This is a first in our Alternative Capital Explorers Series, the story of Gumroad.
Since launching Reason Street Capital Library I’ve had many taboo conversations with founders, funders, and students all over the world who want to talk about money. There is a fear for certain kinds of capital and what capital expectations do for founders and companies. Debt feels morally wrong to some founders, even if the terms are less expensive than equity. Raising Venture Capital is an embodied experience. Founders speak of weight on the back of their neck or feeling like they have someone sitting on their shoulder, encouraging them to put their breaks on the pedal and maximize for top speed.
I’ve had those feelings myself in the past and tried to convince myself that I was being irrational. Financial capital, after all, is a figment of our imaginations. But our conception of other types of capital may have a stronger hold over us.
Sahil Lavignia’s story of hype, loss, and redemption for Gumroad shows that there is a deep profound need for capital arrangements that recognize and benefit the company, its customers, and its community. Sahil’s journey from USC dropout to high profile VC and angel fundraising rounds to equity crowdfunding gives a rich case study for the promises, pitfalls, and possibilities of these incumbent and emergent capital types.
From College Dropout to Top Tier Fundraise
A personal experience with the inefficiency in selling a logo to a customer-led to a weekend MVP build and the inception of Gumroad – a platform that would allow creatives and others to sell their products directly to audiences with quick, simple links. Sahil Lavignia was “backable,” a 19-year-old USC engineering dropout who was “Pinterest’s employee number 2” and whose concept attracted the who’s who of angel investors and VC, including First Round Capital, Accel, and Gumroad rented a $25,000 per month fancy office in SF’s SoMa neighborhood and expanded the team to focus on product development.
Fizzle, Too Early in the TAM
Gumroad’s business model was fairly simple at the start – a marketplace transaction cut every time a creator sold a creation, built off of the early Stripe payment engine. Yet despite over 52,000 views on Hackernews and lots of interest in the fundraising announcements, there simply weren’t that many creators who were thinking about monetizing their work in 2012. Investors love big total addressable markets or TAM, but the creator economy was just starting back then, and throwing marketing at the problem wasn’t helping. The market had to be carefully cultivated
VC Mismatch and Layoffs
The mismatch in VC expectations of monthly revenue and exponential growth caused the team at Gumroad to try several avenues unsuccessfully to bridge the gap. Even after a ‘bailout’ $2 MM Series B bridge round, the funds were depleted below an 18 month runway. Sahil had to implement a 75% layoff and consolidate operations towards business sustainability or face a definite shut down. Investors at this point wanted him to shut the company down.
Here is a story less often told about Venture Capital. We know that the average VC invests in 10 companies and expects one of those 10 to be a home run. But the work of managing the other 9 is sometimes fraught. VCs do not want profitable slow growing companies in their portfolios. They manage funds with 10-year time horizons, but are often fundraising for a subsequent fund based on their returns on the current fund.
Therefore companies that are growing slow, or stalled, even if profitable, mess up the key performance indicator for VCs: The Internal Rate of Return (IRR%). As a founder you may be happy with the business, but your investor may shut down your company or arrange an “aquihire” – an exit that is not very lucrative but at least gets your company out of their portfolio.
In Sahil’s case, in fact, they wanted him to shut down the company and try something new — they even offered him money to do it. But he couldn’t, as he explained: “We helped thousands of creators get paid every month. About $2,500,000 was going straight into the pockets of creators — for rent checks and mortgages, for student loans and kids’ college funds. And it was only growing! Could I really just turn that faucet off?”
He couldn’t. So he laid off all but five employees. They stumbled along for a bit, but as time went on, the remaining five all eventually left for more exciting opportunities.
Loneliness, then a Buyback Option
“I was basically alone,” he says in his story about failing to build a billion dollar company. With Gumroad scaled back to the bare minimum, Sahil moved to Utah and learned to paint. He worked on sci-fi novels. And in his spare time, he answered support emails and fixed bugs to keep Gumroad afloat. (SADNEWSS) But there was a silver lining: Gumroad was finally profitable.
“You know, in some ways, the growth is kind of annoying. It’s stressful!”
Then he got a fortuitous call. In November 2017, the exit of Mike Abbott from Kleiner Perkins, prompted the firm to divest Gumroad for a sum of $1 in lieu of the operational hassle of appointing a new board member and following up on what seemed like a bleak chance of a turn around while gaining a tax advantage. This would bring their cap table down from $16.5M to $2.5M, and Sahil could run the business however he wanted. He didn’t have to play the VC game anymore.
At the start, the company took a pure transaction fee of 7.5% + 25¢. When the company started to focus on profitability over growth, they experimented with a Software-as-a-Service model with a different growth curve and take rate. Eventually Gumroad settled on a hybrid model: free with 8.5% + 30¢ a transaction, and option two is $10/month and 3.5% + 30¢ a transaction.
A Change in Regulation, An Equity Crowdfunding Record
In 2021, in a post pandemic world, the creator economy was booming allowing a renewed chance for Gumroad to grow and create value for its creators. Additionally, a new SEC ruling in March of 2021 raised the crowdfunding limit from startups from $1M to $5M. Anchored by Angel Investors Jason Fried and Naval Ravikant to add social credibility through a $1M round in March 2021, Gumroad opened up its cap table for investments through a crowdfunding round on Republic.co. In 12 hours, 7,600 new investors joined the cap table with investments between $100 and $1000 of which 2m300 were active creators selling their products on the platform.
To be sure, Equity Crowdfunding on its own will not right wrongs, correct injustices, and reduce gender and racial wealth gaps. The investor pool in Gumroad’s equity crowdfund raise was overwhelmingly male at 91%.
But the shift in strategy shows how Gumroad values its customer community and how its funder can now focus on an aligned mission. With a deviation from an approach that valued raising money, hiring people exponentially and focusing on winner-take-all strategies, Gumroad is centered on serving their creator customers.
Equity Crowdfunding: As part of the 2012 Jobs Act, the SEC on March 15 raised the cap individual private companies may fetch from crowdfunding investors to $5 million, up from $1.07 million. Equity Crowdfunding has been popular with Black-owned businesses like CurlMix, Pop Com, and Supreme Foods Financing to build community-backed businesses.
Venture Capital: Investors provide capital into an early stage business with high growth potential in exchange for an ownership share.
VC is a type of investment designed to fund high-risk investments in early stage companies that demonstrate high-growth potential. Venture capitalists invest money from high net worth individuals and families, pension funds, and university endowments so that their portfolios can grow larger by taking risk.
Our Alternative Capital Explorers case studies officially kicks off with Gumroad, the first company to raise $5 MM when the new SEC law went into effect. I believe more companies will tap into this type of financing to non-accredited retail investors that are part of their customer base, making it possible for a greatr diversity of people to become participants in wealth creation.
New and rediscovered types of capital are creating different social arrangements between organizations, their backers, and beneficiaries. An explosion of varying capital, organizational structures, and fundraising mechanisms are opening up possibilities and doors for entrepreneurs and leaders. I’ll be tracking how founders like Sahil Lavignia combine and recombine capital types, business models, and community strategies to build and share wealth. Reach out if you believe your company would make a great case study, or if you have a suggestion for a company we should cover.
Disclosure: This article represents the opinion of the writer, Jen van der Meer, who does not own a stake in Gumroad. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. Make sure you consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services.