A Failed System
We use a story-telling approach to examine why so many entrepreneurs and investors (women and men) experience a lack of success in raising flexible capital and making profitable and sustainable investments that build financial security and wealth. This story recounts a fictional meeting between Mark Livingston and the three principals and management team of Healthy Workplaces LLC.
Healthy Workplaces is a $4 million-dollar enterprise in the health and wellness space. Yvonne, Maria, and Tess started the business fifteen years ago with $30,000 of personal savings. Under their leadership, the organization has grown steadily through word of mouth recommendations from loyal customers. Their proprietary tools for building “healthy cultures” have made a positive societal impact by improving the health of employees and their families, lowering insurance premiums, and improving the productivity and performance of employers across the U.S. and Canada. Combined with responsive and personalized service, Healthy Places has built a strong position in the health and wellness marketplace.
For about a year now, the three co-owners of Healthy Workplaces have been looking at the possibility of raising outside capital to fuel the growth of their “baby” into western Canada and the U.S. They’ve talked with banks and investment firms, including a local “angel network” of private investors. They’re not convinced that a bank loan or sale of equity is a smart move. They like the control and independence of running the business on their terms.
Yvonne, Maria, and Tess have reviewed the ten key findings from Mark’s research into Positive Impact. They’re excited about the possibility of raising flexible revenue-based growth capital to scale their positive impact across North America. Curious to learn more, they’ve invited Mark to meet with them and their management team of Meg, Lisa, Marcie, Jalen and Raul to answer a few questions.
Yvonne: Hi everyone, thanks for taking time from your busy schedules to meet. I think everyone has had an opportunity to review Mark’s research. Mark asked me to tell you that any and all questions are welcome. So, let’s get started. Who would like to go first?
Maria: Mark, what point are you making with “be careful what you ask for”?
Mark: Maria, this mantra is about the “obligations” and “price tag” that come with pursuing and achieving any personal or professional goal. I don’t need to remind you of the price you’ve paid to build Healthy Workplaces over the last fifteen years. I know you all have worked very hard to get here. And, I’m sure you worry now and then about sustaining this success.
In Key Finding #8, I discuss the hyper-growth expectation (or price tag) that comes with selling a percentage of your business to private equity investors or investment firms. In my experience, few entrepreneurs and business owners (women and men) understand the business models and expectations of these investors. The entrepreneurs in my focus groups verified this.
Failing to understand the expectations of banks, lenders, or investors is a big mistake. It leads to erroneous thinking that raising capital or securing financing is the end game. It’s not; it’s just the beginning of a journey. And that journey can be harrowing if you and your organization are not ready to deliver the revenue growth and cash flow demanded by these profit-driven investors.
It is extremely challenging to deliver on these expectations, as my four data points in Key Finding #8 showed. It is very rare for new ventures and even established enterprises to deliver hyper-growth of 50% or more each year over a sustained time period. Typically, the law of averages kicks in, and growth slows down. And, as “Luni” revealed in his video, the landing can be pretty hard for 70% of equity investors and the enterprises they fund.
Tess: Mark, can you breakdown the expectation of “10X exit in 5–7 years”?
Mark: Tess, 10X exit in 5–7 years is code for a model of finance and investment called the Silicon Valley Model. There are three parts to this model.
First, “10X” refers to the desired level of profit expected by private equity investors. In exchange for an up-front investment of cash, these investors receive equity or a share of ownership. They expect a return of ten times their capital investment (a return on investment of 900%). They also expect a seat on your board and the ability to influence key strategic decisions, especially financial ones.
Second, exit refers to how these investors turn an “illiquid” investment of equity shares into a “liquid” payout of cash. Typically, these investors hope the company will be acquired, enabling them to “cash-out” and earn ten times or more on their investment. Sometimes, this exit occurs with an initial public offering of stock on the stock market (called an IPO). Here, investors expect to receive 25–50 times their investment. It rarely occurs, but it’s enough to keep these speculators coming back and rolling the dice, even though they lose all of their invested capital 70% of the time.
Meg: And 5–7 years? That’s important, right?
Mark: Yes Meg. It’s the third part of the Silicon Valley Model. This number is critical because it establishes the annual rate of return on the investment. It represents the number of years these investors expect a “liquidity event” to take place after their initial outlay of cash. As I mentioned, this event can be an acquisition by another company or a sale of stock on Wall Street.
A “10X exit in 5–7 years” works out to an Internal Rate of Return (IRR) of 40–60%. It’s a key metric equity investors use to determine if they want to invest. It’s also the potential return on investment they use to recruit other investors for their deals or funds.
Jalen: In Luni’s video, he showed equity investors only getting 2.3X.
Mark: That’s right. A “2.3X in 10” works out to just 8.7%. Not even close to the goal of 40–60%. Remember, this is a financial return for a portfolio of ten equity investments. As Luni explains in the video, equity investors only need one 10X to make up for the seven out of ten 0X–1Xs.
Most investors are not aware of the myth of 10X. I think Luni has done us all a service to expose the real rate of return.
Marcie: What happens to the 70% of investments that return 0X or 1X?
Mark: I asked this same question to the angel investor who assisted me in the validation of our 3X-in-10™ Revenue Sharing Model. This is the individual in Key Finding #7 who had personal investment losses of $1 million dollars. He brings gravitas because of his 30 years of experience in Silicon Valley as both an entrepreneur who raised millions and lost a fortune in these type of investments. His responses to this question were: “total loss” and “they run out of money.” He added that Luni was “putting more weight on 1X returns than should be given.”
My source also made an additional comment. This former Silicon Valley investor said that for many of these angel investors and venture capital firms, the 70% failure rate is nothing more than a “cost of doing business.” How would you like your “baby” – Healthy Workplaces – to be dismissed so casually? It should give you an insight into the mindset of these 10X profit-driven investors.
So let me ask. If you were listening to an angel investor, venture capital firm, or Wall Street investment fund pitch the Silicon Valley Model, and they revealed a failure rate of 70%, would you write them a check? Be honest. I bet you would call their model broken or ineffective, or …
Mark: Thank you, Lisa. In fact, there’s a theory that explains this decision making process called the Greater Fool Theory. A 70% failure rate is a track record no better than the ten-year business failure rate I found in data from the Bureau of Labor Statistics. I think this is one of the root causes for why so few entrepreneurs and investors (women and men) build long-term financial security and wealth. The broken Silicon Valley Model is based on assumptions and expectations that are not realistic, achievable, or sustainable.
Yvonne: Can you speak to the two questions raised by Luni in his video?
Mark: This is Key Finding #5. Let’s focus on the first question that Luni asks in this part of the video. It relates to an expectation of equity investors that entrepreneurs and business owners deliver hyper-growth rates of 50%+ per year and then sell their ventures in 5–7 years. The Silicon Valley Model is for all practical purposes a “build-to-flip” model because of this expectation. And, as I just mentioned, selling the business is the only way to “exit” and “cash out” investors. So, the question Luni is asking is: “Are you building a business to flip or to keep?”
What do you think happens when a “build-to-keep” business or social entrepreneur pitches to a “build-to-flip” investor?
Mark: That’s right. If you want to build and keep an enduring, sustainable enterprise to generate long-term social and economic value, equity investors or investment fund managers may listen to your pitch, but they won’t invest.
To illustrate, I attended an “investor pitch” in late 2016, and the manager of a local angel network and investment fund point blank told the audience of 50–60 entrepreneurs, “We only look at 10X business models.” Now, we need to give him credit. At least he made his expectation clear. Unfortunately, he offered no other options for the entrepreneurs and business owners in the room thinking, “I don’t have a 10X business model.”
Tess: What happens if you’re a 3X or 4X business model like us? Do we have any hope of raising capital?
Mark: Tess, you’ve just introduced the second question Luni asks in his video. He phrased it this way: “What if there were no possible 10X’s”?
Luni is making two points here. First, he’s showing the bias of Silicon Valley Model investors toward build-to-flip business models that deliver 10X exits and profits. Second, he’s reinforcing the exclusivity of this model. It’s a biased and broken system of finance and investment that only focuses on 5% of ventures in the U.S. and 5% of investors who are wealthy enough (or foolish enough, thank you Lisa) to gamble money on unproven companies with hyped-up projections of revenue growth.
However, Luni offers hope to the other 95% of businesses, like Healthy Workplaces, and the other 95% of investors who are not high net worth. With a revenue sharing model, Luni is pointing us toward a third option that is more entrepreneur-friendly than debt and equity.
Revenue-based finance and investment represents a better option for Healthy Workplaces to raise flexible growth capital. It doesn’t have the onerous terms, conditions, and obligations that come with debt or equity. Combined with crowdfund investing, this is a practical and viable way to raise the capital needed to scale the positive impact of your enterprise.
We think good old-fashioned revenue sharing combined with crowdfund investing has the potential to help many more woman business owners, entrepreneurs, investors, and HeForShe advocates in the U.S., Canada, and around the world. We think it’s one of the keys to closing the gender wealth gaps.
Jalen: Would improving access to capital help close gender wealth gaps as well as racial wealth gaps?
Mark: Improving access to capital won’t do a thing to close gender or racial wealth gaps. But, improving access to the right capital will. Funding in the form of debt and equity is simply the wrong capital for early-stage ventures or established enterprises launching new ventures or new strategies to scale their business impact. That’s because these businesses are operating in a condition of extreme uncertainty. They need flexible and entrepreneur-friendly capital to fuel the successful launch of new impact-driven business models.
Conventional debt and equity financing come with too many onerous terms and conditions (aka, obligations) that require fixed monthly payments or hyper-growth rates of 50%+ per year. Also, remember the 70% failure rate means the owners of these ventures “crash and burn.” It is not stable or sustainable investing and it won’t help women and communities of color build lasting financial security and wealth.
Women and minority entrepreneurs and business owners need access to flexible revenue-based growth capital, especially if they have 3X or 4X business models, which is the typical situation for most enterprises. But they won’t get help from banks, lenders, private investors, Silicon Valley venture capitalists, or Wall Street investment firms. They’re too invested in the 10X profit model.
It’s time to create a new inclusive system of finance and investment, one that enables women and communities of color (about 75% of the U.S. population) to access the right growth capital.
Lisa: Does the Silicon Valley Model fail women and contribute to the gender gaps?
Mark: Yes Lisa, it does. In fact, I would call it not only a failed system but a “systemic failure.” Here’s why.
The Silicon Valley Model started in the 1960s to finance new technology start-ups in the region around San Francisco. Since those days, men with programming, engineering, and technology backgrounds have dominated the industry, including the venture capital finance industry that sprung up around it. In the beginning, few women were in these careers, and none were in senior management positions. Even today, women hold just 24% of technology jobs, and less than 10% of women even make it to the partner ranks of venture capital firms.
So, a certain mindset or bias developed into a culture that is now called the tech start-up culture or more to the point, the bro culture. Women from my generation call it the old boy’s club. Both the technology and venture capital industries have struggled with an unfortunate byproduct of this culture in the form of gender bias, sexual harassment, and discrimination against women.
Atlantic Monthly provided an in-depth expose of this systemic bias in their April 2017 issue. If you want to read other accounts, you can read Dan Lyon’s book about his time in a technology start-up or search the history of Ellen Pao’s unsuccessful lawsuit against one of the biggest venture capital firms in Silicon Valley. And, as you know, we have a much greater problem in our society. Witness the old boys’ culture at Fox News and the almost-weekly headlines about sexual harassment in industry after industry from east coast to west coast.
There’s another aspect of this systemic failure I want to mention. Americans are obsessed with the notion that any system can be replicated in other industries, communities, or countries. As a result, over the last fifty years, this biased and broken model has spread into every aspect of our financial system. We see it in the volatility and casino-like mindset of Wall Street investment firms dominated by men. We see it in the lack of access to capital for 3X business models on “Main Street.” We see it in business schools that continue to teach “profit is the only purpose.” And we see it in the way retirement and pension funds invest our hard-earned money in high-risk and speculative private equity portfolios.
As a result, this model and all it represents (good, bad, and ugly) has become the dominant force in finance and investment around the world. And it’s now becoming the strategy-of-choice for impact investment portfolios that have the primary aim to address and solve social and environmental problems.
So yes, the Silicon Valley Model is a biased and broken system that fails women (and men) on so many different levels.
Meg: What are some of the barriers that prevent women from raising flexible capital to scale positive impact?
Mark: You just mentioned two of them Meg: flexible capital and positive impact. The banks, lenders, investment firms, and private investors don’t care about flexibility or impact. They have a debt or equity model that requires “feeding.” Impact? It’s really about the 10X profit and 10X exit. If there is a positive impact, that’s a nice by-product, but it’s not at the top of corporate strategy maps or performance scorecards on Wall Street or in Silicon Valley. Remember the quote I shared from Peter Nadosy, chairman of the Ford Foundation’s investment committee? He said, “When Wall Street smells a profit opportunity, you have to be careful.”
Another barrier for woman business owners and entrepreneurs is the legal and accounting costs associated with raising equity capital (they vary from $50K–100K). Typically, these costs start at $15,000+ for lawyers just to compile 35-50 pages of legal documents and then haggle over innumerable terms, conditions, and provisions. Then, there’s a business valuation that has to be conducted. Oh, let’s not forget the financial audit and additional costs for another round of reviews with securities regulators at the federal level or in each state you’re seeking to raise capital. For most woman business owners and entrepreneurs, these costs are insurmountable. Several entrepreneurs in my focus groups used the term “outrageous.”
Previously, we talked about the “build-to-flip” versus “build-to-keep” expectation of equity investors. If you don’t have a 10X business model, angel and venture capital investors won’t even talk to you. The banks may talk, but their terms and conditions are not flexible, and they will never provide the amount of capital you really need.
The biggest barrier for women is this: the finance and investment playing field is not level. Men make all the rules and have all the power. They control the process and set the terms. The system is biased, broken, and fails both women and men. Three books on this topic include Shortchanged by Mariko Lin Chang, The H-Spot by Jill Filipovic, and Brotopia by Emily Chang.
Lisa: How will revenue sharing and crowdfund investing break through these barriers?
Mark: Lisa, if it’s done right, I think good old-fashioned revenue sharing combined with new crowdfund investing laws offer women a great opportunity to “flip” this imbalance of power right on its head.
Revenue-based finance avoids most of the legal fees and costs associated with the Silicon Valley model. You don’t need 35–50 pages of legal documents, just a revenue sharing agreement or promissory note of 5–8 pages.
With a high-quality revenue sharing offer on a funding platform with reasonable fees, women business owners and entrepreneurs can make a compelling investment offer and set the terms. You now have power and control over the capital raising process, instead of giving that power and control to bankers, lenders, and investors.
Most importantly, Lisa, you don’t have to “beg for money” anymore. When any system forces you into a subordinate or second-class role, there is never a happy ending, at least for you. Revenue sharing enables you to stay in control of your destiny.
Maria: Do you think revenue-based crowdfund investing will help women build financial security?
Mark: Yes, I’m excited by the potential of revenue-based crowdfund investing to help more women create the kind of financial assets and net worth that men have accumulated. It won’t happen overnight. It’s not a “get-rich quick scheme” like the equity investments angel and venture capital investors covet.
However, for woman entrepreneurs and business owners, this is an opportunity to raise flexible growth capital and build a sustainable, high-impact enterprise without the constraints of debt financing and obligations of equity financing.
Yvonne: Are there any downsides or limitations to revenue-based crowdfund investing?
Mark: Yes, there’s a need for gross margins to be high enough so you can afford the revenue sharing percentage (30% is considered minimum). You also need to have strong “product-market fit” to ensure reliability of revenue streams to meet the revenue sharing promissory note obligations.
You also need to be able to deliver sustainable growth and results over an extended period of time. However, you won’t have to grow unsustainably at 50%+ per year. More like 5–10%, which is still challenging.
Another limitation you will have to overcome is the lack of experience many investors have with online crowdfund investing. However, this is a fantastic opportunity for Healthy Workplaces to stand-out from the crowd with a high-quality business plan and revenue sharing offer that delivers sustainable results and compelling social and financial returns.
Raul: Mark, I just did a Google search and found angel and VC investors in the U.S. make about 50 billion dollars’ worth of equity investments each year. So, if 70% fail, that’s $35 billion down the drain. How do we avoid becoming one of those?
Mark: First, you need to raise flexible growth capital by selling a share of revenue, not a share of equity. Remember, equity investors are not your friends. They are 10X profit-driven investors first and foremost. They only make money if you rapidly grow the business and then sell it. Stay away from any form of financing that limits your flexibility and ability to build an enduring business for long-term success.
Second, I shared three key management capabilities in Key Finding #9. I recommend this team start building the capability to (1) manage organizational change, (2) lead business transformation, and (3) create a high-performance work system. These are the key management capabilities most equity investors fail to check in due diligence, but which are critical to long-term business success.
Raul: Is that a real story about the angel investor losing $1 million?
Mark: Yes Raul, it’s true. This angel and venture capital investor was one of two finance experts I worked with during my research and design. By the way, this gentleman spent the majority of his career in Silicon Valley as a serial entrepreneur and venture capitalist, personally raising $75 million of equity investment.
He confirmed my key findings on equity investment and advised on the design of our innovative 3X-in-10™ Revenue Sharing Offer. I appreciate his sharing his experiences with me. He asked that I not disclose his name, which I’ll honor.
Marcie: I read that article in Atlantic Monthly about gender bias in Silicon Valley. How can women successfully raise capital or make profitable investments if men have all the power?
Mark: Marcie, my answer is simple. Don’t compete in a finance and investment system with rules created by men for men. You can avoid so many of the hassles, costs, and pain by just avoiding this broken and biased system. You’re not going to wrestle away the power and control. But you can easily avoid all the negative problems with a new model built on revenue-based crowdfund investing.
Women have so much talent to offer this world. Unleash it with a new system of finance and investment that puts the needs of women first.
Yvonne: Mark, we want to have you back to show us this new system and the 3X-in-10™ Revenue Sharing Model at the heart of this system. But our time is almost up for today. What parting thoughts do you have for us?
Mark: Thanks, Yvonne. I do have a parting thought. It’s a quote from Buckminster Fuller who said: “You never change things by fighting the existing reality. To change something, build a new model that makes the existing model obsolete.”
In conclusion, what are your inner barriers?
In this section of Gender Wealth Strategy©, we discussed the external barriers preventing women and HeForShe advocates from successfully raising flexible growth capital and making profitable and impactful investments that build financial security and wealth.
However, we did not talk about two “inner barriers” that sometimes create conflict in women: money and power. Author Barbara Stanny in her excellent book, Sacred Success, described it this way:
“Men are motivated by profit, perks, and prestige. For men, the promise of affluence is a powerful incentive. But it’s different for women. A woman is rarely motivated by money alone. What motivates her, most often, is the opportunity to help others. These are two very different paths–show me the money versus show me how to help.”– Barbara Stanny, Sacred Success
Stanny adds: “I believe when enough powerful women in partnership with enlightened men come together, we’ll have the resources, values, vision, sensitivity, and courage to loudly, proudly, and decisively say no to the “old boys’ club,” paving the way to saner solutions for healing this planet and changing this world.”
In this short exercise, we’d like you to think about four questions. There are no right or wrong answers here. It is a conversation with your inner voice (yes, the one that usually visits in the middle of the night). Here are four questions to think about:
After recording your responses to these questions, continue on to Whose Needs Come First?, the next module of Gender Wealth Strategy©.