Last week’s post was designed to be a simple and direct announcement that our initial Indie.vc experiment was ending and would no longer be accepting applications. I’d always intended to follow up with a few more posts to unpack our experiences and lessons learned for those looking to build on what we’ve started. Today is the day for that next installment.
Whenever I hit publish on a piece I have some personal predictions about how the post will be received. Last week my finger lingered longer than ever over that publish button bracing for a wave of disappointment, dunks, and “I told you so”s.
I couldn’t have been more wrong.
The wave of support, encouragement, and, well, for lack of a better word, love that washed over me was a much-needed balm for the rawness of emotions I was still in the middle of processing.
A recent note from a friend read “at times like these there is value in volume”. If I never live those words again, I’ve certainly lived them this last week. And the value of the volume of your responses has changed me forever.
So, thank you. Thank you for showing me the best of you. And thank you for forgiving me when I’ve fallen short along this journey. There’s much left to be done and so much left to be shared.
On that note, what follows is an exploration of some headwinds we’ve faced getting Indie to cross over from experiment to institutional-grade investment strategy.
From the first article written about Indie to that latest, outsiders have always tried to frame it as “an alternative financing program that was aimed at slow-growth, bootstrapped founders”. Despite a portfolio with many companies growing revenues 3x to 10x yoy and several putting up low to mid-eight figures of revenue that “slow growth” narrative is one we’ve been unable to shake. There seems to be no room for nuance in a discussion about funding, growth, and ambition. It is, apparently, a package deal.
To state it clearly and unequivocally, Indie has never, EVER, been about building a portfolio of plodding companies lead by unambitious or unfundable entrepreneurs.
The seeds of Indie were planted by my early exposure to founders at Atlassian, Github, Qualtrics, Pluralsight, and many others who’d shared a common lineage. Despite having massive financial outcomes and impact, they’d chosen to focus on fundamentals early, each opting to raise little to no outside capital until they were in control of their own destiny and after having achieved significant scale. As I shared in a soundbite from a previous conversation with Ryan Smith of Qulatrics:
“Raising a seed round would have been a huge mistake for us. If we’d have raised a seed round we would have been focused on the markets and milestones that investors needed to see and not on the needs of our customers.”
At the time we launched the Indie.vc experiment, it was common knowledge that 85%+ of the returns generated in the VC asset class for any vintage year were driven by roughly 12–15 companies. With that understanding firmly in place, the race for those rare unicorns was on!
The thinking behind Indie was a bit different- how can we unlock the next 12–15 of those value-driving companies? At the heart of the Indie.vc strategy is a belief that there are hundreds if not thousands of venture scale opportunities going overlooked or overfunded who might have a higher likelihood of reaching their full potential if they had a different path to follow and a community of likeminded operators and advisors to share that journey with.
These are not slow-moving or unambitious individuals. But they are often in markets that are out of favor, or come from demographics that are wildly underrepresented in venture-backed startups, or, believe it or not, they just don’t want to build the way the startup world tells them they have to.
That we couldn’t shake this perception while the biggest headline of the week is Zapier’s $140M of ARR after having only raised $1.5M in total funding is not lost on me. There are thousands more “Zapiers” out there dying of starvation OR suffering from the indigestion of overfunding who could benefit from the Indie path and founder community.
Unfortunately, that has proven to be an incredibly difficult narrative violation for media and institutional capital allocators alike to overcome.
(side note- the VC quoted above saying Indie is a slow-growth strategy is also a co-investor with us in an Indie company that grew revenue over 5x last year…)
Value Hand in a Growth Game
One key tenet of the Indie approach is the value of independence, or as we termed it Permissionless Entrepreneurship:
We want to enable a world where founders don’t need permission from an increasingly small group of fickle funders to exist. We want to see companies thrive that live more than 30 min from Sand Hill Rd. or San Franciso. We want to see entrepreneurs who don’t look like, talk like, think like or see the world like they do achieve their full potential. There’s a wild, weird and wonderful world of opportunity that will go unrealized if we continue running the current VC backed startup playbook of asking permission to exist every 12–18 months.
The primary way we attempted to unlock that independence for founders was through a focus on fundamentals- revenue, margins, profitability. Once achieved, our collective ownership and optionality would compound.
For example, we have an Indie company we’ve funded that’s on track to do $10M+ in ARR this year. They have grown revenue 2–3x each year since we invested. We own 20%+ of that business. They don’t need or want to raise more money. The value of our, and the founder’s, ownership is compounding instead of diluting. They can raise more if they want, they can sell if they want or they can continue growing and compounding. This is not an aberration, this is the Indie model. Given the rate of growth and the strength of the fundamentals in that business, it will likely return our entire fund many times over.
Despite many stories like the one above playing out in our portfolio, in a world awash in cheap capital looking for fast yield, fundamentals have fallen out of favor. I have experienced an incalculable number of blank stares as I rattle off key metrics that our Indie companies are achieving, or the low mortality rate across our portfolio (12% vs. typical VC which hovers between 30–50%). It’s been like speaking a foreign language.
Turns out when capital is abundant and everything is up and to the right, the way to manage ownership and optionality in the minds of many is simply raising more money at increasingly higher valuations.
As I shared this frustration with a friend and LP, they replied “you’re playing a value hand in a growth game”. They were absolutely right. The way the startup game is played, even compelling fundamentals take a distant back seat to how much money companies are raising, at what valuation they are raising it, and which top-tier firm is leading the raise. This is not a knock; rather, an acknowledgment that those are the rules. I tried to play by a different set of rules and got burned.
Bugs Disguised as Features
Another key tenet we felt was important to Indie was putting founders in control. Not just of their companies, but of their cap tables too. One important way we manifested that value was through our unique set of terms that allowed founders to control their dilution by repurchasing up to 90% of our equity at any point for 3x our initial investment.
What we believed was a feature, was largely perceived as a bug.
Capped returns?!? 3x is really expensive capital!?!
Despite being nearly identical to a classic convertible note in every conceivable way, the release valve of redemptions and capped returns was a very steep learning curve for most to come up. What we thought was our way of hard coding founder optionality, proved to be a hard pill to swallow for more founders and LPs than I can count.
After interviewing many Indie founders post-funding it was clear the repurchase option was interesting maybe even attractive, but what really drew them to Indie (besides the money, duh) was an alignment on values, an opportunity to play a role in a growing movement, and a desire to be a part of a community of founders that wanted to build and scale similarly. Post financing, nearly all of them were intent on helping us to realize the upside of our initial investment to prove to the market the value of the alternative scaling path that Indie opened to them, not just get us a 3x return out of cashflow.
In for a Penny, In for a Pound
If it wasn’t clear where Indie was positioned on the spectrum between banks and blitzscaling up to now, it should be snapping into focus that we were designed to be more VC adjacent. Although we have a revenue redemption release valve in our convertible note, we’ve made our funding decisions based on potential equity upside as opposed to the likelihood of 3x redemption.
But as the old saying goes, in for a penny, in for a pound. By having any element of revenue share in our model, we became a revenue-based finance (RBF) lender in most people’s minds. As I recently wrote to a prospective LP:
We DO NOT consider ourselves RBF.
In fact, we actively work to distance ourselves from that term. We’ve even gone so far as to ask to be removed from this seminal piece on Techcrunch which featured us prominently before we asked to have the bit they wrote about us taken out.
Last year we shipped a product called INTRO to offer a front door to the emerging market of non-dilutive lenders and revenue-based financiers that sit closer to banks on the above-mentioned spectrum. We love our lending partners! but we are not one of them.
If we were to be viewed as an RBF lender we would look like a terrible one. What lender in their right mind would offer 2 to 3 years before a single redemption was required? We are investors, not lenders. But having a revenue share aspect in our terms overshadows that in the minds of many. And makes the cost of capital calculation for founders who view us as RBF that much muddier. From the institutional LP side that leaves us without an obvious allocation bucket to be put in.
I‘m no accountant, but this bit is important.
When institutional LPs look to invest in a Fund they evaluate their Internal Rate of Return (IRR) against other firms and industry benchmarks (among other return metrics).
Fair valuing equity investments according to GAAP is pretty straightforward and valuations are adjusted quarterly to reflect either a mark-to-market value or the valuation of the most recent financing round. Indie.vc investments are technically an option on equity, rather than equity itself. Until our investment converts onto the cap table, GAAP, and industry best practices, say we have to hold those investments at cost- no mark-to-market, no next round. Given we often hold these investments as options on equity for years also means we have to hold those investments at cost for years, even if the underlying companies are making tremendous progress. And even when they do convert, we only mark them against a conservative market multiple that doesn’t often reflect how that company would be priced if they were raising from VCs or private equity shops.
An example- one of our Indie.vc companies is on track to do roughly mid-eight figures in revenue this year with low seven figures in profit. We own just shy of 20% in that business. They have not raised outside funding in 5 years. I’ll refrain from speculating on what valuation that company could fetch in this frothy market but I will share what valuation our auditors, and GAAP-based accounting, have us carrying them at: $12.5M.
As you might imagine, carrying fast-growing companies at cost for years on end comes at a price. And that price is paid in our IRR.
Since we’re all friends here I’ll share the actual performance numbers behind both our lifetime Indie.vc strategy (keep in mind our Indie investment strategy straddles two funds) and our Fund IV (which was majority Indie investments). I’ll contrast our GAAP numbers with what the numbers would look like on an “as converted” basis using a similar market multiple to the example company above.
As of 12/31/20, the lifetime gross GAAP IRR for the Indie.vc strategy is 16%. In contrast, the gross “as converted” IRR is 48%.
Now, let’s talk about Fund IV which has a 2016 vintage year.
The industry benchmarks that follow reflect a 2016 fund vintage. For 2016 Funds an upper quartile net IRR (net of fees) is 29%, a median net IRR is 18% and the mean net IRR is 20%.
Our Indie forward Fund IV is currently marked at 11% net IRR which doesn’t even register on the benchmarks above. However, the “as converted” net IRR on Fund IV is 42%.
The gulf that GAAP accounting creates between those two numbers has proven to be an incredibly difficult one for us to cross in the minds and spreadsheets of institutional LPs.
Pity Party for One
As I note in my previous post, none of this is intended to be a pity party.
When all is said and done, what ended Indie was me.
This was not a failure of LPs. Over the last 6 years I’ve talked to every flavor of LP under the sun from large and small family offices, to endowments, fund of funds, and foundations who publicly profess the need for alternative funding models but privately ghost those of us building them (that’s a story for another time…).
It was me that couldn’t translate the demand we were seeing and the progress our companies were making into a product institutional LPs wanted to support. And ultimately, it was me who decided that without that level of support I couldn’t continue to push the Indie experiment at a smaller scale than I believe it deserves.
It was also me who chose to depart from the proven path we’d worn at OATV that has delivered pretty great returns for our existing LPs. I understood the risks and have lived many of the consequences. And I wouldn’t trade my experience taking them for the world. The genie is out of the bottle for an entirely new category to be built here, playing a small role in that has been some of the most rewarding work of my career. And, as I mentioned in my previous post, I’m convinced our Fund IV returns will rival even the best performance of our previous funds.
OATV will continue (we’re holding a first close on Fund V today) and Indie will find a way to continue as well. Whether we see a thousand “Indies” bloom or whether we bring back a 2.0 version down the road, it’s in my DNA and will undoubtedly find new and unexpected ways to express itself in any of the work I do from here on out.
I’ve never called Indie a movement but many others have. There’s a saying I’ve always loved that goes something like “it’s only a movement until it moves without you”. So, for now, I’ll be watching where you all move it from here.