Why I Invested in SparkToro

Three years ago, I wrote in Entrepreneur that revenue is the only kind of funding your startup should need. I said that raising a round tends to create a “churn-and-burn mentality” that creates “an environment of short-term thinking.”

Given that we just told our story of how we used debt to realign Wistia and our shareholders for the future, I thought it would be interesting to dive into why I decided to invest in SparkToro a couple of months ago.

SparkToro is a software company designed to help marketers better understand what publications and influencers reach their target audience.

I haven’t suddenly reversed my views about fundraising. I still think that the status quo of fundraising is deeply broken for most companies as it limits their options and can misalign incentives.

I’m excited about SparkToro because they’ve shown me that there’s a promising new way to reject the status quo. They’re running an experiment to see if investors can give companies the space and incentive to grow organically into whatever makes the most sense for that specific company, whether that’s a huge IPO or just reliably creating value and bringing in revenue on a smaller scale.

That experiment has only just begun, but I’m already optimistic about what the results could mean for the future of fundraising.

Why we need experiments like this

Raising money seems like success but it’s only a ticket to play the game. Unfortunately, the way we decide which companies to collectively focus on is driven much more by funding and valuation than customer value.

Most venture funding is obsessed with looking towards huge events that will multiply investors’ upfront capital many times over — something like a buyout, or an IPO. From the entrepreneur’s perspective, there’s a deep problem with that model: even if you start a company that might end up generating that insane amount of growth, accepting a VC’s terms prematurely limits your company’s possibilities to only those boom-or-bust outcomes.

Plenty of companies create a ton of value for their customers, their team, and their investors without this kind of unbridled growth — by distributing dividends, for example. But once you’ve gotten on the VC bus, other options can quickly fade into the rearview mirror. And even if a big exit does end up being the best option for your company, traditional fundraising can be counterproductive to your company’s development.

There are three main ways VC funding can end up hindering you instead of helping you.

Traditional VC funding can estrange you from your company’s growth. Many traditional VCs expect founders to take sizeable salaries once their companies get funded. Those larger salaries can disconnect founders from the real progress that their company is (or isn’t) making.

Before the VCs come in, salaries are directly tied to growth: founders gradually pay themselves more as revenue gradually increases. VC-funded salaries, on the other hand, are effectively pre-paying for expected future growth. A VC raises a founder’s salary from $30k to $80k, and suddenly the founder is working like an employee to meet someone else’s growth projections, rather than leading the company’s development at whatever pace feels most appropriate.

Traditional VC funding is designed to be addictive. It’s called “Series A” for a reason: once you’re in the VC funnel, there’s an expectation that you’ll have future rounds and raise more money. Founders can end up focusing more on running the fundraising circuit than on actually running the company: everything is about hitting the milestone for the next round of funding, not about creating customer value.

At its worst, the addictive nature of fundraising can leave founders emotionally compromised. Founders chase the high of closing a high-profile, prestigious round, and then they end up depressed after the round closes. With that in mind, it’s no wonder that founders wouldn’t be able to sustain running the company in the long-run — which aligns them perfectly with VCs who are looking for an exit.

Traditional VC funding can rob your company of strategic focus. VC funds focus on saturating companies with cash to fuel those 10x-100x returns they’re hunting. As Rand Fishkin, one of SparkToro’s founders, discusses in his book Lost and Founder, this can create a pressure to spend more money than you know what to do with.

What would you do if you had to spend $10 million but your core product strategy could be executed with $2 million? Maybe you’d build another product. Maybe you’d try to penetrate a totally new market. Maybe you’d do both! Before long, you’d have a lot of irons in the fire beyond your core product strategy, and that split focus could end up distracting your company from what made it valuable in the first place.

In opposition to these pitfalls of traditional funding, several experiments have recently cropped up in an effort to fund companies in a more sustainable, empowering way. indie.vc provides funding and connections to profitability-focused companies without encroaching on their independence or redirecting their focus to funding milestones. RevUp Capital invests $100K-$250K in startups, taking no equity, helping them use that capital to efficiently boost their bottom line, and sharing in the subsequent profit.

When Rand Fishkin and Casey Henry founded SparkToro, they approached fundraising with eyes open to the costs and benefits. While they could have bootstrapped the company, they chose instead to make their own contribution to this burgeoning field of new fundraising methods: they’re building a new, open-sourced way for investors to succeed by giving companies room to grow naturally.

Reframing investors’ relationships with companies

SparkToro and I are betting on a simple, powerful idea: if you invest in something you believe in, it’ll grow into something good — even if you don’t know exactly what it’ll grow into.

Rand and Casey started SparkToro because they see a problem that they believe they can solve: it’s virtually impossible to discover every publication and influencer that matters to your target audience. Their solution to this problem might end up growing rapidly, but they don’t want to be tied down to the expectation of insane growth from the get-go.

We intend to pursue this problem space, which we believe is a giant market with a ton of opportunity, aggressively. But we won’t do so with a “growth at all costs” mentality. We are not willing to trade lower risk, profitable growth for a higher growth rate that brings high risk consequences to our long-term prospects.

It’s crazy that there isn’t already a commonly accepted fundraising option for founders who are passionate about solving a problem, but don’t know how much growth potential their solution will end up having.

Rand and Casey think this is crazy, too: that’s why they’re open-sourcing all of their investment documents. They don’t want their investment strategy to be a secret sauce: they want it to empower a new generation of companies that might never get off the ground otherwise.

The key to SparkToro’s investment model is flexibility: it gives the company the optionality to grow in the way that makes the most sense for it at any given time, while also ensuring that investors will get a fair share of that growth.

  • SparkToro is an LLC, which gives them the option of profit-sharing through dividends.
  • SparkToro has the option to either pay dividends or reinvest in growth in any profitable year.
  • SparkToro’s team (including founders) has salary caps that can’t be exceeded until investors’ original capital is repaid.
  • If SparkToro is sold or acquired, its investors get the greater of two amounts: their initial investment, less profit distributions up to that point, or the percent of the company’s units represented by their shares.
  • SparkToro has the right to raise future rounds, and its investors have the right to participate in those rounds pro rata.
  • Future changes in SparkToro’s structure require holders of at least 80% of units to vote in favor of those changes.

I’m excited about this investment structure because it establishes a healthier relationship between investors, companies, founders, and customers — one that avoids the three problems with traditional VC fundraising that I mentioned above.

SparkToro won’t be estranged from its own growth. Explicit salary caps prevent its team and founders from losing sight of its current growth rate, and the option to pay dividends or reinvest in growth forces them to consciously evaluate their growth rate in every profitable year — without the arbitrary demand for maximum growth as fast as possible.

SparkToro won’t get addicted to fundraising. Without the pressure to have insanely fast, outsized growth, there’s no reason to chase further growth with further fundraising rounds. Rand and Casey have already emphasized that they don’t intend to have another round in the future.

SparkToro won’t lose its strategic focus. The flexibility of the company’s terms ensures that SparkToro and its investors win in any condition of profitability, which lets them focus on a single, simple strategic goal: getting and staying profitable.

As an investor, I’m not betting on a low-probability, high-profit acquisition: I’m just betting that this company’s real solution to a real problem will be profitable.

That’s a different kind of bet, and I’m hoping it’s one that can change the landscape of startups in the years to come.

Changing tides

It’s been said that 3 out of 4 startups fail to return investors’ capital. But does anyone really think that 75% of VC-funded startups are bad ideas?

We do entrepreneurs a disservice when we prematurely box their imaginations into a grow-or-die mentality. And as much as we might try to “solve” this problem by decrying fundraising altogether and preaching the value of bootstrapping, that’s no real solution.

Imagine a tech industry where people invest in good ideas without knowing or caring about exactly what kind of company will grow out of that idea: an industry where we give founders the space to explore and forge the best path for their company, rather than “helping” them to find the path with highest potential growth.

That’s the future that SparkToro’s investment model is trying to realize, and it’s one that I’m thrilled to be backing.

Why I Invested in SparkToro was originally published in Savage Thoughts on Medium, where people are continuing the conversation by highlighting and responding to this story.