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I was intrigued when Matt Smith, a Bend entrepreneur developing a mobile app and looking for investment, proposed the idea of structuring the investment as a “Shared Earnings Agreement,” or SEA. This is a new type of investment vehicle that is attracting attention in the angel investing community because it offers advantages for a small investment in a startup business. It’s neither debt nor equity, exactly, but a new hybrid of those two forms of investment.
When certain types of angel investors conclude that a startup idea is “just a lifestyle business,” it’s the most withering form of insult. Why would that be? Well, a rule of thumb guideline shared with new angel investors is that startups will either produce a return of “10X” or zero, so you need to invest in ten different startups to break even. So a “lifestyle business,” which is capable of succeeding on a small scale, supporting the entrepreneur and a small staff, is never likely to “scale” or “blow up,” so it doesn’t offer the exciting possibility of a 10X return.
But a shared earnings agreement is investing, not gambling. And it’s attractive to many angel investors, who have a dual intent to their investments. We want a return on our money, sure. But we also want to invest in our local communities, and provide support and guidance to entrepreneurs who are just trying to do what many of us have already done.
An investment group called Earnest Capital developed the SEA concept with the idea of supporting entrepreneurs through the early growth of their companies, while creating minimal pressure on them to grow too fast or in a particular direction. Once the business reaches a modest level of profitability, the SEA calls for the company to make payments to investors, but only until the investor receives payments up to a pre-determined “earnings cap,” which is usually around 2-4 times the original investment. So if an investor puts in $50,000, and the negotiated cap is 3X, then the payments stop once the investor has been paid $150,000. The investors don’t take ownership of the company, and once the payments are complete, the founders are free to continue on or do whatever they wish with their business. Earnest Capital and some early pioneers were so excited about their shared earnings model that they “open sourced” their idea, making key legal documents available for others to use as a starting point.
I was thrilled to become the first outside investor in Tribe Pilot, Inc., under a shared earnings agreement with a 2.5X earnings cap. If the company succeeds, and I receive payments up to the earnings cap over a ten-year period, the rate of return would be at least ten percent compounded annually, while a five-year payback would produce a rate of return of over 25 percent. And I will happily wish Matt well as he goes on his way with a company he continues to control.
With a background in business valuation, Susan Massey invested in and ran several businesses. After a successful sale of a start-up company, Massey became an angel investor. She has participated as an investor with the Bend Venture Conference, and was a founding investor in Cascade Angels.