One of the biggest threats to scientific innovation has always been the lack of capital. Venture capital only really makes sense if companies can grow rapidly, and most other equity investments tend to be illiquid until an exit is found.
Brian McConnel at Gigacom takes a look at ‘Class R’ stock, a possible investment model that is halfway between a conventional investment and a loan. Here’s how it works.
Let’s say for rough numbers that a group of angels invest $500,000 for a 10 percent stake in an early-stage company and 5 percent of gross revenues with a 5X cap (total payout: $2.5 million). The company does OK and turns into a nice small business with revenues of $2-$3 million dollars a year. Happy with that, the owners decide not to sell or try to grow much bigger. The investors in this situation will be receiving $100,000-$150,000 per year (off $2-$3 million/year in revenue), which is not a bad annual return, and will get up to $2.5 million over the life of the agreement. In other words, everyone wins — the entrepreneur is rewarded for creating a viable business, and the investors do well without having to force a sale. And they still have 5 percent equity so that if, 20 years later, the founder retires and the company gets bought, they are very happy vs. just merely happy.
Of course there is no downside protection, but then again there rarely is. However it does address one of the major problems with commercialising technology, that of what happens if the company is just a nice company, rather than a spectacular success. In some respects it’s not too different from paying a dividend, which most companies prefer not to do, certainly in the early stages, but it may be a way , combined with tax breaks, that would actively encourage much needed angel investment.
PS it’s worth looking at the comments for some other alternatives.