Why the Startup World Needs New Funding Options
Imagine you’re a startup founder. You’ve sourced your founding team, and conducted some early market research that’s very promising. Now, you need capital to build the MVP of your product and validate your business. Where will you turn?
Unfortunately, you don’t have many options:
- No bank will extend credit in these early stages.
- Most people do not have $10,000+ sitting idle, so you won’t be able to self-fund.
- Pulling together $50K from friends, family, and personal savings isn’t always possible.
- Until you have customer traction, a realistic business model, and an addressable market valued at approximately $1B, Seed and early stage VCs typically won’t take a second look.
Even when friends and family may be able to offer backing, an early or bootstrapped company may want to accelerate growth or traction with a large capital injection.
As an early stage startup founder, your only option is to ask friends and family to invest in you. This “friends and family round” is where your wealthy connections take a chance on your potential.
If you don’t have willing or wealthy friends and family, or you are not inclined to ask your relatives for investment money, you’re out of luck. You can try to launch your startup while working your day job, using your income to pay for startup costs. That is, if your employer allows you to. Or, you can charge up your high-interest credit card - but this route can cause more harm than good.
If you’re not personally wealthy or connected to people who are, it’s very difficult to secure early stage startup capital.
The Reality of Startup Funding Today
Today, idea- and early-stage founders who need capital to grow have one primary option: asking friends and family for money.
Typically, these “friends and family” investments come in because there’s trust built between you (the founder) and the capital provider. That trust takes years.
Founders who don’t have wealthy connections might try to turn to angel investors and early stage VCs.
In the absence of established trust, these investors bet on an idea and the execution of that idea, which is extremely risky (90%+ failure rate). That’s why angels and VCs rely on heuristics, herd mentality and power law portfolio construction to fund opportunities that fit a certain criteria. Less than 5% of startups will fit these criteria and secure angel or early stage VC investments.
The reality is that 95% of new businesses fall outside that criteria, yet many of these are very capable founders with very viable and innovative businesses.
How does the status quo impact the startup ecosystem?
- Minority and female founders may be excluded from entrepreneurship from the very beginning due to their personal financial situation.
- Privilege and powerful networks is a functional prerequisite for accessing the capital needed to start and grow a business.
- This leads to a homogenous startup ecosystem that solves the same problems in the same types of ways, from the very earliest stages of entrepreneurship.
- Untold numbers of incredible ideas never reach the market.
So, there is a clear industry need for startup funding alternatives.
We believe that entrepreneurship and innovation shouldn’t be limited to a tiny handful of privileged founders. That’s why we believe the startup world needs new funding options.
More funding options could lead to:
- More innovation, as different perspectives set out to solve different problems.
- More financial prosperity, as communities and individuals are activated.
- More fundable founders at the later stages, as startups gain traction and evolve.
- A more resilient economy, as more startups and small businesses emerge.
A New Funding Option for Pre-Traction, Pre-Seed Founders
At Chisos, we’re focusing on breaking the bottleneck at the earliest stages of entrepreneurship.
The CISA is an alternative to the “Friends and Family” round. Instead of spending 5 years getting to know you at backyard barbeques, we’re looking at your accomplishments, your career, your vision, and your track record.
By widening the top of the funnel, we’re increasing access to entrepreneurship, creating a new innovation funnel, and increasing the velocity of funded founders to drive more investable companies down the line.
With our proprietary hybrid investment approach, called a Convertible Income Share Agreement, or CISA, we write checks of $15-50K to pre-traction and pre-seed founders. The CISA blends an Income Share Agreement with a SAFE Agreement; you can learn more about how it works here.
In exchange for capital, founders agree to pay a portion of their income and grant a small percentage of equity in their startup. A blended approach allows us to offer capital at a stage when very few other investors will.
It works like a sliding scale, or a see-saw. As founders make payments toward the ISA, they gain back equity. If and when founders raise larger rounds, they reduce their ISA obligations.
Here’s how it’s designed for idea- and early-stage founders:
- Salary Floor: If and when your annualized income ever drops below $40K, you won’t owe any payments for that time.
- No Compounding Interest: Unlike traditional debt-based financing, the CISA doesn’t charge compound interest.
- Repayment Caps: Founders will never pay back more than 2x the investment amount. If you do raise more than $3M in funding, your ISA repayment cap drops to 1X. It’s almost like you’re buying out the ISA.
- Flexible Payments: With $0 payment periods and more founder-friendly features, the CISA payments fit your life - instead of the other way around.
- Retain Your Authority: The equity you grant Chisos keeps control in your hands, so you get to run your business your way.
- Equity Clawback: As you make CISA payments, you’re clawing back up to ⅔ of the equity granted to us.
- Founder Resources and Support: We’re building a network of partners, investors, and accelerators committed to supporting early stage founders. As a portfolio company, you’ll get access to that community and resources.
- Not Unicorn-Hunting: Unlike traditional VC, we don’t need unicorns for our model to work. That’s how we’re able to take a more patient, founder-focused approach to startup funding.
We fund pre-traction, pre-seed founders in the US. To be a candidate for startup funding from Chisos, all you need is an idea. Here’s a deeper dive into our funding criteria.
How the CISA Differs from Traditional VC
Traditional VC invests using just a SAFE agreement, where investors provide capital in exchange for a percentage ownership in the business. This agreement typically is dilutive. Said differently, your new investors get a say in how to run - and how to fund - your business.
The SAFE agreement isn’t typically used to invest in idea- and pre-traction startups, because it doesn’t provide enough risk protection for investors. If it did, we’d expect to see more early stage investments and less emphasis on unicorns. That’s not the case.
The CISA is different. It combines a SAFE agreement with an ISA to provide founders with flexibility and authority, while de-risking the investment for investors.
When founders secure a CISA, they agree to repay Chisos a portion of their future income each month. Like a small business loan from a bank, the CISA is a financial contract and personal obligation that the founder takes on. Unlike an SBA or Bank loan, the repayment amount never exceeds what you can afford. As you make payments, you’re also clawing back a portion of the equity granted to Chisos.
For Chisos, the CISA is de-risked, but not risk-free. Some percentage of our portfolio will probably either decide not to pursue their idea or decide to close their business entirely. Depending on their income, Chisos could lose money if the ISA payments made during the repayment period don’t add up to the amount of capital we extended.
Finally, the CISA doesn’t impact your future growth path. As a founder, you can choose to raise a larger round, bootstrap, or seek capital via other sources. It’s your business, and you can scale your way.
The New Wave of Alternative Financing
Chisos is one option, but there’s a wave of alternative pre-seed and seed funding sources emerging. These new approaches are designed to be more accessible and more founder-friendly. Learn about 5 alternative options here.
Addressing the Diversity Gap in VC Funding
Since there’s very little formal investment happening at the pre-traction, pre-seed stage, there is no reliable source of quality data about demographics and thus diversity of capital access or distribution.
However, we do have visibility into diversity in later stage VC funding - and it’s not promising:
- Less than 1% of all VC-funded startups are led by black founders.
- Less .5% of VC-funded startups are led by Latina women.
- The current VC funding system capitalizes women and minority founders at 80% less than businesses overall.
(Keep in mind that under 2% of all startups receive VC funding, and most of this goes to white, male, Ivy League- educated founders who live in Silicon Valley.)
As much as we might wish the existing startup funding options made entrepreneurship accessible, they don’t.
In a recent report by Morgan Stanley and the Kauffman Foundation, the cost of the failure to fund women and minority owned businesses amounted to a missed opportunity of up to $4.4 trillion.
Our thesis, however, is that by increasing access to capital in a diverse and inclusive manner at the idea and pre-seed stage, this naturally increases the aggregate number of companies with founders from a diverse background. This should begin to change the Venture Capital numbers as these founders grow their companies to stages where they are ready for Venture Capital.
Prioritizing diversity, equity and inclusion isn’t just the right thing to do - it’s also good for business.
How Chisos Solves for Impact
We’re committed to diversity, equity, and inclusion in startup funding. And while we’re not perfect, we are working to ensure that our processes are as fair and equitable as possible. Here’s how:
- We are Diversity VC certified, and continue to work with leaders to evaluate our processes and systems for equity and inclusion.
- Our application is available 100% online, and anyone can access it. At this point, we can only invest in US Citizens, but we’re working to be available to other nationalities soon.
- Our application review and evaluation process is partially automated to be more efficient and reduce bias.
As investors, we don’t “target” founders based on gender, race, ethnicity, or other demographics. We just don’t discriminate or pattern match against female and minority founders, either. There’s a big difference.
We’re on a mission to democratize access to entrepreneurship.
Startups are the backbone of the economy. For too long, becoming an entrepreneur has been limited to the privileged few.
Now is the time to embrace change, shake up the startup funding landscape, and build solutions that are designed to support founders throughout their entire journey.
If you’re an aspiring founder seeking funding, you have options. The Chisos CISA is perfect for founders who aren’t a fit for VC or bank loans, don’t have wealthy friends and family, and don’t want to (or aren’t able to) use a high-interest credit card.