Abundant liquidity is the hallmark of developed economies and the lifegiving oxygen of startup companies. Much of my professional career has been spent understanding how and when the levers of public policy and private sector innovation can be used to expand access to capital, so more innovators can bring their productive ideas to life and to scale.
Over the past 20 years – during most of which time capital was not only plentiful, but cheap – a certain well-trod path emerged: investors looked to pool capital in the hands of managers, who then take ownership stakes in a wide array of emerging companies, and ideally a significant share of those emerging companies succeed by bringing to market new products, processes or services that consumers find valuable.
This formula facilitated the tech boom of the 2000s and the creation and rise of technology companies that are household names today; companies that have enriched our lives, made us more productive and even put the world at our fingertips. And new software companies continue to emerge and follow the path of hyper-growth first, profits (hopefully) later.
This journey – from mere idea, to “unicorn,” to app that resides on billions of phones worldwide – has become so widely recognized today that it’s been satirized and parodied, to great effect, in recent popular culture.
But what if this funding model is too narrow? According to the National Venture Capital Association, 40 cents of every venture capital dollar went to software start-ups in 2021, more than what went to health care, pharmaceuticals, transportation, energy, and commercial products and services combined.
This is not an indictment of venture capital, an innovation ecosystem which has successfully incentivized the creation of some of the world’s most successful and life-changing companies. But the venture capital model doesn’t fit for every innovator.
Venture capital firms invest on about a five-year timeframe and take equity stakes in a number of startups, and about 75% of those startups fail to even hit, much less exceed, their break-even. So venture capital funds are looking for quick proof-of-concept and high returns from those that succeed. Manufacturing and other types of companies don’t grow as fast, typically have lower profit margins and require more upfront investment.
Many investors today are concerned about rising income inequality, “jobless innovation,” the loss of U.S. manufacturing jobs, the vulnerabilities of a global supply chain and the desire for cleaner energy and cleaner industrial production. Venture capital’s outsized focus on software leaves them looking for other ways to put their money to work.
What’s needed is innovation in and a greater proliferation of alternative funding models and mechanisms that can allow capital allocators to pursue multiple strategic objectives, like supporting U.S. jobs and manufacturing, scaling proprietary brick-and-mortar assets and processes, and, of course, making a decent return.
And new models are springing up. Robert Cote, managing partner and co-founder of Cote Capital, offers just one example. He has developed an approach he refers to as the “IP capital” model.
The model works with revenue-generating companies, often in legacy and capital-intensive industries (e.g., textile manufacturing), that are looking for capital to scale and grow. This capital is effectively securitized by proprietary and contract-backed assets that give the company a legally protected edge in their product or process. That IP remains domiciled in the United States.
Rather than taking an equity stake, “IP capital” investors are returned a revenue-based, scalable dividend (similar to a bond) that increases if and only if the company hits preordained performance metrics along a preset timeline. The model works well for companies with breakthrough innovative physical products that create an asset base – e.g., new product design, know-how, and manufacturing assets – whose value is underwritten and secured by an IP contract. Think, for example, an IP-protected process developed in Texas to rejuvenate leftover fabric waste into virgin-quality fibers for recycled use in global mass-retail clothing production.
For the investor who wants to help rejuvenate the “real” economy, a model like this can make sense. The investment is backed by assets, providing an additional layer of protection. The companies receiving capital are engaging in the overhauling and modernizing of legacy industries in an effort to make them greener, more sustainable, and more efficient.
Americans’ increasing interest in investing with a purpose has brought an enormous array of innovations to the mutual fund, ETF and broader retail investor space. Similarly, the channels for investing in early-stage innovation will adapt to meet the demands of these investors. The IP capital model is just one of many new investment vehicles that can enable these investors to help grow revenue-generating companies with societal impact.