Michigan startup investing requires alternative financial instruments

In this post I advocate for alternative financial instruments for early stage startup investing in Michigan. Our ecosystem is currently optimized for venture scale companies which leaves many investors and entrepreneurs on the sideline. We can invigorate our ecosystem by adopting alternative investment terms like Shared Earnings Agreements and Revenue Based Financing. We can give our startups the early capital they need without forcing them down the VC route.

These alternatives are available elsewhere in the country, but yet to be widely accepted in Michigan. I argue we should standardize term sheets for Shared Earnings Agreements and Revenue Based financing to reduce friction in the investment process.

Enjoy. And as always, please share alternative opinions or anything you think I missed.

The current investment landscape in Michigan

In Michigan, both founders and investors are increasingly searching for alternative financial instruments that fit the unique needs of the local startup ecosystem. Traditional venture capital, with its focus on identifying the next unicorn, doesn't quite align with many founders here who are building solid, ambitious businesses but aren't necessarily chasing billion-dollar exits. These founders envision creating something speculative but reasonable—perhaps aiming for a $10 million exit—and need capital to get started without being tied to an endless fundraising treadmill.

-> I wrote more about the founder's "Mid-Exit" ambitions here.

This is the space that classic angel investing is supposed to occupy: backing promising founders with enough capital to get going, without the pressure of perpetual growth at all costs. Unfortunately, in Michigan, the angel investment landscape is relatively weak.

>> Overall, new early-stage, pre-seed investment capital in Michigan has decreased more than 40% in the last five years alone. (source)

Without sufficient angel investment, many promising ideas struggle to get the initial support they need, creating a bottleneck in the ecosystem.

>> Startups in the Great Lakes Region take an average of 2 years longer to raise their first $500K vs. startups on the coasts. (source)

This gap leaves founders caught in an awkward middle ground—needing funding, but not a fit for traditional VC. Strengthening the angel investment community in Michigan could help bridge this gap, but it will require a concerted effort to build awareness and attract individuals who are interested in supporting early-stage startups.

Venture capital's 'grow fast or die' philosophy can create significant pressure on startup founders. This model has fueled many of the tech giants we see today, but it is not without its flaws—especially in a state like Michigan, where the startup ecosystem is still growing and evolving. The state has a unique culture of entrepreneurship—rooted in resilience, practicality, and community-mindedness—that doesn't always align with the relentless pace of venture-backed growth. Founders here often seek to build companies that provide steady jobs, contribute to the local economy, and have a positive impact on their communities. This kind of growth trajectory is often slower and steadier, making it a mismatch for traditional VC investors who expect rapid, high returns. As a result, Michigan founders are seeking funding options that allow them to grow at a pace that works for their businesses, without sacrificing their long-term vision or community values.

Alternative financial instruments

This is where the idea of alternative financial instruments becomes increasingly appealing. The current investment landscape in Michigan presents a significant opportunity for innovation in funding models. Many founders are turning toward innovative funding mechanisms that might be a better fit for their goals. Instruments like Revenue Based Financing or Shared Earnings Agreements (SEAL) are emerging as promising alternatives. These options allow investors to share in the company’s success in a more sustainable way, while providing founders with the flexibility to grow on their own terms. Such models offer a realistic path for Michigan startups that value controlled growth, autonomy, and community impact over the classic unicorn chase.

Introducing Revenue Based Financing

Revenue Based Financing, for example, allows a business to raise capital in exchange for a percentage of future revenue until a predetermined return is met. Unlike traditional equity financing, where investors take a stake in the company and often push for aggressive growth, Revenue Based Financing aligns the interests of both founders and investors with the company’s actual financial performance. This type of funding can be especially attractive for Michigan founders who are seeking to grow steadily while retaining control of their companies. It offers the flexibility to repay investors based on revenue, which means that during periods of lower revenue, payments are lower, reducing the pressure to grow at an unsustainable pace.

Under an RBF agreement, a company receives funding from an investor in exchange for a commitment to share a percentage of its monthly revenue until a predetermined cap is reached (typically a multiple of the original investment, such as 1.3x to 2x). Unlike traditional debt, RBF repayments fluctuate based on the company's actual revenue, which means businesses pay less when revenue is lower and more when revenue is higher. This flexibility can be crucial for companies with fluctuating income streams, such as SaaS or subscription-based businesses.

The key difference between RBF and other financing options, like Shared Earnings Agreements (SEALs), is that RBF repayments are tied to gross revenue, not profits. This means that the business must make payments to the investor even if it's not yet profitable. However, since the repayment amount is based on a percentage of revenue, it adjusts to the business’s cash flow, making it less burdensome than fixed loan payments.

Example RBF Scenario

Consider an e-commerce startup that secures $100,000 in funding through an RBF agreement. The company agrees to share 7% of its monthly revenue until it has repaid 1.5x the original investment ($150,000).

1. Year 1: The business generates $30,000 in monthly revenue. The startup pays $2,100 per month (7% of $30,000) to the investor. By the end of the first year, it has paid a total of $25,200.

2. Year 2: As the business grows, it starts generating $80,000 in monthly revenue. Now, the monthly payment increases to $5,600 (7% of $80,000). By the end of the second year, the company has paid an additional $67,200.

3. Year 3 (6 months later): The company continues generating $80,000 per month, allowing it to reach the $150,000 repayment cap within six more months. At that point, the RBF agreement concludes, and the business no longer needs to share its revenue.

Platforms like Ned (https://nedhelps.com) put the entire Revenue Based Financing process on autopilot for the lender and borrower. Frankly, from a lender/provider perspective, it's even easier to get paid each month compared to invoicing.

Introducing Shared Earnings Agreements

An alternative that has been gaining traction is the Shared Earnings Agreement, also known as SEAL. Under a SEAL, investors receive a share of a company's earnings once it becomes profitable, but they do not take equity or demand rapid growth. This type of instrument is particularly appealing to founders who are wary of giving up ownership and control of their business. SEALs allow founders to maintain their autonomy while ensuring that investors are rewarded for their support. In Michigan, where many founders have a strong desire to stay true to their original vision and maintain a close connection to their community, SEALs represent a funding option that respects these values.

With a SEAL, the business owner agrees to share a portion of their profits once the company starts generating earnings, with payments continuing until the investor receives a multiple of their original investment (e.g., 1.5x or 2x). Importantly, if the business struggles or fails, the entrepreneur is not personally liable to repay beyond the earnings shared, making SEALs a lower-risk alternative to debt financing.

Note: This differs from Revenue Based Financing, where repayments are based directly on gross revenue, regardless of profitability, while SEALs only take effect when the company is profitable.

Example SEAL Scenario

Let's say an early-stage software startup needs $100,000 to grow. The startup enters into a SEAL with an investor, agreeing to share 5% of its monthly earnings until the investor has received 1.5x their investment (i.e., $150,000). The SEAL agreement includes a profits threshold that must be met before any payments to the investor begin. This threshold ensures that the startup only starts sharing earnings after it reaches a certain level of profitability. For example, let’s set the threshold at $15,000 in monthly profits—meaning the company will only begin paying the investor once its monthly profits exceed this amount.

Here’s how the scenario unfolds:

1. Year 1: The company earns an average of $10,000 in monthly profits. Since this amount is below the threshold of $15,000, the company does not make any payments to the investor during the first year.

2. Year 2: The business scales up, generating $50,000 in monthly profits. Now that it has crossed the threshold, the startup starts paying the investor 5% of its monthly profits. This results in monthly payments of $2,500 ($50,000 * 5%) to the investor.

3. Year 3 (6 months later): The company continues to earn $50,000 in monthly profits. The cumulative payments reach the cap of $150,000 (1.5x the original investment). At this point, the SEAL concludes, and the company retains all future earnings.

In this example, the SEAL allowed the startup to secure the capital it needed while aligning repayment terms with its actual growth, providing flexibility during the critical early stages.

Resistance to SEALs and RBF

Michigan based founders and investors have some apprehension to alternative funding approaches because they sound experimental and/or risky. No founder wants to sabotage their business by taking investment on the wrong terms. We just wrapped our heads around convertible notes and SAFE agreements; do we have mental room for another model?

In one situation involving a Michigan startup, the investor and founder spent a significant amount of time discussing how SEALs work. From there, they redlined and beat up terms. Ultimately, the process took too long and too much friction so the startup decided to walk away from the investor. They wanted to work together, they believed in each other, but the uncertainty around the instrument got in the way.

How to advance SEALs and RBF in Michigan

We need to address the reasonable objection that SEALs and RBF are new/different by standardizing the terms as much as possible. In 2010, Series Seed set the precedent of standardized term sheets (https://www.seriesseed.com/). The documents have been legally reviewed and battle tested. Anyone can use the terms as-is (most common) or adjust to meet their unique situation.

More recently, AirTree open sourced their SAFE agreement terms. (https://www.airtree.vc/open-source-vc/safe-template).

Calm Company Fund open sourced their Shared Earnings Agreement terms. (https://docs.google.com/document/d/10KNj6HJpfF9EjssJzRaGIw2LBxEdawjWbtfLZCGLFl8/edit?tab=t.0#heading=h.gjdgxs).

Now we need to adopt or create standardize terms that work for Michigan investors and founders. I argue that we need a "Michigan SEAL" -- should we call it at an otter?? -- that is a standard set of terms used by early stage investors and startups to accelerate and simplify the funding process.

Similarly, we can standardize RBF terms. We can establish expected return multiples, timelines, and percentage of revenue shared. We can standardize the platform to be used (I recommend Ned) and even create a "common application" experience for startups so they only have to "apply" once and gain access to many potential investors. Alternatively, we can create a new fund that exclusively invests on RBF terms and benchmark their performance against more traditional VC models.

Wrapping up

Unlike more mature startup ecosystems, such as Silicon Valley or New York, Michigan doesn't have a dense network of venture capital firms or a steady stream of billion-dollar exits to attract large-scale VC investments. Instead, it has a wealth of talented entrepreneurs who are building solutions that address real-world problems, often with a regional focus. These founders are passionate about creating companies that contribute to Michigan's long-term economic stability, and they need financial partners who share that vision.

Emerging funding options are not only beneficial for founders but also present a compelling opportunity for investors. For those interested in supporting the Michigan startup ecosystem, alternative financial instruments provide a way to participate in the success of early-stage companies while mitigating some of the risks associated with traditional venture investing. By offering more flexible terms and aligning with the realistic growth expectations of Michigan startups, investors can help foster an environment where more businesses have the opportunity to succeed. This, in turn, will help build a more resilient and diverse local economy, with successful startups that are deeply rooted in their communities and committed to long-term impact.

The Michigan startup ecosystem is at a turning point. As more founders and investors embrace alternative funding models, the region has the opportunity to build a distinctive, self-sustaining environment for entrepreneurship—one that reflects Michigan's values of resilience, practicality, and community. By moving away from the traditional venture capital model and embracing innovative funding instruments, Michigan can create a thriving ecosystem that supports a wide range of founders and business models, ultimately leading to a more diverse and resilient economy. This shift toward alternative financial instruments represents a significant step forward for Michigan's startup community, providing the flexibility and support that founders need to bring their visions to life while maintaining the integrity of their mission and their commitment to their communities.

Conversation starters

• Do you know any investors or startups in Michigan that are currently using SEALs or RBF?

• Is there another model that you've seen work well?

• What concerns pop into your head after seeing these models?

Thanks for reading! And stay tuned for the next trend.

Previous posts:

• Misaligned founder archetypes

• Mid-Exit Founders

• Most founders don't know about the ecosystem

• Evaluating Michigan's Startup Ecosystem

• Introduction to this project

About this project: I am on a quest to speak to 500 Michigan Entrepreneurs, Investors, Entrepreneur Support Organizations (ESOs), and Policy Makers. I recently passed the halfway mark—250 conversations—and it feels like the right time to share some of the key trends I've observed so far.

If you're interested in contributing to this ongoing effort, or if you find these trends compelling, please reach out. Michigan's entrepreneurial ecosystem is growing, and your involvement could make a difference.