Is This a Smart Way to Get Funding? No. Absolutely Not.

I’ve finally gotten around to reading the May 2010 issue of Inc. Magazine. I couldn’t believe what I was reading the other night when I read the article Is This a Smart Way to Get Funding?. Essentially three kids out of college are selling a percentage of their future earnings for cash now:

Erickson and two other young social entrepreneurs recently made the decision to, in effect, take themselves public. Through an online marketplace called the Thrust Fund, the three have offered up a percentage of their future lifetime earnings in exchange for upfront, undesignated venture funding. Erickson is willing to swap 6 percent of her future lifetime earnings for $600,000. The other two entrepreneurs, Saul Garlick and Jon Gosier, are each offering 3 percent of future earnings for $300,000. Despite the fact that her plans remain vague — she is writing a book and has ideas for nonprofit and commercial ventures — Erickson says the response from investors has been positive.

Let’s stop right there. She doesn’t even know what she’ll be doing with her life. And she wants funding? Because she’s smart? Or because she’s a nice person? I don’t get it. It’s akin to selling an idea because you think it has value. What value are these investors getting. If you really need funding, why not start a venture that will actually produce a return and then sell a percentage of that?

This might actually make sense from an investors standpoint if she had a job. A promising young doctor or lawyer or engineer, or a professional athlete. Then again, a promising young professional doesn’t need an investment because they’re already earning money.

Also, I’m not so sure this type of “salary prostitution” is legal (what if she “fails” and has a normal job and needs every penny she makes?), but I suppose that’s beside the point.

Then there’s the factor of motivation. At least when someone takes VC they’ve done something. They’ve created a demo. They’ve started working on a product, or maybe even released it. How many people just out of college would be motivated with $600k in their pocket that they don’t have to use for any particular purpose to return on the investment?

In sum, I think this is a bad idea for the kids and for the investors, and I agree with the quote from Neil Patel later in the article.

Neil Patel, a Seattle-based angel investor and co-founder of the Internet analytics company Crazy Egg, says it doesn’t work that way in the real world. “Hunger, in my opinion, is what makes most entrepreneurs successful,” he says. “Give a young entrepreneur a big check, and that takes away a lot of their drive, because they don’t necessarily have to make money that month or even that year to survive. Without that lump sum, you’re going to figure out a way to make money.”

15 comments on Is This a Smart Way to Get Funding? No. Absolutely Not.

  1. Tim says:

    I’m just blown away by how ignorant investors can be, the fact that it’s being taken even sort of seriously is mind blowing. What really gets me is it appears that the 3 who are looking at becoming indentured servants for life have experienced next to no profitable business experience. Look at average lifetime earnings for Americans with various levels of education granted this is an average, but I see nothing in that article that suggests above average potential and that makes them extremely over valued. Her lifetime earnings would have to break $10m in order to see any return based on her proposal. Factor in disabilities, accidental death and whatever else life throws at them and it’s hard to imagine a decent return is worth the gamble.

    I agree with Neil Patel, the hunger is what makes entrepreneurs so unique, the ability to play a veritable Rumpelstiltskin and spin next to nothing into a sustainable business.

  2. Rob says:

    This could be a really dumb move for either party, depending on how things go.

    On the side of the individual, they’ll effectively be indentured as Tim said and that’s not going to be the greatest of feelings, regardless of the money. As has been said, I don’t think that having all that money available will be a great motivator.

    From the side of the investor it seems quite risky. That’s a good chunk of capital up front that is going to be repaid over a hella long period. Nobody knows what could happen in that time – she could earn very little, skip out on the contract (what would happen?) or die.

    Are there get-out clauses?

  3. Tim says:

    Rob, they can always get out by dying! Isn’t that a cheery thought.

  4. Adam McFarland says:

    Totally agree with everything you guys said. Good link Tim. That really makes you wonder how it could possibly be considered a good investment at all. The whole time I was reading it I kept thinking “this can’t actually be real”

  5. Rob says:

    I wonder if the contract would actually be up if she died. Do you think that they would have a claim on her estates, or would the debt be passed to heirs?

    • Adam McFarland says:

      My guess is that they would try to claim on her estate and that would be all. Although, there may be some minimum payout and then maybe the debt would be passed to her heirs. Imagine inheriting that!

  6. Tim says:

    If I were to invest in this I would require life insurance and a LOT of it, enough to cover the investment in full plus any fees associated with getting involved.

  7. Rob says:

    When you invest you do that and in return get risk (usually). What I think we’re all thinking is that it’s enough of a risk that she isn’t going to earn more than 10 mil, never mind her dying!

  8. nethy says:

    The $600,000 question is whether or not she was really able to find investors.

    Those terms means her earning potential is being valued at 10,000,000 today. Taking into account risk and time, that’s assuming she earns what $50m over her lifetime?

    I’m pulling numbers out of my ass, but isn’t that something like 10 or 20 times average, even if you only compare her to (for example) law graduates?

  9. Tim says:

    Nethy, ironically enough the student who picked that $600,000 value also pulled that figure from her ass – so you’re not too far off!

    You do bring up something I’ve totally forgotten, that $10m in lifetime earnings is in todays dollars, with inflation it will be MUCH greater. This just has disaster written all over it, what about retirement accounts? Will her partial owners get a piece of that? What about birthday and wedding gifts? The list could go on and on… then factor in the legality of this, if she changes her mind and defaults on the payments it may be difficult to collect, the courts may not support a case that claims even partial ownership of another. This is worse then the girl who auctioned her virginity on ebay.

    • Rob says:

      Re. the girl on ebay – I agree. at least in that transaction both sides were exchanging something of less value (to them) in return for something of more value (again, as perceived by them). This is just plain nuts.

  10. Adam McFarland says:

    “This is worse then the girl who auctioned her virginity on ebay.”

    Haha hilarious but probably true.

    Basically the more we think about it, it seems like a worse and worse idea. That’s just a bunch of guys on a blog thinking about it here and there for a few minutes. How did this get enough support to get into Inc.? Shit, how didn’t the first person she told the idea to say “no, that’s a horrible horrible idea, don’t ever mention it again. I’ve lost a little respect for you.”

    • Rob says:

      @adam – LOL at the “little respect” comment.

      Everyone – under what terms would this be a viable idea? Could it ever be? Are there any figures that work?

      Also, do you think a man could get more money than a woman as a woman is more likely to take a career break to have children? (Can of worms? Much!)

      • Adam McFarland says:

        I think you could maybe get the math to work out, assuming you took more of an average salary and factored in all of the risks, but I’m not sure if it would ever be legal. And if it was legal, I think it borders on stupid in the sense that the kid is almost an indentured servant and the adult isn’t seeing a return on their investment for like 50 years unless the kid becomes Bill Gates.

  11. Tim says:

    With my understanding of US law, I’ve never really investigated this area of law, I don’t think this would be legal as it is outlined in the article. I believe it could be argued that it falls under the 13th amendment, then again I’m not a lawyer and this is FAR from my area of expertise when it does come to law. Either way the contract would have to be drafted very carefully and even then if it were to go to court it may not hold up. If the contract is deemed as a violation of constitutional rights, the agreement would mean nothing and the investors would lose their entire investment.

    In order to make this sort of deal more feasible, in my eyes at least, a number of things would have to change. For starters any time I see round numbers in a business plan or proposal I always have to ask myself if this figure has any data backing it or was it just arbitrarily chosen. If she were looking for $613,867.00 I think it would be more believable then a nice round $600k. That aside, looking at this current deal the initial investment amount would have to be lower and the “ownership” would have to be higher, say around $400k and you get 10-15% of future earnings(pre tax of course) with sufficient life insurance and collateral equity to secure the deal for at least 20 years.

    As Rob mentioned the main focus of the article was on a female student, I think that does lower the value. I’m not trying to be sexist, but this is a business deal and the metrics and data to support my claim is pretty compelling. High level executives and founders of larger successful businesses are very rarely women, not to say it never happens, but it’s statistical far less common. Then factor in that she is considering taking on up to 20 investors to reach her randomly picked financial target, that in itself will take a lot of time every week to coordinate and manage, time spent with that is time NOT spent working toward making money. With a group of 20 you can guaranty there is going to be at least a few who will need a lot of hand holding and want to remain in damn near constant contact. Then there are the other long term potential problems, getting married, having a child, etc…. What happens if she gets married and changes her name, which is the norm even today? The contract may be on some shaky ground if that happens. What if she has a child and feels that is now the purpose of her life now and is going to stop working?

    Bottom line is there is not a lot of strong data, at least that I’ve seen that helps sell this to me, in fact the more I look at it the worse of an idea that it looks! Most female Billionaires have inherited it or are second, third of even forth generation involvement in a family business. The Oprah’s are FAR less common, there may not be another Oprah in our life time, she is literally 1 in 350 million – that’s one hell of a long shot!

    One final note/point and I’ll shut up. Do you think Bill Gates would have reached the level he did if he didn’t have to scratch and claw his way to the top? If he had a cushy big financial backing I bet he would have lost a lot of the drive he had earlier in life. To that same point, Gates lost a lot of his tenacity and his drive for world domination slowed significantly when he got married, he shifted his goals to philanthropy and his family. Since these events took place his net worth has declined by about $50 billion dollars the goose stopped laying the golden eggs.

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