January 5, 2024

Why I’m excited about profit-sharing startups

I’ve been working in tech for 15 years. I joined a few startups, started and sold one, and invested in over 100 companies. Along the way my net worth has grown substantially, but 95% remains illiquid[1] in the form of startup equities and carry. The most successful outcomes in tech often take many years to mature where the majority of value is compounded in its later years… or collapses to zero.

We’ve all seen seemingly successful, well-funded companies go bankrupt or trade at a fraction of their last round valuation[2]. The future is unpredictable and the macro environment cannot be controlled. This was particularly evident in 2023.

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Increasingly this has been the topic of conversation among my peers that have gone the traditional VC route.

I anticipate more tech founders and investors will start and invest in profit-sharing startups – through dividends, stock buybacks, etc. – as everyone looks to diversify their net worth and capture liquidity sooner than the typical 10+ year startup grind to exit[3].

This isn’t new

VC financing is the default path within our tech bubble, but it isn’t the norm in business broadly. It’s foreign to many, including my dad.

My parents are classic SMB entrepreneurs. They started multiple businesses since my childhood, primarily self-funded. When I told my father we raised a $6M Series A at Product Hunt, he asked me to send him the docs. He wanted to make sure I wasn’t personally liable for the funds, shocked that we were capitalized with this much money, early in our journey. For them, bootstrapping or taking a small amount of debt (through an SBA loan or credit cards) was the only path toward funding.

At larger scale there are well-established private equity and lending industries that invest in and/or acquire cash-generating businesses that share profits throughout the life of the venture.

And then there’s a contingent of tech entrepreneurs quietly starting and backing profit-sharing software-driven businesses.

Of course the profit-sharing model only applies to businesses that have a clear path to revenue (it’s hard to share profits when there are none!) and best suited for companies that can start with minimal capital. It’s suboptimal, and perhaps foolish, for winner-take-most, capital-intensive markets. E.g. Uber would not exist at any meaningful scale without venture capital.[4]

Why now?

Alternative financing models have been the topic of conversation in tech for a while. Here’s a collection of blog posts and thoughts here, here, here, here, here, and here if you want to go down a rabbit hole.

But I believe a few big shifts will drive more founders and investors to pursue profit-sharing models in 2024 and beyond.

There’s a culture shift in tech toward profit-generating businesses.

Founders want to control their destiny, and profitability eliminates their reliance on VC funding for survival. My biggest regret at Product Hunt was not prioritizing monetization sooner. While doing so would come at the cost of prioritizing other things – such as growth of the user base which would longer term translate to higher revenues – we should have dedicated a small portion of our energy toward business model testing[5].

Beyond control, many founders, operators, and and investors (like me) that are waiting for paper money to materialize, are increasingly interested in opportunities to get paid sooner and diversify their heavily “paper” net worth.

There’s a tech shift that enables talent to build more with less.

This is an ongoing trend and part of my thesis when I started Product Hunt over a decade ago. It’s increasingly easier for people to bring ideas to life with software. Cloud infrastructure, open source, and standardization have played a major role. We saw an inflection with the rise of no code tools four years ago.

Today, AI is that next big shift. If one person can do the job of 10 people in the future, we won’t need as much capital for payroll, decreasing costs and increasing margins in ways that can unlock new business models and distribution opportunities.

Teams may not need nearly as much capital to start and reach profitability. Some will do so entirely bootstrapped. Some will raise relatively small amounts of capital from wealthy angels or firms that specialize in profit-sharing investments.

There’s a regulatory shift that makes exits challenging.

A few weeks ago Figma announced that Adobe’s $20B acquisition fell threw. Everyone knew this might happen considering regulator’s track record in recent years. The FTC’s attempted block of Meta’s $400M acquisition of VR startup, Within, illustrates their litigious mindset.

Traditional VC relies on a healthy M&A market. If an IPO is the only path to exit, for investors and founders, liquidity events will be even further delayed and less frequent than in the past.

What’s missing?

If these shifts are true, why aren’t we seeing more founders pursue profit-sharing models? There are two big challenges.

We lack standards and education.

YC’s SAFE agreement has had a larger impact on the startup ecosystem than most people realize. Standardization significantly reduces transaction costs between early investors and founders. Almost every startup I see raises their first and sometimes second round on a SAFE.

Funds like Indie.vc and Calm Fund have open sourced their unique financing docs, but we don’t yet have a universally accepted “SAFE” for profit-share financing terms. This makes agreement between founders and investors difficult.

Bonside (disclosure: we’re investors at Weekend Fund) is a good example of an emerging platform that introduced standardization with their Repeatable Revenue Agreement for the B&M market. I’m an investor in a few businesses on the platform and receive dividend payments monthly. I like it.

Success stories and examples are lacking (relative to VC).

We all know the unicorn and decacorn founders that built massive companies fueled by VC. These case studies dominate headlines and conversation. Many founders and investors are friends, or one degree away, from these successes.

On the other hand, most founders don’t know someone that has raised on profit-sharing terms. There are fewer examples to point to and reasonably smart arguments to not innovate in corporate structure or funding models (there are enough risks in tech startups to manage).

There’s often stigma when tech founders pursue alternative paths. Without anointment from a VC, some fear judgment from others that assume, “They must not have been able to raise from ‘legit’ investors.” Although this cultural judgment is starting to change.

VC isn’t the enemy, ofc

Of course, self-funding or alternative financing does not preclude founders from raising traditional venture capital. Some businesses need VC and should pursue large, patient capital to scale and win a market. Sometimes reinvesting revenues into the business is best for all parties longterm.

And to be clear, VC is a beautiful invention. Most people don’t have the savings required to go without a salary and hire a team for a new idea. Some ideas need time to mature before charging their first dollar. VC has enabled many founders to pursue their ideas and in some cases change the world (truly). I’m not in the anti-VC camp, after all I invest in high-risk, high-potential startups via Weekend Fund. But VC isn’t the ideal model for everyone.

I remain committed to backing big ideas with venture capital with Weekend Fund. But I’m also interested in meeting founders that are starting (or started) cash cows that want to pursue alternative profit-share models.[6]

Drop me an email at ryan@weekend.fund if that’s you. :)

[1] Founders and investors may be in position to sell their position on the secondary market but this is not easy to do and limited to a small subset of breakouts in our portfolio.

[2] We’ve also seen the reverse. Persistent, driven founders can make magic happen.

[3] Some founders have an opportunity to sell a portion of their equity on the secondary market well before the company exits, but this largely dependent on the board, VCs, and the macro environment.

[4] I’ll try to prioritize another post that highlights the ideal characteristics of a profit-sharing venture with examples.

[5] Funny enough, once we prioritized monetization, we reached cashflow break even within 9 months and we did so by simply giving people what they asked for: An ability to pay for additional exposure post-launch.

[6] I’m also very interested in new models for backing people and creators. Humanism and Slow’s Creator Fund.

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