“So, there's been a hole in the market for that kind of company that's going to be a great company that's not venture-scale.”
Repeat founder and super angel Jay Batson talks about his new passion: Revenue-Based Finance. He likes the possibility it opens up for startups that are great but not quite venture-scale. Learn what RBF does for founders and investors.
Highlights include:
Sal’s Intro
Acquia & Drupal
Revenue-Based Finance Is Introduced
The Debt Model vs. The Equity Model
“Well, the problem is, there's kind of a hole in the middle, because banks don't like to take risks that startups pose.”
“So, venture capital is great if your company is the kind of company that will provide large capital gains to the investor.”
“…venture investors tend to say, "Is this a company that could create a billion-dollar company?"”
…"This isn't a venture-scale company,"…
“So, there's been a hole in the market for that kind of company that's going to be a great company that's not venture-scale.”
Wistia as an Example of a Great Company that’s Not Venture-Scale
Being Venture-Scale Means You Have to Grow at All Costs
“So, the investor makes money by the entrepreneur's business generating the revenue to provide the investor the returns; the entrepreneur retains ownership of the company during the duration.”
“…your returns that you see as percentages on your money, are really going to be defined on how fast the entrepreneur repays you.”
“It's not venture-scale, but it's going to be a fine company, thank you very much, but it needs an influx of cash to help grow the go-to-market.”
“...we want RBF to be the kind of thing that's notable and well-known for something that people do in Boston.”
Sal Talks About His Investment in Gelesis
Jay Batson and Sal Discuss Various Aspects of the Current Crisis and How Startups Might Respond
“…this won't be the first time you've had to embrace the suck, you know? It's kind of part of the deal of being a founder and being an entrepreneur.”
“And then, I hate to say this, but now's the time to cut costs kind of hard and fast, and this may mean cutting some people. And that's really hard to do.”
“It's not even just snagging other companies, Sal, it's snagging customers.”
“…the things that are happening in the stock market in terms of valuations are probably going to happen to you.”
Transcript of, “Jay Batson on Revenue-Based Finance”
Sal’s Intro
SAL DAHER: Welcome to Angel Invest Boston. I'm your host, Sal Daher, an angel investor who delights in the fascinating tech companies being built in Boston's singular ecosystem.
Because of the unique concentration of great universities here, Boston is a massive exporter of great startup ideas, and a massive importer of capital. This cash-poor, idea-rich environment allows me to invest early in really interesting companies. Case in point: Gelesis, Inc. I'll tell you more about Gelesis later on, but now, I'm very happy to introduce a really exciting guest, JAY BATSON: super angel, repeat founder, and a very deep thinker among angel investors here in Boston.
JAY BATSON: Oh, my. You're setting the bar really high for me, Saleh.
Jay Batson’s Bio
SAL DAHER: You know, among founders and angels in Boston, Jay is known for his generosity and his insight. He's a person who's casual utterances can change the course of your company, or even your life. Because he thinks very deeply, and he's very sparing in his comments but frequently very astute. So, I treasure every opportunity I have to speak with Jay because I always learn something valuable.
Anyway, you can get a more complete treatment of Jay's really remarkable story in an episode called JAY BATSON: Open-Source Dude. Okay? It's a early episode in this podcast and it's still current today. Great story but I'm going to summarize it a little bit here. Pardon me if I'm reading this, but the short version is really like this:
Jay started out his working life while he was in college as a landman, okay? In the petroleum area. Land-man is a person that goes and bird-dogs oil leases, helps them get set up, and so forth. They do, I suppose, there are different levels of landmen, and so forth. Actually, George W. Bush started life as a land-man. The father of T. Boone Pickens started out as a landman before he became very rich.
And so, Jay was running around, fishing for these oil leases, and he discovered that there were problems. This is, I guess, in Wyoming. He just decided that he was going to create a database, an online database... It was kind of a complete switch in directions. He'd gone to law school to become a better landman, and then he goes off, veers off into this database business, and he discovers software, okay? And that becomes his career. A lawyer who does software; it's really unusual. One of the most well-spoken software people you're going to find.
And so, he sold his early company. What was it called, ELSI?
JAY BATSON: Energy Logic Systems, Inc. Yes, ELSI. That's exactly correct.
SAL DAHER: To Dun & Bradstreet, a hallowed name... and went off and worked in various software areas including BB&N, the storied company from which came the internet, and he worked at Forrester Research, where he had very wise advice to companies like 3Com or Oracle. Imagine, he was the oracle of Oracle at Forrester. This is the kind of person that we're talking to today, a privilege; a very deep thinker, a very wise person who's seen a lot of things.
Jay went on after that to start his own software startup, which was in the business of enterprise telephony. His software is still used today, and eventually, he became the founding CEO of Acquia, and Acquia is the commercial support for the Drupal community, the Drupal open-source community. And Drupal is the... Jay, you can explain what Drupal is, right?
Acquia & Drupal
JAY BATSON: Well, I want to actually correct you just a little bit, because although the company started by providing commercial support for a web platform known as Drupal, that allows people to create content-rich web experiences, the company's grown well beyond that now to what's now called the digital experience management company because it's now not just web anymore. It's web and mobile and commerce and all rolled into one. But nonetheless, it's a digital experience management company with Drupal, the web platform at its core.
SAL DAHER: Yeah, and Drupal is a huge portion of a lot of websites... on the web, are doing their content management...
JAY BATSON: It's the second-most commonly used content management system on the planet. WordPress has more, but most of the WordPress sites are smaller. Certainly, plenty of Drupal sites are smaller, but Drupal tends to scale to larger sites better. So, it has everything from most of Procter & Gamble to most of NBC Universal to all of the above. So, a different class of system, and still quite widely used.
SAL DAHER: Excellent, excellent. So, here we have the mini-biography of Jay Batson. If you want more detail, I refer you to the episode, and he's just so kind to make time to be with us here.
By the way, after Acquia, Jay has become very involved, even more involved, with the startup community here in Boston, and he is a member of UnderscoreVC, he's in residence at Techstars, and lucky is the startup that can snag Jay as an advisor. He's one of the super angels in Boston. Well, as I said before, I mean, one of his casual utterances can change the course of your company. So, he's tremendous.
JAY BATSON: Two things, Saleh, while you're talking, I want to reflect on both of those for a moment. It's actually somewhat humbling because I regularly, I would say once a quarter, will have somebody come back to me and said, "Do you remember me? You spoke to me three years ago back in this place, and you said something that changed the direction of our business," most of the time don't say it well.
SAL DAHER: Well, those rare instances...
JAY BATSON: And I want to take that comment to heart in that, things that someone like me who's later in his career and who says stuff that feels instinctively right at the moment, can have influence. And sometimes, that influence might end up being bad. So, I'm constantly cautioning the elders who mentor the Boston community to make sure you know you're not maybe the smartest person in the room, to offer your thoughts but also encourage them, the founders, to get thoughts from others. Because you can have impact. You got to watch out for that.
SAL DAHER: I think that when we give advice, the best advice is, it's the kind of thing that the person sort of knows they have to do, but it hasn't quite gelled yet, and when they hear it, it's like, "Oh, jeez. Yeah. That makes sense to me." Okay? And then, it happens.
Because if you give advice and a person's not ready to receive it, if you give advice and it's not consonant to something in their life, it'll go right over their heads, in one ear and out the other, forget about it. Okay?
There's a great story, there's a video online that you can find... Actually, it was a TED Talk, I think. This guy was explaining the influence you can have on somebody's life, and he was selling raffles for some kind of a charity thing in a university in Canada, and there was a line of students waiting to register for courses. So, as a sales pitch, he kind of said to this guy, and there was an attractive young woman behind him, and says, "Why don't you buy this young woman a raffle ticket? You know, this is a really interesting woman for you to meet. Buy her a raffle ticket."
And it just went on, right? He says when he was about to graduate four years later, he got an email from this couple now. It said, "You know, you put the two of us together in that line, and we're getting married four years later." And it's out of the blue. Of course, if they were people who were not going to hit it off, that stupid, empty introduction would have just been blown away, right? But there was something there, and perhaps those people... there might have been a social barrier between them that would not have been overcome except for this minor gesture.
So, continue to give your kind of advice, because it can be so helpful.
Revenue-Based Finance Is Introduced
Today, Jay is here to talk about something entirely different. One of his passions right now is something called RBF, and RBF stands for Revenue-Based Finance, and that means... Well, let Jay tell us what it means.
JAY BATSON: Well, before we necessarily talk about what revenue-based financing means, and the short answer is that it's a way of acquiring and using capital that's not using an equity form but a different type of form...
The Debt Model vs. The Equity Model
But the principal thing to look at here, I think, is capital comes in various types. There's debt capital, and debt capital can come in different ways from different sources. You've got your credit cards... when you're really trying to bootstrap and get something going with buying all your computers on your personal credit, and that kind of thing. You get more mature, maybe you're going to find yourself using debt financing from a bank, maybe they'll take receivables that you have as a collateral or something like that, and those things, the person with capital makes money via charging you interest. And you, the founder, or you the business owner, are providing the return to the investor.
Venture capital, on the other hand, or angel investors at an earlier stage, have been defined by the company selling a stake in their company, or the founders selling a stake in their company, and giving up some ownership in exchange for the cash. The deal for the investors, that they make their money on capital gains down the road somewhere. Somebody buys the stock that the founder sold to the investor. It's been a really great model, and we've seen lots of great companies come out of it. Acquia, my company, did really well based on that model.
“Well, the problem is, there's kind of a hole in the middle, because banks don't like to take risks that startups pose.”
Well, the problem is, there's kind of a hole in the middle, because banks don't like to take risks that startups pose. And that's what venture capital did, is it stepped in to provide capital where banks wouldn't, and take that kind of entrepreneurial and marketplace risk and product risks that banks weren't comfortable with. Because banks were investing money of your average person who has cash in the bank, and they want that to be there safely, and venture capital is investing other limited partners' capital, where they were willing to take a risk to get better returns.
“So, venture capital is great if your company is the kind of company that will provide large capital gains to the investor.”
So, venture capital is great if your company is the kind of company that will provide large capital gains to the investor. And if you look at an investor, for example, a typical venture investor, the story used to be, and it's maybe changing a little now, but the story's always been that if you'd take a 250 million-dollar venture fund, and they make 10 investments across the fund, one of those investments, if they do their job right, will make them enough profit to be equal to the size of the fund. One deal might return 250 million dollars in gain. That's great, because we call it returning the fund, and it's awesome.
And then, two or three or maybe four of those investments will return some multiple less than 10, or something like that. Maybe three or four X on invested capital, or something like that. We call those base hits or doubles or triples, something like that, and that will allow the investor to add to the overall gains of the fund, and in fact, lots of funds, the gains that come on the fund... over the lifetime of the fund, come from those doubles and triples after the one big one return to-
SAL DAHER: Right.
JAY BATSON: Out of the remaining five to seven, whatever the number is in any given fund, some number of those are going to be total zeroes. They'll literally be washed out. It'll be capital down the drain. They might have invested five or eight million bucks and not going to see a dollar back out of it. There might be a few where they get some less than a dollar back on invested capital. They invested five million, they get back $500,000 in a bailout sale or something like that.
“…venture investors tend to say, "Is this a company that could create a billion-dollar company?"”
So, that means that they have to make sure that every one of those 10 investments they make out of that fund has the potential to return 250 million dollars. Now, let's assume for the moment that they are going to own 25% of the company when that happens. That means that the company has to be worth a billion, because four X 25% is 100%, and so, four X 250 million's a billion. And that's why investors that are venture investors tend to say, "Is this a company that could create a billion-dollar company?"
Because in order for us to make an investment, we have to be of the mindset that this has the potential to be the one. Now, every one of my 10 has to be the potential to be the one. That means that when an entrepreneur shows up, if the company is the kind of company that is going to be maybe a fine technology company, or maybe not a technology but a technology-driven company in some way, but I just can't describe how it's going to be worth a billion dollars, the venture capitalist walks away.
And the language that you'll hear is that this isn't venture-scale. And so, Saleh, you and I've heard that word all-
SAL DAHER: Right.
…"This isn't a venture-scale company,"…
JAY BATSON: You know, "This isn't a venture-scale company," and so, the venture capital investor passes and says, "Keep in touch. We'd love to hear if something gets better, and maybe something will change about your business such that it does become venture-scale, but it doesn't work for us."
“So, there's been a hole in the market for that kind of company that's going to be a great company that's not venture-scale.”
Now, it doesn't mean that you don't have an awesome business. And so, the question is, what does a startup like that do? They're not ready for bank financing yet, they're not going to get debt anywhere of any substantial amount that will change the needle. So, there's been a hole in the market for that kind of company, that's going to be a great company that's not venture-scale.
Wistia as an Example of a Great Company that’s Not Venture-Scale
We have a great company here in Boston that you probably know, Saleh, named Wistia, and Wistia is a video company that's great. They may or may not end up being a billion-dollar company, but that's not their goal, to create a billion-dollar company for investors.
SAL DAHER: No.
Being Venture-Scale Means You Have to Grow at All Costs
JAY BATSON: And interestingly, one of the reasons that companies decide to not take that track, is that this notion of, "I have to be worth a billion dollars," causes all kinds of secondary knock-on effects in a company. You have to grow at all costs. Once you have product market fit, you're going to burn cash to grow the top line because you know that eventually, the ability to dial down the spending and make it be profitable will be there, but in the meantime, you go, go, go, go, go. And it changes almost everything about the company, and not every company wants to get on that locomotive.
SAL DAHER: A locomotive, no. A rocket ride.
JAY BATSON: Well, it is. It can be, yeah, but it could also be a relentless just drumbeat of, "You've got to go, you've got to go, you've got to go." And it can have a lot of downsides. So, some companies just don't even want to go up that route. They might have a fine company.
So, how do they raise capital? I'm going to share the story of a company that was one of my Series A investors at Acquia. O'Reilly AlphaTech Ventures is the fund named after the publisher, Tim O'Reilly, who you may or may not know of as the publisher as lots of technology books like Linux manuals and things like that, C++ programming manuals. He had done well and set up a small seed fund in the mid-2000's, and in fact, he was one of our early Series A investors. They were one of the first funds around the country to declare themselves as being a seed-focused fund.
And then a few years later, in the mid-2010's, they looked around and said, "Look, there's just lots and lots of seed funds around now. It's hard to distinguish ourselves now. Can we do something different? The same way we did when we set up as a seed fund." And so, they looked around and saw this gap in the market that I just described, and said, "How can we serve that collection of awesome businesses?"
So, they played with a kind of financing model, it's a bit of a hybrid between the debt financing model, where the entrepreneur provides the return to the investors, and the equity model, where we use stock instruments rather than debt to try to actually make the security work. They're now on V3 of their term sheet, and to summarize it in quick terms, the investor makes an investment in a company that's similar to a venture investment or a seed investment in it might be a quarter or a half million dollars of capital, it's designed to help the company make some progress quickly...
The deal generally says, "Why don't you use that capital for a couple, three years? Just ignore me. Have a monthly call, keep in touch, let's make sure that you got all the resources that you need to keep your business going," and what that half a million bucks buys me as an investor is an option on preferred stock. We're not going to make you issue stock at a preferred financing. So, it feels a little bit like a SAFE or a convertible note in that sense. It's kind of an option on preferred stock.
But we hope you never actually issue it. What we think will happen, what we agree will happen between us, is that in two or three years, whenever we start repayments, you're going to start to give the investor an agreed percentage of your GAAP revenue, your top-line, generally accepted accounting principles revenue, and you do that every month. So, it might be five percent of GAAP revenue every month, and you use that to buy back the options that the investor had.
“So, the investor makes money by the entrepreneur's business generating the revenue to provide the investor the returns; the entrepreneur retains ownership of the company during the duration.”
And if you continued to do that for some period of time, you'll have bought back all of the options that the investor has, and now, you, the entrepreneur, still own all the company, you've provided the investor a return, because you end up buying back a multiple on the dollars that were invested... You can call it interest. It's not actually done as interest, but you buy back a multiple of the dollars invested. So, the investor makes money by the entrepreneur's business generating the revenue to provide the investor the returns; the entrepreneur retains ownership of the company during the duration.
Now, the nice thing about this particular structure is that if the company does turn out to be a breakout company that really wants to go off and raise venture capital, and it really can become a big company, the options just convert into equity in that preferred round the same way that they would with a SAFE or a convertible note. So, the company's left in a very healthy position that doesn't foreclose any future options. It also, since the investor's buying an option on equity, it doesn't put debt on the balance sheet.
So, the company looks good from an external balance sheet perspective; it's no more than a capital stock qualification in the cap table of the company. The stock hasn't been issued but there are options outstanding. And so, this is a nice hybrid between venture and debt, because it allows that kind of company, who might not be the big-scale company but who could make use of a debt-style structure to provide the returns that are necessary, and to get the capital they need, and they don't have to be a unicorn, or try to be a unicorn, in order to get access to that capital.
SAL DAHER: As an investor, let me ask you something. You're telling me that basically, you have an option to buy preferred shares in the company. At the same time, the company has a right to pay you three X or whatever, and get rid of that contingency. Right?
JAY BATSON: Correct.
SAL DAHER: A contingent liability, or whatever you want to call it. Now, let's look at two scenarios. One scenario is you get the expected progress of the company, sales grow nicely, they don't explode. It doesn't become a unicorn, it just sort of goes along. Then they start paying you five percent of their GAAP gross income every month, and at the end of three years, you're paid out three X or whatever was the agreed multiple, and that you're out of the picture.
Now, what happens if the company sales just explode because of some accident? Like they connect with a use case that just they had not thought about before, and it is indeed a venture-scale company, what prevents the founders from just saying, "Hey, you know what? We're going to give you five percent of our GAAP income, or we're going to borrow money, or we're going to have some VCs give us some money, and we'll just buy you out at three X."
And then, you're left drooling, looking at the potential of this thing having been a 30 X, and you're just given three X.
JAY BATSON: In the case of Indie.vc in their term sheet, which, by the way, you can Google. You can go Google Indie.vc, that's I-N-D-I-E.V-C, V3, because they're on Version Three, and GitHub. They actually published the term sheet on GitHub, and then Bryce Roberts, who's the primary investor there, writes on Medium. So, you can just go look at Medium.com/Bryce or something like that, and you'll find him.
SAL DAHER: Whoa, okay.
JAY BATSON: Bryce has, in his deal, "I was stupid for letting the entrepreneur buy back all the stock plus." So, in fact, as part of the deal, the entrepreneur and the investor agree on a percentage that the entrepreneur can redeem. In Bryce's case, let's say he would do a deal that says, "Look, out of the 100% that you could redeem, I'm going to let you redeem 90%. And that way, if it turns out you are a billion-dollar company, I have a sweetener for my portfolio returns."
SAL DAHER: All right, so, 10% of that is not redeemable, 90% is redeemable?
JAY BATSON: That's right. And by the way, if you redeem all of me really quickly because the sales go really nicely, that's great for me because it increases my fund's IRR greatly. I'm getting my money back sooner, because if you look at it from the investor's perspective...
“…your returns that you see as percentages on your money, are really going to be defined on how fast the entrepreneur repays you.”
I want to mostly stay focused on the entrepreneur, but if you do look at it from the investor's perspective, your internal rate of return, or your returns that you see as percentages on your money, are really going to be defined on how fast the entrepreneur repays you.
Let's assume that you have a different outcome, not the one that you suggested where the sales go explodingly up, but let's say the sales are growing but slow. So, the company uses a half a million bucks, uses it for three years, and they go from a million in ARR with the time of the investment, to two and a half at the end of three years. And they're kind of growing maybe a half a million bucks in ARR every year.
And so, to pay back... let's use the number three X again. Let's say that they took in a half million. They have to pay back a million and a half, and if we say that they're doing it with five percent of revenue, that means that it requires a total of 30 million dollars in revenue over all the years to redeem that million and a half.
Now, if they're doing three million bucks a year and not growing very fast, that's going to take 10 years to redeem. Your IRR's not going to be particularly good. Triple your money in 10 years, is okay; it's better than putting it in the bank, but it's not venture-scale returns.
So, your job as an investor with this kind of financing is to try to find those companies that you think are going to have that nice seam of growth where a half a million bucks will really accelerate their go-to-market in some way, it'll take them from 750K in gross revenue to a million and 750, to three, to four and a half, to six and a half, to eight and a half. They don't have to be triple, triple, double, double, double like you do with a venture fund, but if at the end of three years they're doing four million or five million in revenue, and they're going to go to seven, and they go to nine, it's only going to take four years or so to get your cash back, four or five years to get your cash back. And it's much better than the 10-year scenario that I painted first.
That means your returns'll be higher. You've gotten gains over a shorter period of time. So, it's okay if the company's revenue explodes and they want to pay you back fast. It's great for IRR, and you keep a kicker in your fund for a sweetener by saying, "You only get to buy 90% back."
For the entrepreneur, let's look at it from their perspective for a moment. Assume that they are a founder that has got one businessperson that has gone off and found a market seam, found a couple of engineers to go off and build some software with them; maybe even one of the original founders also had a developer, but has the ability to talk to customers and sell pretty well. And they get to the point where they're doing 50 or 75K in monthly recurring revenue, or maybe even 100K in monthly recurring revenue... we can say that's between half a million and a million in annual recurring revenue, and even though their margins are good, they may not quite have enough yet to hire that first salesperson or marketing person that can really help grow the company.
Because they're paying themselves, they've got to pay their own children and income, and so they're... maybe don't have a spare 350, 400K around. You know, look, you and I know that it's going to take 200K probably to hire a good salesperson. They're going to make 100K based and make 100K-plus on target on top of that, and then, a good marketing person, if you want one that's any decent, it's going to cost you 100, 100 and a quarter here in Boston. So, you're going to need to have visibility, that you can make an additional 400K to pay for those in the first year. And you know it's going to take six months for them to come up to speed.
So, you got to have some cash in the bank to hire them, and a lot of times, these companies can't quite get past that hurdle of the founder being the chief cook and bottle-washer, and 400K would change the game.
SAL DAHER: Can get them above the threshold, yeah.
JAY BATSON: Exactly right. So, that one good first salesperson could generate another million in revenue. You and I know that a good B2B SaaS salesperson, an inside sales rep out to be able to generate a million, million and a quarter a year, maybe a million and a half if they're really good. And if you've got a 90% margin of business, not unless you hire the next salesperson, and the next salesperson beyond that.
“It's not venture-scale, but it's going to be a fine company, thank you very much, but it needs an influx of cash to help grow the go-to-market.”
So, that first half-million bucks, or quarter of a million or half-million bucks, can be a game-changer and really jumpstart the company from where they're at to where they want to go. And that's kind of the ideal use case for revenue-based financing. You got a company, bootstrapped, great product, good product market fit, the founders are doing it all themselves, and it's going to be a nice company. It's not venture-scale, but it's going to be a fine company, thank you very much, but it needs an influx of cash to help grow the go-to-market.
That's just ideal, and those exist. You and I looked at one for our December Walnut Ventures meeting, and looked at the entrepreneur, and, "This is going to be that kind of company." And so...
SAL DAHER: Did you go forward with that company?
JAY BATSON: I didn't for a couple different reasons, nor did some others. In that particular case, let me give you an example of how we underwrote that. That company is a company that was started outside the US, most of its sales has been outside the US, but the founder just moved to Boston. Founder was going to try to build the company in Boston, but doesn't have any evidence that he can sell here in the US yet. That's a different marketplace than where he's been selling in Europe, and I think, well, we'd like to see some evidence that he can get four or five or six deals here in Boston. Do that, or in the US. Go get five customers...
And this is a perfect example of a place that, "Okay, great, now you're ready for sales and marketing here. You're in town. Let's go help you build a team," and it's a perfect example. So, I think in four to six months, that person'll be perfectly positioned….
SAL DAHER: I'll bet you on that, as well. I think he's very determined. So, I look forward to maybe having him on. If you guys do a deal, it'd be really nice to illustrate a deal.
JAY BATSON: We'll come back and do that, should we do that in the middle of the year. Yeah.
SAL DAHER: Now, Jay, is there anything else you want to say on revenue-based finance?
“...we want RBF to be the kind of thing that's notable and well-known for something that people do in Boston.”
JAY BATSON: Yeah. I think what I want to spend 2020 doing, as an individual in this Boston market, is to try to find others who are interested in this, whether they be entrepreneurs or investors, and try to create a location of excellence around it. Whether it be web content that we create, whether it be info that we do in cocktail hours or things like that, but we want RBF to be the kind of thing that's notable and well-known for something that people do in Boston.
By the way, there are other investors like that around the country, other than just Indie.vc, and I'm happy to help direct companies to those investors. I intend to be one this year; I intend to actually build a syndicate of investors around me that I hope will invest alongside of me when we find deals that are like that. Because I think this is an option for how to build your company that's not well-known, there are a bunch of companies that are well-suited for it, and we need to make it present for entrepreneurs that this is an option.
So, I want to spend time with you and others to try to help make this well-known, create content for people to absorb and learn more about it.
SAL DAHER: Well, if anybody here, a listener, is interested at all in RBF, think they have a company that's RBF-worthy, or if they're investors who want to invest in RBF, I can think of no better person to contact than Jay Batson, who is just, as I said, is a tremendously thoughtful person and from whom I learn valuable things every time I interact with him. So, I think that is a great thing to dedicate 2020 to.
Now, we're going to go on to another topic that Jay also wanted to discuss, but first what I want to do is I want to talk a little bit about... I should say, Jay Batson, super angel, repeat founder, really one of the most valuable advisors that a startup can get in Boston.
Sal Talks About His Investment in Gelesis
Anyway, earlier I mentioned a company called Gelesis as an example of the kind of company that I run across here in Boston. I've been invested in Gelesis for 10 years. April of last year, they got FDA approval for a novel treatment for obesity. It's a weight loss aid which is approved by the FDA. It happens to be a topic that I've spent a lot of time thinking about, perhaps not doing enough about but at least thinking...
Basically, it's treated by the FDA as a medical device because it acts in a physical way inside the gut to make people feel full and therefore, eat less. Now, the intriguing thing about this company is this is the type of technology company that kind of floats around the Boston ecosystem, and I invested in them 10 years ago. The company's appreciated very nicely, and they are just about to come into the market. So, if you hear something about Plenity, that's their product. It's available to something like 70 million people in America who have a little bit of weight but are not morbidly obese, but are pretty chunky. It's a body mass index of 27, between 27 and 45.
And so, I'm hoping it'll be very, very big, and the point of this is to say, if you're interested in investing in this type of company, okay, that has this kind of potential, go to my website, angelinvestboston.com, if you're an accredited investors; it can only take accredited investors... Fill out the form for accredited investors on the website, and then we can talk about companies. Not Gelesis, because Gelesis is no longer investible, they're an affiliate of a publicly listed company, they're off to the races. But there are other companies that maybe in five years, maybe in 10 years, could be in the same boat, which I like to invest in, and then you have a opportunity to join me and my syndicate in investing in these types of companies.
Jay Batson and Sal Discuss Various Aspects of the Current Crisis and How Startups Might Respond
Anyway, so, Jay, the other topic that you wanted to address today is perhaps a little timelier than what you were saying before, but I think it's also a little bit timeless. So, please introduce that topic.
JAY BATSON: Well, Sal, you and I should talk about this jointly, because we've both been through this. We're both gentleman with either no or gray hair, so, we have seen this before. But as we're recording this, and we don't know when you're listening to this, whether it be in a month or in three months, or in a year, but as we're recording this, we're seeing the rapid and dramatic fall in the public stock markets arising from the COVID-19 virus spread.
And it's been pretty dramatic. I don't know about you, but we kind of come home and watch the news every night and say, "Holy cow, another X percent drop is... Wow." That gives you some pause.
And I've been approached by at least four or five of the entrepreneurs that I've worked with the last couple years in the last day or two, saying, "Holy cow. Well, how do I handle this? Now what do I do? Do I raise some money really fast? What do I do? With a little bit of angst and panic and concern in their voice, understandably so.
And I guess I, like you, have seen this dog before, a little bit. And yes, I'll admit that this feels different in character because it's pandemic-related rather than simply economic-related, but I look back and in 2000, we had the dot-com world of spending so much money to buy clicks, and the stock market lost 40% of its value in roughly a month or so. And then, in 2008, right after I founded Acquia, the subprime mortgage crisis hit and it erased half, half of the value of the Dow from November to May of 2008 to 9.
SAL DAHER: Well, 1987, you know, there was... yeah.
JAY BATSON: Black Thursday, 1987, exactly right. Or stagflation in the '70s, or the Japanese challenge to the US in the '90s, and all these things are examples of things that we see cyclically. And the thing about it is that this pattern, it does repeat. It absolutely repeats, but what you see in analyzing it is that we always have this time when valuations expand when times are good, and the money chases the momentum, so we have this rush of money, just like we've had the last few years in venture and angel and startups.
And then, some, some kind of external shock happens. Whether it be in subprime, whether it be a Black Thursday, whether it be whatever's going to happen. When the shock happens, people freak out and money and investors just scatter. Everybody panics, which stokes the flame, and we see this downward spiral.
What I want to keep people's focus on is that the underlying characteristics of the world hasn't changed. We still have the same number of people, all of them still have to feed their families, and though they might spend less to do it, there's still a lot of people are going to be spending money on buying stuff for their families. And while the level of growth and rate of change might pause for a while, the underlying world is still the same.
“…this won't be the first time you've had to embrace the suck, you know? It's kind of part of the deal of being a founder and being an entrepreneur.”
So, take a breath. Yes. This sucks. It even sucks for guys like you and I, who probably have a fair amount of our assets in the stock market, you know? But as an entrepreneur, those entrepreneurs out there listening to this, this won't be the first time you've had to embrace the suck, you know? It's kind of part of the deal of being a founder and being an entrepreneur. So, the real deal is, right now, take your mind away from the big and scary and high-stakes things, and focus on the small and specific.
Right now, is the time to figure out, "What can I do right now, and what is longer-term and can be postponed and should be postponed, that takes time and money to do?" And on the revenue side: is there a smaller customer that you can close quicker, now? Go do it. Close a small thing now, faster, than waiting for the big thing and investing lots of time and money into an account that's going to take a longer period of time to happen, while you wait for it.
“And then, I hate to say this, but now's the time to cut costs kind of hard and fast, and this may mean cutting some people. And that's really hard to do.”
And then, I hate to say this, but now's the time to cut costs kind of hard and fast, and this may mean cutting some people. And that's really hard to do. You and I had to do that before, and it just sucks, because these are people's lives that you know, they're your friends, they're people you spend your... you're family with them during the day. But you can't just do the easy cuts. You kind of have to do the hard cuts, because if you don't do the hard cuts sooner than later, that money may go out the door and you may wish you had it. It might be the difference between staying alive and not staying alive later.
“…some of the best businesses around have had to go through those hard times, and learn what it takes to build a business in the tough time, not just in the good time.”
So, essentially, work on getting through the next couple of months. And then work on getting through the next couple of months. And take a bite at a time, bite at a time, but take hard and fast bites. Get cash now and get rid of cash-related expenses now, and realize that in both downturns, and all the downturns I've been through, if you manage to make it through and you manage to hunker down and figure out how to bring your company through in a healthy way through that, you come out really strong on the other end. And some of the best businesses around have had to go through those hard times, and learn what it takes to build a business in the tough time, not just in the good time.
And so, if you navigate it well and strong, you'll get there. But it's going to be tough for a while. Just remember that it's happened before, there is a formula, and if you can do the formula, you'll get through and you'll make it.
SAL DAHER: Yeah. Putting it back to the 2000 crash, dot-com crash in April of 2000, don't be the Pets.com; be the Amazon.com. Both those companies that existed back then, and only one of those is still kicking, and it's become a giant.
And so, there are opportunities that show up when the market is down. This is something that you can talk to your investors about. "Look, we had these plans for tremendous expansion. But now..." If you're a startup that's made some headway, maybe you even want to look at consolidation.
Andrew Carnegie used to say that he kept something like 45% of his net worth in liquid form so that he could buy steel mills that were built perhaps too well but not too wisely, in the good times, and consolidate them. Basically he built his fortune largely by acquisition. And so, there's an aspect of that, as well.
I mean, this is for somebody like Wistia, okay? The guys at Wistia, they have a business that's pretty... very nice, I think they have probably something like 30-something, 40 million dollars annual recurring revenue, is my guess. I don't have numbers from them, but it's just my guess. And those guys, there might be ancillary businesses that could really enhance their business now, that they could think about acquiring, bringing them into their really excellent culture. Because those things'll become available, and those guys might have been competitors in the future, and they might reach out now and snag them. So, that's another thought.
“It's not even just snagging other companies, Sal, it's snagging customers.”
JAY BATSON: It's not even just snagging other companies, Sal, it's snagging customers.
SAL DAHER: Yes.
JAY BATSON: Most companies have somebody that they compete with. It's almost better to have somebody you compete with, because if you don't compete with anybody, it's kind of the sound of one hand clapping. You can't compare yourself to your competitors. And so, if you have competitors, it's helpful to... now, if you're stronger than they are, as their customers start to get squeamish, you might be able to convert those customers into one of yours. If you can go in there, show your strength, your ability to survive the downturn, and go capture customers.
SAL DAHER: Right. Now, Jay, I want to emphasize a point that you made before. The likely expectation, we are probably going to have a slowdown; at least, the first quarter of the year might be negative growth. We had a very strong growth leading into this, but it might be negative growth for one quarter. It is entirely possible that this thing burns out by May or June, and that you don't end up even having two quarters of negative growth, which is the definition of a recession. And that, then you have very strong growth after that, picking up.
So, for those people who can think about bridging things over, number one, if you're in the stock market, the horse is out of the barn, okay? Prices are off very substantially already...
JAY BATSON: Don't sell now.
SAL DAHER: Yeah, don't sell now. You're probably going to regret it later on. It may go lower, you may say, "Oh, I wish it'd go higher," and go lower, "I wish I'd sold some," but the reality is that when people sell, they don't go back in. They get burned and then they miss all the progress, all the increase in valuation they can get in the subsequent years.
So, unless you really need to meet an expense very soon, you're buying a house or something like that, don't sell. And the other thing is that, keep in mind, we have been in a time of very, very strong growth in the US economy.
We're in a time that worldwide had been in the past 10 years something like 50% of the people living below the poverty line are no longer below the UN's official one-dollar-a-day poverty line. And they expect by the year 2030, within 10 years, that there will be nobody in the world living below that poverty line.
So, the world is getting rich at a very, very fast pace, okay? Changes all the formulas. I mean, Africa used to be... I did business in Africa for decades. Now the child mortality rate in Africa is comparable to the child mortality rate in Europe in the early '50s. Okay? It was still terrible compared to today, but the rest of the world is catching up to this massive potential, huge amounts of human capital that all of a sudden can be accessed to produce new ideas and so forth, so that the future for the globe is extremely bright, if we don't do something crazy, but it's extremely bright.
So, from a perspective of if you're invested in the US stock market, if you're invested in global markets, have a long-term view because there's a lot of really impressive stuff that's coming about.
“…the things that are happening in the stock market in terms of valuations are probably going to happen to you.”
JAY BATSON: Two comments, Sal, before we go or finish on this topic. First is, I will say as an entrepreneur, the things that are happening in the stock market in terms of valuations are probably going to happen to you. It's quite likely that those companies who might have thought they could command a million dollars on a five-million-dollar capped note might find that that five million dollar cap isn't quite as acceptable anymore to investors. So, you should presume that there may be an impact on valuations for you.
On the other hand, I wouldn't necessarily assume that, at least from commercial investors, companies who have... VCs who have funds, the capital available will go away. Most of those investors have been through multiple of these cycles, and know that oftentimes, the best companies can be born out of these difficult times.
And so, I have seen less of an issue in institutional capital from VCs going away as much as, maybe, the pricing. You may find that angel and family office capital might get more thin, because they may find that, "I want to have only 10% of my net worth invested in early-stage," and if my net worth just went from 20 to 10 million, my early stage, and I was invested at $200,000, "Now I'm over." Or, do the math. I got it wrong. But now I'm over what I wanted to be in terms of my allocations. So, there may be some drying up of angel capital, though I would say institutional capital might, though it can be more selective, it might be still around.
SAL DAHER: Yeah. Well said, I think. Very true. Another thing to keep in mind is that early-stage, investment in early-stage companies, is in the high risk, low liquidity end of the market. And right now, people are fleeing the US stock market, which is a very liquid but somewhat risky investment, to... it's called flight to safety, to things like US treasuries; treasury rates are record low level, the 10-year treasury's below one percent. And so, when that happens, the illiquid, more risky end of the investment continuum is going to suffer.
So, keep in mind that if there... a negotiation about pricing and so forth, don't be stubborn. Because this is the condition that you're in right now. Unless you can weather it a two or three months, and this is likely to take, adjust to current conditions and keep your company alive.
Jay, love to have you on more often, and let's make that at least a plan that if that company you're talking about possibly doing revenue-based financing with, if that goes forward, let's have them on and let's do a case study on revenue-based finance with the founder. You, the founder and me, and let's talk to them.
JAY BATSON: I think that's a great idea, because I really like the founder. I'm still bullish on the company, and if we move a little further along with them, we may still be able to pull this off with them. So, let's do reconnect-
SAL DAHER: Yeah, I like that founder. Okay? I must admit that when you talked to them about doing revenue-based finance, I was a little skeptical, but your explanation of it here has kind of gotten me more interested.
JAY BATSON: Well, hopefully it helped others, too, and I may or may not have drilled down in as much specificity is required in order to make sure that people knew exactly what every term in the term sheet looked like and what it meant. But the basics are still there.
As a note, by the way, I did mention there are some other investors around. Some of those use a different structure than Indie.vc's term sheet. Some of them do a debt structure. Some of them do others. But instead of monthly payment-styled debt, where the debt repayment is fixed every month, the dollar amount is the same regardless of your revenue, in the case of these other investors, they do their debt repayment using a fixed percentage of revenue, the same way that Bryce does it in Indie.vc.
So, it still might be five percent or three percent of revenue to do the payment, and the interest aggregates and accumulates until you've repaid the principal plus the interest using a percentage of revenue. So, the time, the duration to pay varies, as does the amount. And that's different from bank financing with an interest rate. But nonetheless, there are several out there doing different structures of deals, but I think I like the Indie.vc model the most, and I think it leaves the companies really well-positioned for future rounds. And so, I'm happy to come back and do a podcast on that when the time comes.
SAL DAHER: I look forward to that. Once again, I would like to thank the very thoughtful and very generous repeat founder and super angel, Jay Batson, for being on the podcast.
JAY BATSON: Thanks for the opportunity, Sal.
SAL DAHER: Tremendous. I'd like to invite our listeners who enjoyed this really very informative podcast to review it on iTunes. This is Angel Invest Boston, a conversation with Boston's most interesting angels and founders. I'm Sal Daher.
I'm glad you were able to join us. Our engineer is Raul Rosa. Our theme was composed by John McKusick. Our graphic design is by Katharine Woodman-Maynard. Our host is coached by Grace Daher.