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Leprechaun Funding

Mark Mzyk | October 28, 2009

When an investor puts their own money into a startup in return for a stake in the company it’s know as angel funding. It’s the lowest level of formal funding there is, excluding bank loans and borrowed family and friends money.

Why not go lower?

Leprechaun funding is giving an entrepreneur enough money to get a single, simple application built and launched. It is finding a pot of gold at the end of the rainbow, as opposed to discovering a savior from the heavens. A pot of gold is good, but it doesn’t go as far as a savior.

Why leprechaun funding?

The cost of starting a business continues to fall. It’s at the point that a viable business can be built around making small applications. Leprechaun funding would allow entrepreneurs access to a small pool of cash to build and launch small applications, primarily for the iPhone and Android, but it could be any small application.

The investor gives the entrepreneur anywhere from one hundred to five thousand dollars. The point is to give just enough money to launch a single application that can then start generating revenue.  It’s not enough money for the entrepreneur to live off of, but it isn’t meant to be.  It is meant to give the entrepreneur money to cover development costs to get an application launched. The entrepreneur handles the creation, running, and other costs of the business on their own.

What does the entrepreneur give up? A portion of any revenue generated from the application up to, but no more than, 50%. Leprechaun funding doesn’t suck the entrepreneur dry or wrestle control away from them, but allows them to be creative and try out new ideas.

Any leprechaun contract would also include a buyout clause. At any point, the entrepreneur can buyout the investor and stop splitting revenue. The buyout level would be from one to two times the initial investment. The investor doesn’t lose their money if the entrepreneur wants out and the entrepreneur isn’t bankrupted getting out. The main risk to the investor is that the application fails to generate any revenue, leaving the investor at a loss.

No ownership of the startup is ever given to the investor. For funding this small, that’s a price too high to ask. Leprechaun funding should encourage innovation and risk taking while not drowning the entrepreneur with overbearing terms, but still being worthwhile for the investor. This isn’t a game of home runs, but a game of singles.

Leprechaun funding won’t generate returns like those sought by angel investors and venture capitalists. However, it could provide a decent stream of returns to an investor patient enough to give it a try. The returns aren’t as large, but neither are the risks as great.

Is this an idea worth experimenting on, or would someone be better off just sticking with mutual funds?

Leprechaun

http://www.flickr.com/photos/sblackley/ / CC BY-ND 2.0

Filed in: General.

8 Comments

  1. Comment by TJ Stankus:

    I like it. Microfunding for startups. For $5k you could get something pretty decent launched and cover cost of living for a short time. I think if you could come up with a boilerplate contract and an app that allows developers to privately share ideas with investors, you might have a winner.

    October 28, 2009 @ 14:21
  2. Comment by Mark Mzyk:

    I hadn’t considered creating an app for bringing together investors and entrepreneurs/developers. That’s a good point. A boilerplate contract would also be good, to encourage the idea. I’ll have to potentially seek out a lawyer to create that.

    October 28, 2009 @ 16:54
  3. Comment by Abe Crystal:

    Mark, what’s the difference between this model and something like Y Combinator? Or you just want to see these kinds of funding models become more widespread?

    Also, have you seen http://www.kickstarter.com/?

    October 28, 2009 @ 17:41
  4. Comment by Mark Mzyk:

    Abe,

    This differs from Y Combinator in several ways. One is that it is intended to operate on a smaller scale than even Y Combinator or TechStars. The other is that those programs look at the entire startup. The point of leprechaun funding is just to fund the creation of small applications, one application at a time.

    An example might be a startup that wants to create flash based online games. If they received leprechaun funding, they would get funding for either one application at a time, or they would receive multiple contracts to fund several apps. They would then build the app or apps, release them, and then the investor gets part of the revenue that comes in.

    This allows the startup to get small amounts of funding as they need it to build applications, but they don’t slowly transfer ownership away. The investor gets revenue from the app as their return for investing in it.

    I think what I’ve proposed is very muck like Kickstarter – which I had not previously heard of. The difference with my proposal is I structured it more like a formal investment and I didn’t imagine there being investors pooling their money, but instead a single investor providing funds.

    Does that clarify things for you? What is your opinion now? The more angles this is viewed from, the better it can become.

    October 28, 2009 @ 20:38
  5. Comment by Chris:

    The funds invested may be small, but the profits from (potentially) small revenues from these applications may not be worth the investment and time for investors. I think investors want two things: 1. To make ridiculous returns 2. to be able to say “I invested in Google when it was just a research project.” This model doesn’t give them either, because those two things are one in the same.

    How does the Ycombinator model drown the entrepreneur with overbearing terms? And if this were to be a “mutual fund of start-ups” for the average person, how would they get liquidity?

    October 29, 2009 @ 08:33
  6. Comment by Abe Crystal:

    Yup, makes sense. Check out http://billflagg.blogspot.com/2009/09/creative-capital.html . This line of thinking has potential, though it can be hard to shift people’s perspective from traditional forms of investing.

    You could try to prototype this: come up with a specific application idea and funding request, and see if you can attract some interest in it…

    October 29, 2009 @ 16:44
  7. Comment by Mark Mzyk:

    @Chris:

    I don’t think the Y Combinator model drowns entrepreneurs with overbearing terms – if they stop there. Y Combinator does only take a small portion of ownership in the companies they fund. However, the goal is usually to then make those companies attractive to venture capital funding, so therefore the contractual terms and obligations add up, while ownership in the company is continually diluted.

    Leprechaun funding provides a small level of funding without any transfer of ownership in the company. Simpler than traditional funding, but also smaller. You’re right that many investors want to invest in home run companies and make large returns. If that’s what an investor wants, then leprechaun funding isn’t for them. It’s not designed to be. However, to counterpoint the part about wanting huge returns: to get huge returns investors have to take huge risks. The numbers I’ve heard repeated is that for every ten companies invested in with venture capital, nine fail, so the tenth has to bring in huge returns to cover the other nine. I don’t know if these numbers are accurate, but I think there is some truth to them. With leprechaun funding, the risk is so much smaller than with angel or venture capital funding that investors should be able to have a higher success rate.

    As for being a the mutual fund for startups, I didn’t actually say that. I only referenced mutual funds in the last line to ask if this strategy would be better than mutual funds, or instead should we all just stick with mutual funds. However, I want to follow your line of thought: how is liquidity achieved with leprechaun funding? Traditionally, liquidity, or an exit, is achieved with someone either buys the startup or the startup goes public. That obviously doesn’t happen with leprechaun funding. The investor gets their return in two ways: from revenue generated by the applications, which is small but hopefully a continues stream of money over time, and when the entrepreneur buys the investor out.

    Leprechaun funding is different from traditional funding. There’s no way leprechaun funding replaces traditional forms of funding: it’s just an idea for another way to fund companies, so that more ideas can enter the marketplace and more risk can be taken, hopefully resulting in more innovation and some returns for those investors willing to try it.

    October 30, 2009 @ 11:56
  8. Comment by Mark Mzyk:

    @Abe

    Bill Flagg’s post is very much in line with my thinking here. I certainly don’t think this is a new idea, but he’s right that this approach seems to have dropped from most people’s radar. I think we get caught up in the celebrity that is created by startups making it big with venture capital and then forget there are other ways to achieve the same goal.

    You, along with TJ, have now both suggested I prototype this. I think I might have to go that route and see what develops. At the very least, it could prove if the idea is viable and how much work it might take to implement.

    October 30, 2009 @ 12:02