do qualify for traditional financing/funding. The difference is that banks aren't interested in funding high-risk moonshots.

Simplified examples:

Tech Biz #1: Founder identified a niche, has a few customers, and has been working on making the consultant -> product jump. They're paying the bills but see an opportunity to offer their product to many more customers and would like to work on the business instead of working in the business. They want to hire a programmer and invest in marketing but need to borrow money to make it happen.

Tech Biz #2: Founder wants to build X for Y and change the way people do Z. It's going to take many programmer-months to build the product and a sales and marketing team to change consumer behavior. There's no guarantee that they'll find product-market fit but, if they do, the business has the opportunity to scale rapidly with strong margins.

[bsder]

For a running restaurant, sure.

The issue is that the banks will pretty much provide loans for anything with consistent cashflow. This includes tech companies.

The problem is getting investment when you have no cashflow.

[airstrike]

Getting a loan when you have no cash flow to service it doesn't usually work well

[rapnie]

Zebras instead of Unicorns. Maybe you've heard of https://www.zebrasunite.com/

They have a manifesto on what a zebra is, that contains a nice image comparing with unicorn approach: https://medium.com/@sexandstartups/zebrasfix-c467e55f9d96

[tick_tock_tick]

You can get a loan from a normal bank.

[mrnobody_67]

Sounds like a good outcome.

VCs need to have a chance of "returning the fund". If they are investing out of a $200m fund, and they own 15% of your company at exit after 5 years and subsequent dilution, that 15% has to have a chance of being worth $200m.

Otherwise the math does't work.

[imtringued]

The math works out because a fund is investing in multiple companies.

[mifeng]

This is an important point. It's not about what VCs want to fund, it's about the types of businesses that founders want to build. Founders have a lot more choices than they realize.

[adriand]

Another fund in the "new" category is TinySeed: https://tinyseed.com/

Also, congrats on your success!

[usrusr]

But isn't it a scale problem? If you happen to have Softbank-sized cash heaps to administrate and you try to invest them by the single million in almost bootstrapped companies you will inevitably become a handout machine. You can't industrialize investment decisions without exposing exploitable patterns and they will be exploited. Survival rate won't stay at .44 for long once people learn how to push your buttons. Unicorn-scale investments are far from immune to exploitation as well (what happened to Wework anyways?), but at least they can't hide in the masses.

[dustingetz]

Planetary scale finance is FUBAR literally everything; all of civilization, resource allocation, etc needs to be rethought (re-evolved) for a world that is post light-speed communication. Power is now liquid and can be transferred from any random node in the human mesh to any other node instantly. Robinhood bailing out Hertz, Trump, Startup Not-Bubble, all the same root cause and it's barely getting started.

[spyckie2]

I think it's a bit short sighted to say that the high risk high reward model is superior to this model. While that may be true in a theoretical sense, you have to take into account market conditions and competition.

As an analogy, you can have an investment thesis that vending machines with bottled sugary water have extremely high ROI... but you are missing the elephant in the room which is you'd have to compete against Coke and Pepsi's infrastructure and brand.

Similarly, if you are raising a fund and want to play the high risk, high reward game, you need to consider what the market conditions are.

First, it's definitely not an even playing field. Connections and brand mean a whole lot. The leading VCs have all the best deals coming to them and have a bunch of management consultants in the backroom trained to spot large market opportunities. The volume of deals and strong connections allows them to pick and choose the best opportunities, and everyone else is left with scraping the bottom of the barrel.

Second, there's only around 15-30 billion dollar companies created per year in the US, and there's probably 30-100x the amount of incubators or venture firms. It's just a limited market overall.

That's the game. In a theoretical sense, yes high risk, high reward opportunities have better ROI, but only if you are at the top of the game. So I'd hesitate to say that this is an objectively inferior model because for some investor's positions, this strategy would probably yield a much higher return.

Its probably better to compare the two models like Residential and Commercial asset types (a quick google search to show the comparisons: https://www.fortunebuilders.com/commercial-vs-residential-re...)

[ClumsyPilot]

I found the point about minorities and women curious, is that perhaps due to the fact that profitable-ish business can be assesed more rigorously on the foundamental, rather thsn on VC's opinion of the founders?

[munk-a]

Less is riding on personal promotion and networking, both of which men tend to have advantages in. Instead, the focus on business performance allows a less biased selection criteria.

[smogcutter]

> A high-risk high-reward investment model may still produce higher rates of returns than a low-risk low-return model.

So, this isn’t really my area, but if the market is efficient shouldn’t these come up about the same over a long enough period? In other words if one or the other has dramatically better returns that just means the risk was mis-priced to begin with.

The immediate objection I can see to this (without expertise) is assuming that private markets are at all efficient. But that would point to a fundamental problem with pricing in private markets, not the merits of one strategy or another.

[ClumsyPilot]

Behavioural economics dominates the messy real world. Especially when we are talking about startups, new technology that is poorly understood, etc. These are the leading edges of the markets, they are the least efficient of all.

Cue theranos on one hand and probably many companies with potentially profitable innovations that never got funded and we never heard of.

This is one thing that the left social justice crowd does get right - Never forget that at the end of the day, the system runs on wetware - people with faulty ideas, preconceptions, biases and limited knowledge.

[whack]

In an efficient market, investments that are more risky will produce higher returns. If they didn't, no rational investor would invest in them. Why invest in a venture that is more risky, unless you're compensated via higher returns.

You can already see this playing out in the public markets. Stocks produce far higher returns than corporate bonds, which produce higher returns than treasury bills.

There's further nuance here around systematic risk vs unsystematic risk, but I don't think it's as relevant to VCs since their number of investments is too small to diversify away all unsystematic risk.

[smogcutter]

The point is that risk = higher return is an oversimplification. What that risk means is a significant chance of a much lower return. So if a basket of risky assets predictably overperforms... it isn’t actually that risky. Prices should rise in that case (and returns fall).

Having a higher potential return and actually being +EV aren’t the same thing. Just ask any bookie.

[whack]

> The point is that risk = higher return is an oversimplification. What that risk means is a significant chance of a much lower return.

Well yes. This is exactly why higher risk generates higher EV in an efficient market. Because of the significant chance of lower returns.

> So if a basket of risky assets predictably overperforms... it isn’t actually that risky

Depends on your time horizon. The S&P 500 predictably generates higher returns than T-Bills, over a 100-year time horizon. But it is still very risky to a 70 year old retired pensioner. This risk is why the S&P 500 generates higher average returns than T-Bills