Equity Micro-Investing

I’ve been having a serious discussion with two colleagues of mine about closing the gap that exists between two groups:

  1. People of my generation (40 and older) who have capital they want to invest in innovation but only know the VC for-profit-only value model and don’t have any true view into or understanding of social entrepreneurship business models;
  2. People coming out of college today (27 and younger) who are actually creating untold value for the world without taking on investors because they don’t (a) know how to attract them, and (b) have heard too many horror stories

Jay and I fall into category 1 and Michael falls into category 2.  All three of us agree that the gap above exists — due in part to rapidly declining startup costs — and represents a very real (and lucrative) investment opportunity if it can be closed properly. This opportunity is partly what the so-called “black swan fund” is tapping into as well, but I’m talking here of a distinct effort, which we want your feedback and participation on.

Creating a Workable Micro-Investment Model

Michael, Jay and I represent the three basic classes of people in this entrepreneurial ecology.  Michael is an entrepreneur, I am a micro-investor, and Jay is person who sees and creates deal flow.  We are trying to come up with a model that works, especially for Michael and myself — if it works for the two of us, Jay’s life becomes much easier and he makes more money.  To these ends, I’ve outlined here the important elements of a micro-investment from my perspective (that of the investor).  Hopefully Michael and others will chime in and say what’s important from the entrepreneur’s perspective (and what they need to motivate people on their team).

  • I’d like to invest $1K to $5K in a number of different nascent “projects”.
  • Monetary ROI potential is a necessary pre-condition for this activity, but it’s not my main motivation.
  • The main “return” on investment for me is a combination of:
    • catalyzing social good (40%)
    • being “in the mix” on a social/business level (30%)
    • feeling personally useful and productive in my life (20%)
    • getting external ego validation (10%)
  • The thing I want to invest in is a tribe in the Seth Godin sense.  Tribes by definition coalesce around a leader (aka, the entrepreneur).
    • I specifically don’t care about the legal structure or legal standing of the tribe.  It can be a whole company, a project within a company, a de-facto, fluid, amorphous partnership of individuals, or a crowdsource.  If successful, it will evolve into the correct formal/legal structure and I will trust the entrepreneur to honor the spirit of my investment in compensating me (see “moral integrity” bit below).
  • I have to like and trust the entrepreneur first and foremost (and then I take it on faith that the tribe is reflective of that person’s values and energy).
  • I will only invest in projects whose leaders I like personally and who have high moral integrity.
  • I know I will be disappointed on the moral integrity front at some point by someone, and that’s okay.  There will be zero tolerance for moral lapses: no more investment for such people, and they will be ostracized from my circle of influence.
  • I am looking to get about 10% of the equity of the project for my initial investment of $1K to $5K.
  • I expect the first look for follow-on funding if the project gets traction, and I understand the price will go up since the risk is lower.
  • I expect the tribe to know if the project gets traction within about 3 months, if not it needs to be ruthlessly abandoned.
    • I will not shed any tears and will praise the entrepreneur/tribe for making that tough decision rather than dinging them for “failure”.  True failure — tragedy in fact — results from missing the real opportunities due to wasting time and money clinging to a bad or mediocre one.
  • Since the cost for me to get in is about a tenth of the typical angel investment, I feel no qualms about doing little to no diligence or business model validation — in fact I feel liberated.
  • Some entrepreneurs will ask for my strategic help (connections and advice) more than others.  I will (mostly) give it on an as requested basis and not worry if a leader is not making the most of the relationship.
    • Those that do leverage my strategic help are definitely more likely to get funded by me in the future, unless of course they make me a ton of money without it :-)

Three Paradoxes

Here are some paradoxical-seeming truths that I have come to believe through my past experiences, and which the above model of investing relies upon and leverages:

#1  I am more happy and motivated to strategically help projects that I put only a small amount of money into (or no money!) than ones I put a big amount into. With the latter, the leader  needed to convince me they have a brilliant, solid business plan and know exactly how they are going to go from concept stage to being wildly successful over the course of 3 to 5 years.  This, of course, is utter bullshit: no success story follows the original business plan.  But having that CEO come back to me (after convincing me to plunk down $100K) and admit they have no idea how they will eventually be successful, that does not inspire confidence.  With a micro-investment, I’m happy to throw it on the wall and see if it sticks.  If not, let’s all move on — and let’s keep the kitchen open to make more pasta while we still have some dough, the water is boiling and the staff is happy.

#2  Making money has little to do with why I want to invest like this, but if the project does not have making profits as it’s #1 goal, I’m not interested. Why?  Because I don’t think it will be successful in achieving the non-monetary goals either in that case.  When I evaluate a project for potential investment, I will concentrate most of my decision on the money-making potential.  But I will need to convince myself that the project is set up so that non-monetary goals are structurally assured if the money flows.

#3  By “overly” and “naively” trusting the entrepreneur with my money, I know that I will be paid back manifold financially in the long run. Because by giving this trust so freely (once I am convinced of moral integrity) I am invoking powerful social influence factors that will make the entrepreneur feel like treating me more than fairly whenever they have any discretion in making decisions that affect me.  And by not boxing them in with rigid contractual obligations and manufactured incentive schemes, I am increasing the number of discretionary decision points the entrepreneur has.

If you are interested…

If you have actual experience as an entrepreneur or angel investor, I want to hear from you most of all.  Please comment below on what parts of the above resonate with you and what parts do not.

If you have put serious thought into becoming an entrepreneur or making an angel investment but have never done so, I want to hear from you as well, especially the reasons why you haven’t (there are no wrong reasons).

If you don’t fit any of these categories, please don’t respond, your opinion is not relevant.  I will update everyone on what ultimately transpires.

  • http://www.constantbeta.com Jinal Shah

    This is a very provocative post. I am currently an entrepreneur in the making and on the advisory board of a start-up.
    I assume that credentiazlies me and qualifies my repsonse? Also bear in mind, that this response/ opinion is from teh perspective of a 26-year old aspring entrepreneur. I may be completely off the charts here (and maybe angel investors will disgree) but here it is!

    A few things: if the 40% of your reason to invest in 1K – 5k in small businesses is doing social good, I’d suggest you go to kiva.org and find US based (or non!) business to feel good about your money. You wont get 10% equity but you there is a 90% chance you will get your money back in 6-12 months.

    Next: if I ever started a business, there is absolutely NO WAY I’d let you have 10% of its equity for an investment of 1K – 5K. My credit card company lets me borrow more than 5K for zero % APR. The only risk I run is that if my business loses, I still have to pay them the 5K back but I don’t owe the Credit card company anything if my business is successful. On the other hand, I tend to lose 10% of my equity to you for such a small investment. This could either be a genious or an incredibly stupid move for me.

    Also, I don’t know much about you. (I couldn’t find an about page here) But even angel investors and VC’s have their limit in terms of networks and people they can reach. If I knew more about the kind of networks you have access to, I MAY consider the 5K investment, but even that is going to be a hard sell since I am a pretty strong networker and have the gift of tireless persistence. But I’ll grant you that.

    Another point – I’m not sure 3 months is enough time for a business to gain traction. How do you quantify this anyways? I’d love to hear what “traction” is according to your definition?

    Lastly, I’m not sure I’d want a micro-investment. Maybe this is just me, but people my age (I am 26) are also very wary of investors/ VCs and private equity. If I am going to go down that route, I am going to be very smart and do my due-diligence as well.

    And I’d want an investor who is interested in me and sees value in my business not from a surface level but from an in-depth, vested level. Your 5K investment makes me feel like you are not vested enough in my business and probably won’t care if it failed. That is not the note I’d want to begin an investor-entrepreneur relationship on.
    I have to be able to trust and have confidence in my investor as well. And I’m not sure this type of arrangement will do that.

    I think there this concept of micro-investments is great in theory (and in practice with organizations like kiva.org – but the motive there is purely altruisitic) I’d be curious to see you refine this further and find a way to balance your need to do social good and still profit from it.

    Would love to hear your response to this.

  • http://rafefurst.wordpress.com/ rafefurst

    @Jinal, thank you, this is the exact type of feedback I was hoping for from exactly the right demographic. I will respond to your questions and issues raised more throughly after enough other people have weighed in as well, but I’ll address one point now since it’s a meta-issue.

    The percentages I gave were my own personal mix but I expect other would-be micro-investors to be all over the map, so don’t get stuck on that particular motivation profile. While I do think that most angel investors will SAY their #1 motivation is monetary ROI, that can’t really be the case. For one, given the risk of ruin, no angel investor needs the expected return they get from angel investing to make a living, it’s a glorified hobby. And even as a hobby, if you look at the risk-adjusted expected value, it’s not nearly worth their time (let alone opportunity cost for their time). So there must be intrinsic motivations too, and I would say that if we (angels) are being honest with ourselves, money is never the main thing. I know this doesn’t answer most of your questions as an entrepreneur, just clarifying the angel motivations piece.

  • kevindick

    I would take issue with your “not nearly worth their time” statement. As you know, Dave and I have made the evidence on angel returns our #1 research priority. A dedicated angel investor that consistently makes many investments per year does quite well from a return perspective, even taking into account the opportunity costs.

    From this, it follows that some angels may indeed have money as their #1 motivation. Plenty of rich people don’t absolutely require the returns their investments generate. But you can bet that their primary reason for choosing one asset over another is it’s risk-adjusted ROI.

  • mfw1

    Hi Rafe,

    Great article with some very interesting topics touched upon.

    A few of my thoughts as a business man, investor and professional entrepreneur.

    For this point-

    “I expect the first look for follow-on funding if the project gets traction, and I understand the price will go up since the risk is lower.”

    If an outside investor invests 25k in my company, I invest 50k in my company and my dad invests 15k in my company and you invest 5k is it really feasible to request first look at follow up investment opportunities. I do not see how this request is viable in any investing scenario as I would assume there will always be someone with more invested then you that should ultimately have first look at further investing.

    For this point-

    “I am looking to get about 10% of the equity of the project for my initial investment of $1K to $5K.”

    I do not know a person in my age range (28-35) that even can live off 1k a month. 1k to 5k for any respectable business is a very very trivial sum (especially one expected to come with a tribe of people). 10% of an entire company is not in any way trivial. It seems you are asking for way to much given the amount of money risked.

    For this point-

    “I expect the tribe to know if the project gets traction within about 3 months, if not it needs to be ruthlessly abandoned.”

    Are you asking for your 5k back here? Why would you demand something be ruthlessly abandoned when you have so very little invested and so many stipulations maintaining how little you have invested. Again if I have a 100k in my project and you have 5k why would this demand be met after three months.

    The main confusion I would have as an entrepreneur coming to you for money would be determining if you want to be an active or passive investor. At times you seem to want to be very active-

    “Those that do leverage my strategic help are definitely more likely to get funded by me in the future”

    “I expect the tribe to know if the project gets traction within about 3 months, if not it needs to be ruthlessly abandoned”

    “being “in the mix” on a social/business level (30%)”

    “I have to like and trust the entrepreneur first and foremost “

    And at other times very passive-

    “With a micro-investment, I’m happy to throw it on the wall and see if it sticks.”

    “And by not boxing them in with rigid contractual obligations and manufactured incentive schemes, I am increasing the number of discretionary decision points the entrepreneur has.”

    “I feel no qualms about doing little to no diligence or business model validation”

    It just feels like a greater distinction needs to be made on if you stand to be a more passive or active type of investor.

    Last I think to much emphasis/time/writing is being placed on the fact that you must like the people that you do business with. From my experience and when dealing with large successful organizations and business networks your not going to like everybody and most often your greatest business and life successes come with how you deal with the people you don’t like that you must work with (I have not seen a business where this dynamic does not occur on some level and at some point constantly). Life is the same way. It never amazes me how fast a humans likes and dislikes can change over minute items and rapidly. From my perspective as a business man I think it goes without saying that the business should be legal, moral and treat those involved fairly and respectfully. These are givens in business in my eyes and something that does not need to be spelled out in detail.

    Regards
    Matthew Weiland

  • http://rafefurst.wordpress.com/ rafefurst

    @Matthew, thanks for your comments. I think you misunderstand the nature of the projects (not companies) I am looking to invest in. “If an outside investor invests 25k in my company, I invest 50k in my company and my dad invests 15k in my company and you invest 5k” — this is not my target. I’m looking for projects that need between $5K and $25K total to get them to the traditional seed/angel phase. I may be the sole cash investor or one of just a few people. If you, the entrepreneur have cash (from yourself or your friends/family), I’m not interested since you are golden and should just be off to the races.

    Daniel Horowitz reminded me that Y Combinator and growing legion of clones are already playing in this exact space. I’m talking about becoming part of that growing legion, with some differences in focus and model. I think that the gap is probably more huge than most people realize, that there’s room for billions of dollars in this space, and that the Y combinators of the world today are just scratching the surface.

    That said, from what I can see, there seems to be an opportunity in the set union of {social entrepreneurship x NYC area}. This is the space that Michael and many others are in.

    Let me know if this clarification doesn’t obviate all the remaining questions/criticisms you have and I will try to answer them.

  • http://rafefurst.wordpress.com/ rafefurst

    @Kev, okay, maybe I’m guilty of hyperbole, but you can be sure that it’s the very first time I have been, and that I will never be hyperbolic again ;-)

    Regardless, it’s sort of not relevant to the fundamental opportunity as I see it. I was just trying to shed some light on my personal motivation equation and suggesting that there are many others like me if you allow the mixture of coefficients to vary (where ROI is not the real reason we do it).

  • http://bradt.wordpress.com/ Brad

    Excellent post. I found it in my search for a “micro angel investment” service. I found Kiva and Prosper. Kiva targets primarily entrepreneurs in the third-world. Prosper is more of a lending institution where investors gain from interest rates and is used by someone looking for a loan to remodel their kitchen. Your post describes very closely the type of service I am looking for.

    I recently started working as a freelancer and was able to build and launch a startup (more of a prototype really) in between client projects. I thought about getting investors but found it hopeless without a prototype to show. The incubator organizations like Bootup Labs, Y Combinator, and Tech Stars are great but are very limited in the number of projects they take on, require you to have at least one business partner, and relocate to their location. They also seem to involve a little more hand-holding than I need. What I need most of all is seed money, so I can treat the startup as a client project and get it off the back burner. With enough seed money, I could treat it as a full time job and free myself of client projects altogether.

    I think there is a real need for a service that allows angel investors to connect with entrepreneurs, get behind their startup idea, and provide seed money for startups in exchange for a stake in the venture. This is an excellent startup idea in its own right.

    A little about me…

    I am a web developer, web designer, and entrepreneur. I’ve known I was an entrepreneur since I setup a lemonade stand in my home town when I was 7 years old. I moved on to the internet in my teens, teaching myself web design and programming, and producing several popular non-profit web sites in the late nineties. For the past decade, I’ve been working at companies and dreaming of new entrepreneurship opportunities but never having the time to work on them.

  • http://www.constantbeta.com Jinal Shah

    Rafe – I gave a little more thought to your idea. While I am still not wholly convinced, I think micro-seed investments could work for web-based projects that usually just require man-hours to finish (develop/ design etc)
    But even then – 5K barely covers a terrific web designer/developer’s salary for 1 month.

    I’d love to hear what you meant by a business gaining traction in 3 months. What does traction equate? Sales? Press? Pr?

    Brad – FYI, Kiva allows loans to US based small business owners as well. And would you rather pay your money back to an investor with interest or let the investor have 10% equity in your project?

  • http://bradt.wordpress.com/ Brad

    @jinal If 2K is all a single angel is willing to invest and an entrepreneur needs more, then other angel investors can help out as well.

    I agree though, it could be difficult to define what “traction” is. However, I think this could be avoided with incremental commitments. So the angel could commit 2K to the first month which produces a prototype. If they’re happy with it or at least thinks it has potential, they could commit more. Otherwise the entrepreneur will need to find another angel that believes in the prototype.

    Yes, Kiva does not discriminate who they allow as entrepreneurs, however they do market it as helping the third-world. I don’t want my proposal for a new web service competing with a Ugandan village’s proposal to build a new well. It’s just not right. Furthermore, I don’t want interest accumulating as I’m working on a project. I want angel investors who are excited by what I’ve set out to do, believe in it, and want to be a part of it by helping out financially. If the whole thing falls through, I’ve lost man hours and they’ve lost cash. If it succeeds, we both own a share of the business and we both win. I don’t mind sharing ownership in a business that would never have gotten off the ground without financial help from others.

  • http://bradt.wordpress.com/ Brad

    When I say “I’ve lost man hours” I am assuming that I would not be getting fully paid for my efforts in the project. For instance, the seed money would only pay for half of the man hours I actually spend working on the project.

  • http://rafefurst.wordpress.com/ rafefurst

    @Jinal, if $5K covers one month, $15K (three micro-investors) covers the suggested 3 months to gain traction. Plus I would not be insistent that my micro-investees spend 100% of their time on the project. There’s a lot of room to “roll your own” situation within the parameters I’m after.

    It’s a great question you ask, whether the entrepreneur would rather take micro-equity or micro-debt investment. What about you? Brad? Matt? et al?

    As an investor, debt doesn’t excite me in the least. It’s vulnerable to the negative black swan; I take all the risk that you don’t go bankrupt, leaving me hanging, and you get 100% of the upside — minus my measly percentage rate. That said, I think there are many investors who would dig the Kiva model for the same sorts of projects I’m talking about here. And if I’m advising you on which to take, and assuming all you want is money, it’s a no-brainer: take the debt!

  • http://www.constantbeta.com Jinal Shah

    @rafefurst Good points. However, if I take on 3 micro-investors for 5K/each for a hypothetical 10% equity/each in my company, that just seems like its a lot. Additionally, there is a very good chance that I will need more money moving forward and if I’ve already given away 30% of the equity – how much of my own business will I eventually end up owning?

    I am not against the idea of equity. I would rather have that then debt. Even in the case of micro-equity – but then the current model that you have gives major equity in exchange for micro-investment. That is not aligned correctly and that is the part I take issue with.

    Another way to look at micro-investing is also perhaps not in terms of money and in terms of need. I would be willing to share 2% – 5% of my company (with the right partner) in exchange for all branding, identity development and design. (depending on my needs)
    To me, that is more quantifiable.

    Rafe – still waiting to hear your definition of ‘traciton’ :)

    @brad I agree with the notion of incremental commitments – but does that mean incremental equity?! I’d lose 100% of my company in 10 months if that was the case. Please clarify your stand.

  • http://www.acgcommunity.com Rachael Qualls

    Rafe –

    I loved your post. Honest, straight-forward, and funny.

    I sit on all sides of this analysis, I am young (relatively:), I am an Angel Investor (directly and indirectly), and I am an entrepreneur.

    Most importantly for this context is that I support the fragile relationship you have discussed between the entrepreneur and the investor.

    As a third party to the relationship in your post, I carry the burden of making sure everyone’s expectations are communicated and subsequently met.

    All relationships are choreographed around a dance involving expections. Commuincate the steps – everyone falls in line. If you just start moving with no direction – it’s a cluster F*&%.

    For these reasons, I encourage you to think differently about the legal deal structure. Yes the legal documents protect you, but they also give a clear set of guidelines for the entrepreneur to follow.

    When legal documents are prepared well and fairly, they are a great way of helping to ensure a better outcome to the relationship.

    The CEO’s of your portfolio companies want to live up to your expectations, so it is very important you tell them exactly what they are from the time of investment to various exit scenarios.

    Hope that helps,

    Rach

  • danielhorowitz

    @Jinal – I think Rafe means 10% equity for 15k investment (i.e. 3.33% for 5k)

  • danielhorowitz

    @Rafe – I think there are at least three underserved markets which are ripe for funding.

    a) Students (Undergrad and Grad) – You don’t seem to cover this group in your proposal, but I think they are attractive for a number of reasons. They are already part of a large community that offers them many valuable resources and services. They likely already have their basic living expenses covered and can devote the investment entirely to the company. Finally, if the project gains traction, they are ideally positioned to take up the project fulltime.

    b) Young employed individuals with a side project – While perhaps this group has the highest risk profile, I don’t know that they are being served by anyone. Again, they likely have their basic expenses already covered, and can devote the majority of the investment to the company. If the project gains traction, they can take it up fulltime. Since, they already have a job, there is a risk they won’t take the side project seriously and might squander the money, but there are certainly some people with great ideas that just need a little push.

    c) Young individuals that give up their job to work fulltime on the project. This is the group that is currently being served by YCombinator and a host of other “pre-seed” companies. They are appealing because they are essentially giving up other opportunities to devote all their time on the project. Unfortunately, this requires some of them to spend the investment money on living expenses, leaving precious little for the newly founded company. Additionally, when the money dries up (~3 months) these people must either give up on their project or acquire new funding asap.

    I think each of these three markets is lucrative and represents a viable opportunity.

  • http://rafefurst.wordpress.com/ rafefurst

    @Jinal: by traction I simply mean, do you, the entrepreneur, after taking your idea to the prototype stage, still feel the opportunity is a good one. It’s a universal truth that if you stop before the finish line you will never win the race, but with this model we are changing the game and making it easier to switch to a different race that is easier to win. With bigger investment the “sunk cost” fallacy is much harder to resist.

    @Rachael, my personal preference is to set (and reset) these expectations verbally and candidly, but not legally. Legal structure, in my experience, tends to absolve all parties from personal responsibility and encourages them to game the structure to their own advantage rather than relying on trust and “social capital”. Furthermore, because of inherent vagaries and uncertainty at the seed stage, it’s impossible (in my experience) to set up legal structure that doesn’t quickly become more burdensome and inefficient than something that helps the success of the project. Every project has a natural break-point where it makes sense to paper things legally, and I would be seeking entrepreneurs with whom I feel comfortable that we could determine when that is together.

    @Daniel, no I was thinking $5k was worth about 10%. Maybe this is too high, but if we are now just haggling over price, it seems like the model might have legs.

    @Daniel, I completely agree with your assessment of the three “underserved markets” and the opportunities they represent. Furthermore, I expect that the most common use of funds will be to pay rent (which is very high leverage and great, IMO), but it’s even better if rent is covered, as in the markets you site.

    One issue/negative of funding people with full-time jobs is that it’s a real risk that their employers will claim ownership of the project if it’s successful, regardless of whether the employee worked on it in their “spare time”. The lines between “company time” and personal time are getting fuzzier each year. Personally I love the student-entrepreneur market on just about every level.

  • http://bradt.wordpress.com/ Brad

    @rafefurst I believe it depends on the situation of the entrepreneur. If they already have a lot of debt (often the case with a college grad), I believe the equity option would be more attractive. On the other hand, if they are in good financial standing, the loan would probably seem better. I think both are good options, but I’m wondering if an angel would feel like part of the project if they’re just getting paid interest. The micro-lending is really the same as what Prosper.com is already doing.

    @Jinal Incremental commitment doesn’t necessarily mean incremental equity. You could decide from the beginning what percentage of ownership in the venture is for sale and stick with it throughout. For instance, you could need $5K to get a prototype done and decide you’re willing to sell 10% ownership. You split this 10% into 1000 shares at $5 per share. Now say the prototype is well received and you need another $5K to bring it to the next level and launch. So you offer up another 1000 shares at $5 per share. Now the 10% of the business is composed of 2000 shares (I believe this is called “diluting” in investor speak). You must first present these new shares to your current shareholders allowing them to purchase these new shares up to a max of the number of shares they purchased last time. This allows them to retain their initial share of the ownership. For instance, if an investor bought 100 shares in the first round, they own 1% of the business. If they purchase their max of 100 shares in the second round, they retain their 1% ownership, if they opt out completely, their ownership will be reduced to 0.5%. Once all current share holders have decided on how many shares to purchase in this round, whatever shares are left can be purchased by existing shareholders (looking to increase their ownership stake) or new shareholders.

  • danielhorowitz

    @Rafe – The existing pre-seed incubator types offer between 6-25k for 6%. They also provide significantly more non-monetary value than you seem to be offering.

    I understand your desire for 10% equity, but I think you need to offer a bit more money. Also, you need to figure out what other services might be available to the founders. (e.g. legal, mentorship)

  • http://www.alldaybuffet.org Michael

    @Rafe – great post. I’ve been thinking about our phone conversation, and been reading through all the comments on this post. All are interesting and thoughtful. Here are some of my thoughts…

    – Totally agree with @Jinal that a small seed micro-investment for 10% of equity is not favorable for the entrepreneur. One can max out credit cards for $5K without giving away equity. Also, @DanielHorowitz mentions that incubators such as Y-Combinator, TechStars, etc take on average 6-7% for $10K – $15K. They are getting this equity because they offer a lot of the “intangibles” such as access to successful entrepreneurs, community around the “incoming class”, and a pitch event at the end of the summer in front of the entrepreneurial community (TechCrunch and Guy Kawasaki are known to attend these pitch events). Looking at it from an entrepreneurial standpoint, this is a no-brainer to give away 7% equity to get this in return. The $10K doesn’t matter as much as the opportunity to learn and gain exposure for my company.

    – After watching Entourage last night, I realized that the ideas don’t really matter as much as the entrepreneur, and execution of the idea. The scene with Ari Gold asking Turtle to show him some “proof of concept” is how all investments should work.

    – So, I think there’s a massive opportunity within the “Y-Combinator” space that doesn’t involve moving to Boston (yuck!) and giving up your life for a 3-month period. As far as targets, it would be after the “young individuals that give up their job to work FT on the project.” Rather than focusing on pre-seed and idea companies, it would be nice to put your money on entrepreneurs that already have an idea in a place with some sort of traction. Your due diligence would be split between the idea and on the entrepreneur to successful execute it. The micro-investor should also be willing to offer additional intangible resources such as time and connections to ensure a higher success rate.

    – How about this as an idea to structure a real simple agreement between the entrepreneur and micro-investor? Investor provides enough runway for a 3-month salary (roughly $7.5K per founder) or $15K total for 3-months. If certain goals and milestones are met, investor is willing to invest further ($10K – $250K) to grow the business for X amount of equity over X amount of time.

    If the idea fails, the micro-investor eats the $12K, and both sides move onto the next project. (This is the same model for “staking” poker players in major tournaments.)

    This allows the entrepreneur to focus on building and growing the business versus worrying about raising capital. Also, if the company gets further investment, the equity is diluted but the shares are worth much more, which is the goal of everyone invested into the business.

  • http://www.alldaybuffet.org Michael

    Last thing to add to my last post, I think the micro-investor should look at his investment as an “option” to further invest into the startup (which is what the entrepreneur really wants — further investment).

    If the idea fails, and doesn’t pick up traction, the micro-investor eats the cost. If it starts to pick up, the micro-investor can have 1) first option to invest into the company and 2) buy shares at a pre-determined discounted rate.

  • http://rafefurst.wordpress.com/ rafefurst

    Michael, I agree with everything here, except I don’t want to personally commit more than about $5K per investment. Thus it needs to be some sort of co-investment deal, which complicates things somewhat. Not a big issue, and perhaps even an opportunity; i.e. this could be the first project that gets funding, putting together teams of 2 to 3 micro-investors :-)

    I’m ready to start investing, where do I sign up?

  • http://www.constantbeta.com Jinal Shah

    Mike – I totally agree about the idea of micro-investments working as ‘options’ to further investment within the company. That gives both sides enough incentive to make this deal worthwhile.

    I’m not sure if I’d want many micro-investors, but I think this set-up would work great in the early stages of a company where if I just have 2-3 micro-investors, a promise for further investment and my own funds. It would take away the burden of raising additional funds.

    Rafe – Since this type of structuring is relatively new, it would be very interesting to hear first-person accounts from you of how this concept evolves and is put into action. You could on the verge of triggering an entire new approach to starting up businesses :)

  • http://www.alldaybuffet.org Michael

    I think the “options” play would work the best. To keep thing simple, the $5K is an option to invest into the company at a discounted rate.

    As an entrepreneur, the $5K doesn’t really help out that much (the legal fees would be $5K+ in itself), but the promise of additional investment when certain milestones and goals are hit would be appealing.

    For the micro-investor, he sleeps happy knowing that he can still put in a lot of “options” and only invest lots of money when something picks up traction. The entrepreneur sleeps at night knowing that he has a potential investor with some skin in the game.

    Both sides are happy.

  • http://williamtozier.com/slurry Bill Tozier

    Interestingly, I came across this post from a completely different direction, but it applies to a discussion we’re having Friday on a new business model some of us in Ann Arbor are exploring.

    The trick, we’ve found, is using the metaphor of film production companies. Venture and even many local economic development-driven angel funds tend to operate like movie studios managing kept projects and permanently-held properties. But independent film production is much closer to the description you’re giving: a pool of savvy but risk-friendly investors, a suite of small, innovative and often socially-motivated projects not companies, and an intermediary.

    The intermediary we’re calling the production company. Our PC is setting up a portfolio of three small but game-changing open-source and socially astute projects right now, and building the suite of investors, and the best practical advice we’ve found so far comes from books on independent film business plans.

    The other trick, of course, is something that many folks immersed in the company-driven culture of the coasts might miss: we’re all independents, and we will remain independents after our projects are done. But we form a collective, a community of reputation and practice that can fill the “end credits” of any reasonably-sized project in a day or two. Traditional businesses, I’m betting, feel obliged to pay down the risks associated with managing emergent teams; they tend to accumulate expensive employees or contractors, and get bogged down with expenses.

  • http://rafefurst.wordpress.com/ rafefurst

    Bill, I agree with the analogy, and I’m familiar with the model as an investor and producer of independent film projects. I’m just hesitant based on the fact that that model is broken for the investor who invariably gets screwed. A lot of this has to do with funny accounting and the competitiveness and vagaries of the film industry, and so it would be good to know in your experience what of the indie film production model you think works (and you are carrying over) and what does not (and you will try hard to avoid)?

  • http://williamtozier.com/slurry Bill Tozier

    Writing up our notes from last week’s discussion still, but there are a few things I think will clarify.

    First, most of us also understand the risks for investors in film projects, and to be honest the fulcrum of Louise Levison’s Filmmakers and Financing is a single line: “Film is probably the worst investment anybody could ever make.” Optimistically she sets the chance of an independent film generating any revenue at about 1/50; I expect both you and I know people who have worked in the studio system, where the chances of any given movie traversing the path from script to theatrical release is vanishingly small.

    So why does anybody make movies at all? You sound like you’re speaking from personal experience when you say investors feel screwed by experience with film financing, so you already must have realistic financial expectations: Were you screwed out of catalyzing social good, being “in the mix” on a social/business level, feeling personally useful and productive, or maybe getting external ego validation?

    Why would anybody want to invest in open-source software, or projects trying to fix problems in other people’s online infrastructure, or design automation systems… and then to top it all off use their resources to start a nonprofit or stick a GPL on it all and then give it away for free? For whuffie? To build a community? Because they see a social, ethical, technical or aesthetic problem that needs to be addressed? Because they want to use the thing themselves?

    All those.

    What we’re developing isn’t a company aiming at “blockbusters”. Not only are the numbers for that sort of business model ridiculous, the lifestyle is boring.

    What we’re trying to build isn’t analogous to a movie studio, it’s a way of better supporting and completing the innumerable small, functional, simple projects that we ourselves want to use.

    To jump tracks for a second with the analogies: we’re the people who are bored with K strategies adopted by most American business folks. We want the world to swing back towards r strategies: more small, energetic, successful projects getting done. More dying, sure. Ideas are cheap.

    The other analogy that cropped up last week to describe what we’re building? Consulting for ourselves.

    What doesn’t carry over? Seems like a lot of the cultural baggage these metaphors evoke. The analogy to finding a distributor is the trickiest–unclear what lies downstream of what we’re already doing. We’re working on that, and there are some sound ideas floating around here. Maybe we’ll have to make our own distribution channels as well.

  • http://rafefurst.wordpress.com/ rafefurst

    @Bill, all your points are well taken. And I don’t want to belabor the point except to say that the movie industry metaphors are irreparably damaged by movie industry malfeasance and should probably be avoided. That said, everything you are saying sounds like a great model to pursue.

    Just to be specific/clear, I have invested in several independent movies and the catch is that whoever ends up distributing it takes all the profit and claims that it cost more than they spent.

    So it issue for me is not that I’m funding social good, it’s that somebody is eating my lunch while I’m paying all the bills. If someone makes a profit it should be the investor, not the movie industry, but that never happens.

  • http://williamtozier.com/slurry Bill Tozier

    Makes sense to me. And it sounds like a generally-felt pain somebody ought to address.

    Will see what we can do.

  • http://bradt.wordpress.com/ Brad

    So, is anyone actually going to tackle this venture?

  • http://rafefurst.wordpress.com/ rafefurst

    Brad, yes, stay tuned, there’s a group and model emerging and we’ll post something as soon as it’s ready…

    Everyone: Raise your hand if you are interested in beta testing as a micro-investor and have between $1K and $5K you’d like to commit on this in the next month.

    Also raise your hand if you are a social entrepreneur who has a project that fits the space we discuss above requiring between $5K and $15K to get 3 months in and path to profitability.

  • http://bradt.wordpress.com/ Brad

    +1 Social Entrepreneur

  • http://www.dixipe.com Gonza

    Excellent post. As well as Brad, I found it searching for angel investors. Congratulations for the idea Rafe.
    I am an entrepreneur from Argentina (Latin America), working on the advisory board of a start-up.
    I think the gap Rafe shows is a very good investment opportunity. Specially for high potential internet start ups developed in the third-world focused to American or European Market.
    Because, the currency rate makes the investor money more profitable in those companies.
    Imagine that investing 15k dollars in US is just 15k, and with that money we will hardly pay just a few month of expenses, salaries, and forget about starting with even a little office.
    But that same amount invested in Uruguay or Argentina, are more than 50k pesos. With that money, you can cover here an office, and a small team of web designers and programmers, for at least 6 month. Enough time to have your company on the way and making money.
    And you will say, yeah… but the incomes will be in pesos as well as the expenses. But the good new is that, you can start your business in Latin America, pay your costs in pesos, but make your incomes in dollars, focusing your company to US market.
    There is several world class companies have been started in Latin America. And now are doing very good, like for example killerstartups.com

  • Rare Stuff

    I fall foul on the age requirement, oh to be under 27 again.

    Great idea though and the gap does exist, but not just between the 40 somethings and the college grads.

    • Rafe Furst

      Fair enough. Change age requirement to “wherever gap exists” :-)

  • Rare Stuff

    OK +1 Entrepreneur

    Is there somewhere to actually submit proposals or is this still in its infancy ?

    • Rafe Furst

      Keep an eye on the blog, there will be some updates in the next couple of months…

  • http://www.alanwalk.com Alan

    Under 27 y/o entrepreneur and wannabe micro-investor here raising his hand that he’s interested. Please let me know when the system is put in place to invest with video and information on the project in need of micro-capital.

  • Elyloew

    hmm… I'm a bit late into the discussion, but I Googled 'micro-investing' and this was one of the first results to show up. I had not heard the term before, but came to it independently based on the idea of micro-lending. Also, I believe I have created a workable model.

    I'm 27 years old and believe myself to be an entrepreneur, although not yet a very successful one (I've run a couple very small scale businesses, making between 15-25K part time). I was quite inspired by Dr. Yunus' concept of the social entrepreneur, and I've been experimenting a bit in Albania. I have visited a poor village and lived with a family there. For the past two years, I have been working with this family to rent farm land (the village is in a valley, one of the most fertile in Albania). I rent the land, buy the seeds, pay for the labor and harvesting, and split the profit from selling the harvest on the local market. I get the money and the family manages all the farming details.

    The basic business concept is this: any person can invest any amount. Minimum is $100. All the investor money (so far just close friends) is pooled into one 'pot', and I then use this money to pay all the expenses. After the harvest, the total amount earned is divided by the total amount invested, which determines how much ROI each individual investor gets, but all the investors get the same % return.

    The first year my friends and I invested $3000, which we turned into $3500 (each investor got around 16% on their initial investment, no matter what size it was). The second year we put in $10,000. We sold the crops for $20,000. I paid the family $3,000, kept $2,000 for myself, and each investor got a 50% return on their investment.

    I'm on my third experimental year, after which I will legally register the business both in the U.S. and Albania. I think the model has great potential, but I am interested in partnering with other investors with more experience, and to get some feedback and advice.

    After reading your post, I felt that this business model is similar to what you were speaking about and looking for. My primary goal is to bring a family, and possibly an entire village, out of poverty, but I believe this is only possible if this is a money-making adventure.

    I didn't want this comment to be a sales pitch… I agree with the article, and wanted to share my experience as an entrepreneur. If you are interested, however, or believe my idea has some potential, I'd be happy to share more in depth by email or phone… my email is: elyloew@yahoo.com.

  • I_sipos

    In case, anyone still follows this article. Wonder, what would it be your opinion if, the offer and terms to the micro equity investor is very simple. Like this; Double or Nothing! For your small investments $1,000-$10,000.00, our start up company pays double at the end of our fiscal year or we loose everything.

    • Rafe Furst

      I like the simplicity, but don’t like how it misaligns incentives. Why would I want to foreclose on an entrepreneur that I believe is uniquely qualified to launch the business? Why is 2x the right number? Doesn’t say anything about what we think the risk-adjusted multiple is, and doesn’t say anything about how this drain on capital will affect the company’s chances.

  • Luke Gedeon

    Are there any follow-up posts talking more about where this idea has gone? Anyone building this yet? Seems like the first investment could go toward building an infrastructure for making this doable.

    I would love to help build the marketplace where investors and entrepreneurs can meet.

  • Dgold23

    Rafe,

    How do I become an investor? After graduating with a degree in finance and getting my first job I soon realized corporate america is not for me. I am more suited for microfinance where the company is still fast and nimble rather than huge, bureaucratic, and slow. Instead of dealing with what seems like monopoly money, you can actually see the effect $1000 has on a company. To me, that is where the biggest gap lies.

    • Rafe Furst

      The nearest-term impact for you is Profounder.com, which launches publicly very soon. The model is simple: crowd funding like Kickstarter but with for-profit startups.

      We will be integrating Profounder and several other micro-funding enablement platforms into AcceleratingPossibilities.com as well. Come join that community, we need all the like-minded members we can get to help us build it out properly and in a way that will serve the community values best.

  • Zoeyhutch

    How would you like to put your ideas and your money into a new movie production company where the emphasis will be on making action and adventure movies to capture a worldwide audience. The screenplays are ready. The business plan and the executive summary are ready. The money is not. Therein lies the problem. No money … no movies. Go to BajanYankeePictures.com. You can make a difference.

  • Jon Allerton

    Dear Rafe,
     I heard about micro investing on the wireless this week and have just looked it up in Google. I like all that you have to say. It crystalizes my thoughts and I also agree with your percentages for motive, more or less anyway. How do i get involved? Jon Allertonjallerton@btinternet:disqus.com

    • Rafe Furst

      Jon, my thinking on micro-investing these days is that it is best served by investing in the individual.  See my latest variant of this theme: http://emergentfool.com/2011/08/28/investing-in-superstars-part-4/

    • Rafe Furst

      Jon, my thinking on micro-investing these days is that it is best served by investing in the individual.  See my latest variant of this theme: http://emergentfool.com/2011/08/28/investing-in-superstars-part-4/