Edtech isn't all about VC 💰 Newsletter #62
4 funding models for your education startups, and how to pick one that works for you.
Hi there! Alberto here, joining from Madrid this week.
The Transcend Newsletter explores the intersection of the future of education and the future work, and the founders building it around the world.
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Last day to apply: 🗓️Friday, February 3
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👉RSVP here for Friday - Feb 3 @ 8 am pt
Conventional wisdom says that most startups fail because they fail to find product-market fit.
This is mostly right, but with a small caveat: I believe most startups fail because they fail to find product-market fit that fits their funding model, and the growth expectations that come with it.
Let me share an example to illustrate this point: we’ve seen the struggles of coding bootcamps in the last years as a failure to find a real market. Coding bootcamps like Lambda School have struggled mightily, and many have closed down, like Make School, Dev Bootcamp or The Iron Yard. All of these had either raised venture funding to grow or gotten acquired by incumbents.
Did these bootcamps have a product that resonated with the needs of students and employers? Some probably didn’t, but many of them did!
Funding-market fit
Then why did they fail? Their startups weren’t growing enough for the funding model they had chosen: venture funding (VC). They had set expectations to grow really fast and ultimately become unicorns, as the founders and investors were not interested in a building small startup that grew by single digits yearly. There was a cognitive dissonance between the reality of the business, and the model that the founders & investors had set for their organizations.
We shouldn’t simply describe this as a failure to find-product market fit, but also a failure to find funding-market fit. Product-market fit isn’t just about selling and growing: it’s about selling and growing at the appropriate rate for your funding model, and in some cases it seems that venture funding wasn’t right.
But VC isn’t the only funding model out there for founders. It certainly is the loudest, with funding rounds, valuations and exit stories all over the startup world, but we hope this overview inspires you to explore others if you feel like it.
What funding models are there?
Funding models are defined by return expectations: as an investor, what is a percentage return you expect to earn from an investment in a startup? Return expectations are everything, as they impact how investors raise capital, invest it, and how they relate to their portfolio.
Based on our work at Transcend, the 1000s of investors we’ve met, and our own investments, we believe there are four funding models, each with a separate return expectation (we’ll call them ROI for simplicity, or return on investment): venture capital, bootstrapping, patient capital and nonprofit.
Your startup will move at the speed of your funding model, so let’s break down each one of them by ROI so you can identify the one that fits you the most.
Venture Capital
Target ROI for every startup investment: 100x
Venture Capital is the most extreme type of funding model.
Venture Capital investors (VC firms) invest capital in exchange for equity in the startup, and have an expected ROI of 100x: they expect one single home run startup exit to return their whole portfolio!
They usually don’t care too much about companies that double or triple their investment, as those barely move the needle. VCs are risk-seeking, so as to find models that can multiply their investment by 100, and they do so by investing in startups with very high barriers to entry (usually high upfront investments or very technical products) in the hopes they can become high-margin companies.
Very few startups are a great fit for VC: only those who really want to swing for the fences and build something very, very big. And this comes with tradeoffs, like giving up on models that work well but don’t have the potential to become a billion-dollar business, or pushing your team to grow every single month. It’s not for the faint of heart.
Sometimes founders aren’t convinced that they really want to go this route, but they take venture funding because it’s the only one they know about. This can be a costly mistake. A VC-backed founder described it this way:
“if you don't have a strong sense for the formula for how this thing grows and how “dollars in equals growth out”, then you can find yourself caught in a trap”
True venture-scale startups are hard to find in the education space: one positive example is Duolingo, which raised $180M+ to build a brand and acquire users before they monetized, and now is valued at almost $4B in the public markets.
There are many venture funds specialized in education right now, like GSV Ventures, Emerge Education, Reach Capital, Owl Ventures, Learn Capital, Rethink Education, Brighteye Ventures, and many more (our very own Transcend Fund is also a venture fund!)
Note on angel investors: angel investors write checks personally, and each angel investor will invest with different motivations and return expectations – make sure you have a conversation and clarify both of your goals with any angel inverstor.
👉 Here’s Jessica Millstone from Copper Wire Ventures addressing what it means to raise venture capital at the early stages.
Bootstrapping
ROI: 10x
Bootstrapped startups don’t sell their startup equity, which gives them greater control over their company, but with less capital to operate. Bootstrapped startups tend to work in well-validated markets with low upfront investments (like services, training, agencies, or studios), which pave the way for high-margin businesses that can be self-funded.
The target ROI is lower because it’s generally only the founder and the company’s capital at stake, so 10xing your capital is a really great outcome!
There are new instruments that enable bootstrappers to raise capital without selling equity (to avoid dilution) in the form of debt, like revenue-based finance or venture debt, and some specialized funds like the Calm Company Fund focus exclusively on these businesses.
This option also gives founders lots of optionality – many founders bootstrap their businesses until they are sustainable, and then raise capital with a lot more leverage in the negotiations, like PhysicsWallah out of India.
Examples of these startups in the education space include Smartick 🇪🇸 or CodaKid 🇺🇸
Annie Dean, the co-founder of Recast Success told us about her decision to go bootstrapped – she realized her edtech startup had a lot more “ed” than “tech”, so she decided to keep the operation lean and bootstrap her way to sustainability.
Patient Capital
ROI: 10-50x
Patient Capital is the most nebulous funding model, because a) it’s fairly new, and b) it’s very niche. Some folks call it venture philanthropy. But I think it’s going to play a very important role in the future of edtech investing, so let’s break it down.
Patient Capital investors generally expect a less-than-VC financial returns because, while these are profit-seeking startups, they are very focused on the social impact of the startups they back. They often measure the social impact of their investments very carefully. Many combine grants with for-profit investments, and new models of patient capital are emerging every month.
Investors in this category include Long Term Impact, Valhalla Foundation or NewProfit.
A VC-backed founder we interviewed talked about how this model fits education really well, as many companies scale their impact but cannot scale revenue or exit size: “Education exits don’t need to be like fintech / crypto 100x exits!”.
Note on impact venture funds: there are many venture capital funds that label themselves as impact funds, but that doesn’t mean they are patient capital per se. Some venture funds have venture return expectations, but also proactively measure the social impact of their portfolio (e.g. Reach Capital), and they shouldn’t be confused.
Nonprofit
ROI: 0x
Nonprofit investors do not look for a financial return, but for a social impact return. Investors include foundations or philanthropic funds, and their primary goal is to invest in companies that can scale their student outcomes (e.g. number of students reached, % of students who complete a degree, etc.), and will be rigorous with their impact assessment.
Nonprofit startups can raise large amounts of nonprofit funding (like Code.org or Khan Academy) or operate essentially as bootstrapped founders (only taking small member donations, like freecodecamp).
Examples of nonprofit investors include New Schools Venture Fund, the Gates Foundation, the MacArthur Foundation or UNICEF grants.
Hadi Partovi, CEO of Code.org, talked about how their nonprofit status was key to their growth, as they were able to recruit key ambassadors and team members given the focus on a mission without a financial component:
“I am not sure we would’ve been nearly as successful if we started our project as a for-profit. Our ability to win the support of teachers, world leaders, and celebrities has really helped grow our impact, and I don’t know if that would’ve been possible as a for-profit”
👉Check out our full interview with Hadi Partovi here: Code.org: The Billion-Student Startup🎓Transcend Newsletter #54
There is no perfect funding model, just one that works for you, your startup and the mission you are trying to achieve.
You will move at the speed of your funding model, and we think it’s time we open up the conversation about all the options founders have, so you can get aligned with your own team and your investors!
Next steps
A key part of our Transcend Fellowship experience revolves around supporting founders with fundraising and identifying their funding model, and we’d love to extend that to our newsletter readers!
If you are thinking about your funding model or struggling with your fundraising process, we want to help!
Reply to this email, tell us in 2-3 sentences about your startup and your challenge, and we’ll offer you personalized resources and guidance!
The Roundup ☀️
🎓 Transcend Fellowship applications for TF10 close on Feb 3. Apply here.
👩🏫 EdSurge: How are AI Tools substituting teaching? Read more.
📰 Brighteye Ventures: The European Edtech Funding Report 2023. Read more.
🎥 HigherEd meets Hollywood: Dreamscape Learn bags $20M. Read more.
🤖 Forbes: Why 2023 will be the Year of AI in Education. Read more.
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Alberto
Excellent perspective Alberto. Completely agree that there are many initiatives with different legal structures that are possible. Its valuable that you have connected these with types of funds and RoI.
Personally, I believe that more data needs to be captured in terms of qualitative impact and quantitative impact. My experience has been that for profit education entities measure a lot of parameters in order to show traction. The not for profits on the other hand, focus a lot more on qualitative impact...how much a human's life changed (or something like that).
The way entrepreneurs define scale is also very different for various categories. Maybe its because of this parameter or RoI. I have always wanted a much deeper collaboration among the various categories of players.
Akhil Kishore
Partner: GIA ADVISORS