Every few years venture capital says hello to a new wolf at the door. Over the last decade there have been onslaughts from AngelList, crowdfunding and, of course, initial coin offerings (ICOs). Recently, a number of founders have eschewed venture capital funds and chosen different paths for themselves and their companies.
And now, a new wolf has arrived on these shores: Clearbanc and the “marketing advance”.
It’s an attractive proposition for founders and chief executives: Clearbanc will loan you money for online marketing. You repay the loan in small instalments linked to the revenue that you receive over a number of months. No equity involved, and you’ve financed your marketing budget through debt (or something like it).
This new challenge is so new that the segment hasn’t settled on a common vernacular. Clearbanc, the market leader from Canada, calls its product “working capital for online businesses”. UK competitor Uncapped talks of “revenue-based finance”, while Just Capital offers, as the name suggests, “Just capital, not really a bank loan, kind of like VC, just better”. There are a number of other businesses seeking to use their platform advantages to offer similar working capital products too, such as Stripe, Shopify and Amazon.
Whatever we come to call it, and I’ll continue with “marketing advance”, it’s a new challenge. If successful, I can see it bringing much greater change than any of the other recent challengers. Why? The other challengers have come from the outside-in. Those that I mentioned above are, to a greater or less extent, substitutes for venture capital (VC). Revenue-based finance eats away at the heart of a VC investment.
Money for marketing
Any given investment that a startup looks to raise or a venture capital makes can be roughly split up into a few high-level chunks. There’s a proportion going to tech, to operations, to general admin — and to sales and marketing.
The sales and marketing proportion looks different for different businesses of course. Sales and marketing at a business-to-business (B2B) company will often involve big, expensive, human sales teams — for which marketing advances are likely inappropriate. For consumer-focused businesses and those companies who look to sell to individuals within companies or SMEs (small and medium-sized enterprises), marketing advances make a lot of sense as they’ll likely be spending plenty on digital performance marketing. For these types of businesses the sales and marketing proportion that a venture capital firm sees in any given pitch deck usually comprises 20-50% of the total raise amount.
“43% of all venture capital investment goes to Facebook or Google”
Stop and think about that range for a second. 20-50% of many venture capital investments is for marketing. Clearbanc would have you believe that exactly 43% of all venture capital investment goes to Facebook or Google. If that’s true (or near-enough) and marketing advances work, the impact on the VC industry could be nothing short of industry defining.
Let’s just say for argument’s sake that the correct number is 30%. Clearly, founders don’t want to give up more equity in their companies than they have to. So, taking this scenario to its conclusion, those founders will be raising rounds which are 70% of the size that they once were. What does this mean for the VC? This means 30% less ownership in portfolio companies. This means that fund sizes are too big. This could mean that valuations are also far too high. Marketing advances pose a challenge to the economics of venture capital firms that may well be near, if not present.
Does that mean VC funds are too big?
The VC fund is predicated on backing some great companies, getting good ownership stakes and following their money in subsequent rounds. If all this gets a big haircut, it could precipitate huge change. If you’re not getting the stakes that you want and your money is going further, what choice would you have but to ‘chunk up’ and go later stage? Changing investment periods of funds, strategy or fund sizes mid-fund isn’t what VCs’s investors sign up for but there aren’t many choices.
“Theoretically, you could unbundle more parts of the ‘VC package’”
There’s a ‘scarier’ possibility too. What if marketing advances are a harbinger of a greater trend: the unbundling of venture capital. Theoretically, you could unbundle more parts of the ‘VC package’ provided that it didn’t result in increased transaction costs, complexity or time. Perhaps that would be better too: the right kind of funding and advice for the relevant cost line. In theory, that sounds pretty good. You could see specialist products for tech-team expense, enterprise marketing expense, or even software package/stack expenses.
One choice for venture capitalists is to get in the game: perhaps the natural home for marketing advances could be within venture capital firms. There’s good precedent here. In the wider financial world, the ‘bundling’ of financial products is commonplace. When a company takes out a big loan with a bank they’re often obliged to insure against moves in interest rates. This also happens to you and I when taking out a ‘fix’ on a mortgage, which is effectively the same thing.
Bundling standard VC equity investments with marketing advances wouldn’t be without its challenges though. It would change the economics of a venture fund. Funds are legally set up to maximise their gains from the increase in value of their portfolio companies. Adding income from ‘debt’ (marketing advances) would complicate things considerably not least from a tax perspective. Though that’s possibly less painful than changing strategy mid-investment period.
I can’t presume to know how all this is going to turn out but I’m confident that marketing advance is going to take a bigger bite out of VC than the wolves that came beforehand.
Matthew Bradley is a partner at UK-based early-stage venture capital firm Forward Partners.