10.1 Alternative funding models for ExOs
8 min read•august 15, 2024
Exponential Organizations (ExOs) need massive upfront capital to develop tech and scale rapidly. Traditional financing often falls short, so ExOs turn to alternative funding models. These models provide quick access to large amounts of capital, crucial for achieving critical mass and market leadership.
, ICOs, and offer ExOs faster access to capital than traditional sources. These models allow ExOs to tap into global pools of investors and align funding with their long-term transformational goals, rather than just short-term profits.
Funding requirements for Exponential Organizations
Significant upfront capital needs
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- Exponential organizations (ExOs) require significant upfront capital to develop their technology stack and scale rapidly
- ExOs need to invest heavily in R&D, infrastructure, and talent early on to build their core technology platforms and business models
- Example: SpaceX needed large initial investments to develop reusable rocket technology before generating revenue from launches
- ExOs have lower marginal costs per unit as they grow compared to traditional linear organizations
- The scalability of ExO technologies and business models allows them to achieve economies of scale much faster than linear organizations
- Example: Software companies like Google can serve millions of additional users with minimal extra costs once their core products are built
Challenges with traditional financing
- ExOs often struggle to secure traditional financing like bank loans or VC funding in early stages
- Banks are hesitant to lend to ExOs due to their unproven business models and lack of physical assets as collateral
- VCs may view ExOs as too risky or not fitting their traditional investment criteria, especially for capital-intensive hard tech startups
- ExO business models and technologies are often unproven and seen as higher risk by traditional investors
- Disruptive ExO innovations can be difficult for investors to understand or value, as they don't fit into existing market categories or valuation benchmarks
- Example: Airbnb faced early skepticism from investors who didn't believe people would rent out their homes to strangers online
Need for alternative funding models
- The potential for exponential growth and impact means ExOs need to consider alternative funding models that provide large amounts of capital very quickly
- ExOs need to achieve critical mass and market leadership before competitors in order to realize their full potential for growth and impact
- Alternative funding models like crowdfunding, ICOs, or revenue-based financing can provide ExOs with faster access to larger amounts of capital than traditional sources
- Securing the right funding partners who understand and support the ExO model is critical
- ExO founders need to find investors who are aligned with the company's purpose, values and long-term transformational goals vs. just short-term profits
- Example: Elon Musk has sought out investors for Tesla and SpaceX who share his vision for sustainable energy and interplanetary exploration, even if it means lower near-term returns
Crowdfunding for ExO financing
Raising small amounts from a large audience
- Crowdfunding allows ExOs to raise small amounts of money from a large number of individuals online, rather than seeking larger investments from a small group of traditional investors
- Online crowdfunding platforms like Kickstarter and Indiegogo allow ExOs to tap into a global pool of potential backers who are passionate about their products or mission
- Example: The Pebble smartwatch raised over $10 million from 69,000 backers on Kickstarter in 2012, setting a record for the platform at the time
- Rewards-based crowdfunding can serve as both a financing mechanism and way to validate product-market fit and consumer demand for ExOs
- Offering backers a product or service in return for their monetary pledge allows ExOs to presell their offerings and gauge market interest before investing in large-scale production
- Example: Oculus Rift raised $2.4 million on Kickstarter in 2012 to develop its virtual reality headset prototype, which helped validate demand and attract additional investors
Equity and donation-based models
- gives backers an ownership stake in the company, providing an alternative to venture capital
- Equity crowdfunding platforms like AngelList and WeFunder allow accredited and non-accredited investors to fund startups online in exchange for shares in the company
- Having a larger number of smaller investors can help ExOs maintain more control over their vision and operations compared to having a few dominant VC shareholders
- Donation-based crowdfunding is an option for non-profit or social impact focused ExOs to raise capital from individuals passionate about their cause
- Platforms like GoFundMe and GlobalGiving allow ExOs with a social mission to raise funds from donors without needing to provide a financial return
- Example: The Ocean Cleanup raised over $30 million in donations to develop technology for removing plastic waste from the ocean
Keys to successful campaigns
- Successful ExO crowdfunding requires building a large and engaged community around a compelling vision
- ExOs need to cultivate a strong online following and email list before launching a campaign, often through content marketing, social media, and in-person events
- Having a clear and inspiring mission that resonates with people is crucial for motivating backers to support an ExO's crowdfunding campaign
- Strong marketing and storytelling is necessary to stand out from the many competing campaigns
- Professional campaign videos, graphics, and copy are important for communicating an ExO's and making an emotional connection with potential backers
- Example: The Coolest Cooler campaign raised $13 million on Kickstarter in 2014 through a viral video and marketing campaign that showcased their innovative product features
ICOs in ExO fundraising
Selling crypto tokens for capital
- An is a type of crowdfunding where an ExO raises funds by selling crypto tokens
- Tokens sold in an ICO can be used to access an ExO's technology platform, receive a service, or represent an investment in the company
- Example: The messaging app Telegram raised $1.7 billion through an ICO in 2018 by selling tokens to be used on its network
- ICOs allow ExOs to raise large amounts of capital very quickly and with fewer regulatory restrictions compared to traditional public offerings
- By tapping into the global cryptocurrency investor community, ExOs can attract a larger pool of capital than through traditional geographic markets
- Example: The decentralized storage network Filecoin raised $257 million in just 30 minutes through its ICO in 2017
Incentivizing network participation
- ExOs can use ICOs to fund open-source technology development and incentivize network participants
- Giving token holders access rights, voting power or a share of the value created can encourage users to contribute to an ExO's technology platform and network growth
- Example: The prediction market platform Augur raised $5.3 million through an ICO in 2015 and uses its REP token to incentivize users to report on event outcomes
- Successful ICOs require ExOs to develop their own blockchain or token economics model
- Designing a token that aligns incentives between the ExO, investors, and users is critical for creating a sustainable ecosystem and driving
- Example: The Brave web browser sold $35 million worth of its BAT token in 30 seconds in 2017, which is used to reward users for viewing ads and publishers for hosting content
Risks and requirements
- ICOs are a higher risk funding option with little regulatory oversight
- The lack of standardized disclosure requirements and investor protections has led to many fraudulent or failed ICOs, damaging investor confidence
- Example: The Decentralized Autonomous Organization (DAO) raised $150 million in an ICO in 2016 but was hacked shortly after, leading to a controversial hard fork of the Ethereum blockchain
- ExOs conducting ICOs need to be transparent, have a solid technical foundation and address key issues around token security, liquidity and governance
- Providing detailed whitepapers, holding transparent token sales, and implementing robust and cybersecurity measures are important for building trust with investors
- Example: The EOS blockchain platform raised $4 billion in a year-long ICO ending in 2018, but faced criticism over its centralized governance model and lack of transparency
Revenue-based financing for ExOs
Aligning incentives with investors
- In revenue-based financing (RBF), investors provide capital to an ExO in exchange for a percentage of future revenues, until a certain return is achieved
- RBF investors receive a share of an ExO's top-line revenue (typically 2-10%) up to a predetermined return cap (typically 1.5-3x the original investment)
- Example: Lighter Capital is an RBF firm that has provided over $200 million in growth capital to tech startups since 2010, with revenue share rates of 2-8%
- RBF aligns incentives between ExOs and investors, as both benefit from the company's growth, without requiring an equity stake or exit event
- With RBF, ExOs are incentivized to grow revenues efficiently and investors are motivated to provide additional support to help the company scale
- Example: The RBF firm Feenix Venture Partners targets a 2-3x return on its investments over a 3-5 year period, with no equity ownership or board seats
Ideal for predictable revenue streams
- RBF is best suited for ExOs with proven revenue streams and predictable cash flows
- Subscription or transaction-based business models with consistent revenue growth are ideal for RBF, as they provide more certainty of repayment to investors
- Example: The marketing automation platform Klaviyo raised $7 million in RBF from Lighter Capital in 2016, based on its strong monthly recurring revenue growth
- ExOs with lumpy or unpredictable revenues may not be good candidates for RBF
- Companies with long sales cycles, seasonal fluctuations, or one-time product sales may have difficulty meeting the consistent revenue share payments required by RBF investors
- Example: E-commerce companies that rely on holiday sales spikes or hardware startups with infrequent product launches may not have the steady cash flows needed for RBF
Flexible growth capital
- The flexibility of RBF allows ExOs to access significant growth capital without giving up ownership control
- RBF investments are typically larger than traditional bank loans but smaller than VC rounds, providing a middle ground for ExOs seeking to scale
- Example: The RBF firm GSD Capital offers funding amounts of 2 million, with revenue share rates of 1-5% and repayment caps of 1.5-2.5x
- With RBF, ExOs are not pressured to reach an exit or liquidity event on a set timeline, as with VC funding
- RBF allows ExOs to grow at their own pace and make long-term decisions aligned with their mission, rather than being pushed to sell or go public by VCs seeking a return
- Example: The customer support platform Gorgias used RBF to grow to over $10 million in annual revenue without giving up equity or control to VCs
Data-driven investment models
- RBF investors use data-driven models to predict an ExO's future revenues and assess investment risks
- By analyzing an ExO's financial metrics, market trends, and customer data, RBF firms can more accurately forecast revenue growth and structure investment terms
- Example: The RBF firm Novel Capital uses machine learning algorithms to analyze over 100 data points on each potential investment, including revenue growth, churn rates, and customer acquisition costs
- Having strong financial metrics and unit economics is key to securing RBF
- ExOs need to demonstrate a clear path to profitability and positive cash flow to give RBF investors confidence in their ability to repay the investment
- Example: The RBF firm Bigfoot Capital requires potential investees to have at least $500,000 in annual revenue, 30% year-over-year growth, and positive unit economics
Key Terms to Review (16)
Blockchain: Blockchain is a decentralized digital ledger technology that records transactions across many computers in such a way that the registered transactions cannot be altered retroactively. This unique characteristic of blockchain fosters transparency, security, and trust among participants without needing a central authority.
Community shares: Community shares are a form of investment that allows local people to buy shares in a community-led enterprise, promoting social and economic benefits in their locality. This funding model empowers communities to raise capital for various initiatives, such as renewable energy projects, community-owned shops, or local services, fostering a sense of ownership and collective responsibility among members.
Crowdfunding: Crowdfunding is a financing method where a large number of people contribute small amounts of money to fund a project, business, or initiative, typically via online platforms. This approach leverages the power of social networks and the internet to gather capital from diverse contributors, allowing individuals or organizations to bypass traditional funding methods like banks or venture capitalists. It often serves as an effective strategy for rapid scaling and growth, as well as a notable alternative funding model for exponential organizations.
Customer Acquisition Cost (CAC): Customer Acquisition Cost (CAC) is the total expense incurred to acquire a new customer, including all marketing and sales expenses. This metric is crucial for understanding the efficiency of customer acquisition strategies and helps businesses evaluate the profitability of their growth initiatives.
Equity crowdfunding: Equity crowdfunding is a method of raising capital where individuals can invest in startup companies or small businesses in exchange for equity or ownership shares. This approach democratizes access to investment opportunities, allowing a wider range of investors to participate in funding innovative ventures, and is particularly relevant for Exponential Organizations seeking alternative funding models.
Initial Coin Offering (ICO): An Initial Coin Offering (ICO) is a fundraising mechanism in which new cryptocurrency projects sell their underlying tokens in exchange for established cryptocurrencies like Bitcoin or Ethereum. ICOs allow startups to raise capital quickly by bypassing traditional funding routes and tapping into a global pool of investors. This model is particularly relevant for Exponential Organizations (ExOs) as it aligns with their innovative approaches to financing and rapid growth.
Lifetime value (LTV): Lifetime value (LTV) is a projection of the total revenue a business can expect from a single customer account throughout the entire duration of their relationship. Understanding LTV helps organizations allocate resources more effectively, manage customer acquisition costs, and optimize their marketing strategies, making it a vital metric for sustainable growth in businesses, especially in the context of funding models that prioritize long-term relationships over short-term gains.
Micro-investing: Micro-investing is an investment strategy that allows individuals to invest small amounts of money, often through digital platforms or apps, in various assets such as stocks, ETFs, or even real estate. This approach democratizes investing by making it accessible to people who may not have large sums of money to invest, thereby encouraging a broader participation in financial markets and enabling users to build wealth over time without the need for significant upfront capital.
Network Effects: Network effects occur when the value of a product or service increases as more people use it. This principle is crucial in understanding how certain businesses can grow exponentially, as each new user adds value to the network for existing users. This dynamic not only differentiates between linear and exponential growth but also illustrates how organizations can leverage technology and community engagement to scale rapidly.
Peter Diamandis: Peter Diamandis is a prominent entrepreneur, author, and advocate for innovation, known for his work in advancing technology and exponential organizations. He co-founded the XPRIZE Foundation, which incentivizes breakthroughs in various fields through competitions, and has been a vocal proponent of using technology to solve global challenges.
Revenue-based financing: Revenue-based financing is a funding model where investors provide capital to a business in exchange for a percentage of the business's future revenue. This approach allows companies to secure funding without giving away equity or incurring traditional debt, making it particularly appealing for high-growth startups and Exponential Organizations (ExOs) that need flexible funding solutions to scale quickly.
Salim Ismail: Salim Ismail is a prominent thought leader and author known for his insights on Exponential Organizations (ExOs) and the impact of technology on business and society. He emphasizes the importance of embracing exponential technologies and redefining organizational structures to drive innovation and achieve significant growth.
Smart contracts: Smart contracts are self-executing contracts with the terms of the agreement directly written into code, typically running on a blockchain. They automatically enforce and execute contractual agreements when predefined conditions are met, reducing the need for intermediaries and increasing efficiency. This technology enables faster transactions and trust between parties while ensuring transparency and security through blockchain's immutable nature.
Tokenization: Tokenization is the process of converting rights to an asset into a digital token on a blockchain. This transformation allows assets, whether physical or digital, to be represented and traded in a more efficient, transparent, and secure manner. Tokenization can unlock new opportunities for alternative funding models by allowing for fractional ownership and liquidity in previously illiquid assets, enabling broader participation from investors.
Value proposition: A value proposition is a clear statement that explains how a product or service solves a customer's problem or improves their situation, delivering specific benefits. It serves as a promise of value to be delivered, offering reasons why a customer should choose one option over another. A strong value proposition is crucial for attracting and retaining customers, as it clearly communicates the unique advantages and benefits of an offering.
Venture Philanthropy: Venture philanthropy is an approach to funding charitable projects that applies principles of venture capital to social initiatives. This model emphasizes long-term investments in nonprofit organizations and social enterprises, aiming for measurable social impact while often utilizing business-like strategies to ensure sustainability and growth.