Funding 99% of early-stage brands requires a different approach

New Hope Network is excited to be partnering with TIG Brands on our first workshop for Natural Products Business School. Each month, Elliot Begoun will lead a 60-minute workshop guiding brands on relevant topics to help their businesses. This month's workshop is focused on how to raise capital. Brands will learn about finding the right sources, structures and terms to fuel their growth. Register here for the event, which is scheduled for 1-2 p.m. ET on Tuesday, March 28, and read below for an in-depth introduction to what to expect at Natural Products Business School–Raising Capital.

Elliot Begoun

Traditional venture capital is all about the grand slam. One or two investments return the lion's share of a fund. A venture capitalist expects exponential growth, game-changing potential and true disruption.

Most founders can't offer that, and this is where we as an industry go wrong. Either we fund brands and demand exponential growth when it is unlikely they have that potential, or we fail to fund them. Both are bad for our industry, and this should not be a zero-sum game.

Don't get me wrong, venture capital plays an essential role. We need funders and founders willing to bet big. But for the 99% of those that don't fit that big-bet model, we need a funding mechanism that allows entrepreneurs to build great brands and good businesses.

Most emerging brands don't have access to commercial banks and with recent developments, this is only likely to be exacerbated. Asset-based lending is an excellent way to fund working capital. However, it is often out of reach for early-stage startups that have yet to build the needed inventory and receivables to make ABL viable for both the funder and founder. Impact investors, venture debt and grants are options but often hard to come by.

There is an alternative way, one that leverages structured exits and creates self-liquidating investments. Structured exits are risk capital agreements with a specific achievable plan for how investors will receive their return, such as via variable-based payments based on a percentage of revenue or cost of goods sold (COGS), or through profit sharing, dividends or other payment types.

One example is the CARE (COGS Agreement Retaining Equity) we developed and offer as an open-source template. The founder and funder agree to an investment amount, a return expressed as the COGS payment cap and a percentage of COGS. Each quarterly payment is made based on the agreed-upon rate of COGS, which is repeated until the COGS payment cap is reached. Each quarter, the investor benefits from cash flow and takes risk off the table. The CARE does include a Warrant provision allowing the investor to participate in any additional potential upside. But an exit is not required for the investor to see a return.

Other options include redeemable equity or variable-based convertible notes. Redeemable equity shares are purchased by the investor and the founder can repurchase an agreed-upon percentage at a specific multiple or price. Repurchase payments are scheduled or variable-based, such as a percentage or revenue, COGS or EBITDA.

The typical convertible note structure requires at least two third-party transactions. The first is a "qualified financing," a priced round of a specific size that triggers the conversion of the note. A second is a liquidity event, an exit. A variable-rate convertible note does not require either but allows for both. The founder and funder agree to an investment amount and a return expressed as the total obligation. For example, a funder invests $250,000 at a 2X multiple, making the total obligation $500,000. Again, using a variable-based payment such as a percentage of revenue, COGS or EBITDA, payments are made monthly or quarterly and continue until the obligation is met. However, if a "qualified financing" occurs while the note remains open, the funder can choose to convert the remaining obligation into equity.

I offer the above as fodder for deeper exploration and discussion. My real purpose is to encourage us as an industry to better align the structure and terms of investment with the 99% of the brands that don't fit the traditional venture capital model.

Many founders are attempting to build great brands and good businesses. Let's fund them in a way that makes sense and stop trying to put rocket fuel into Camrys.

Elliot Begoun is a 30-year industry veteran, author, podcast host, founder of TIG Brands and champion of Tardigrades. TIG Brands supports a community of entrepreneurs interested in building nimble, capital-efficient, resilient brands that become Tardigrades, not Unicorns. Learn more about TIG Brands’ programs.