The SaaS Anti VCs

How the math works for bootstrapper-friendly investors

Some may think there are only two paths - raising VC or bootstrapping. Yet there are numerous options in between.

For example, investors who focus on capital-efficient SaaS companies and leave it up to the founders to decide which path to take.

Since I first came across models like those from Tiny Seed and Calm Company Fund, I've wondered how the math works for them.

Now I finally took a closer look.

1. Investing early and indexing broadly

It is assumed that the return distribution of VC investments follows a power law curve. More precisely, a power law with ⍺ < 2.

VC Power Law | Source: Robot Mascot

Based on this, various studies like the one from AngelList suggest that investing broadly is the superior strategy. Y Combinator has been doing this for years with great success.

The chart below illustrates the effect of increasing the number of investments on the largest expected return. As you can see, for ⍺ < 2, it makes sense to build a portfolio of at least 30+ startups.

Expected Return Multiple | Source: TinySeed

However, this is only true if you invest early. Late stage investors need to be much more selective.

That’s why both TinySeed and Calm Company Fund index broadly and focus on very early stage startups with a working product and initial revenues (high 4-figure to low 6-figure ARR). Their preferred entry valuation is <$5M and the targeted equity stake ~5-10%.

2. Hybrid stock/dividend instrument

Investing in capital-efficient firms is likely to result in fewer total failures, but also fewer home runs. Therefore, there is an additional dividend component that reduces the dependence on outliers.

Tiny Seed invests at 1x liquidation preference and a side letter, where the founders agree to a reasonable salary cap. Anything above will be paid out as dividends, of which TinySeed participates pro-rata until a cap is reached.

Calm Company Fund has a similar model. They invest via a financing structure called Shared Earnings Agreement (SEAL), through which they receive an agreed percentage of the founders' earnings once these exceed a certain threshold. It’s capped at ~ 2-5x initial investment, so they don't get it in perpetuity.

Their equity component is a convertible instrument similar to a SAFE. The equity entitlement decreases as the shared earnings are paid, with a residual basis remaining after the cap is reached.

3. Added value

It looks like the value added is also higher than that of the average VC.

TinySeed runs a year-long accelerator with prominent mentors. Much longer than the 11 weeks at Y Combinator. So you can assume that they work very closely with their startups - at least in the first months post investment.

Each of the Calm Company Fund mentors is also an investor and therefore has some skin in the game. This leads to an alignment of interests and makes them more likely to invest time in supporting portfolio companies.

The numbers I found for Calm Company Fund regarding returns don't look too bad.

Track Record | Source: Calm Company Fund

I also recently came across D2 Fund, which seems to be the new kid on the block - and I'd love to see more “bootstrapper-friendly” investors in the future.