Ex-Googlers Design an Algorithm for Investing in Young Entrepreneurs

3/18/13Follow @wroush

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a 15 percent internal rate of return. To simplify the math, Upstart recently changed that rule, capping returns at 5 times the amount raised. (For example, say that an upstart raises $70,000, at $10,000 per 1 percent of her income, and she later makes $10 million on the sale of her first company. She’d still owe no more than $350,000.)

While Girouard certainly hopes there will be some home runs like this among the upstarts, he says “we are a singles and doubles business.” For investors, Upstart is designed to have a return of roughly 8 or 9 percent—slightly below that of the U.S. equities market.

“A very small fraction of our people are going to make zero dollars. Most people are going to pay back reasonably well. And a few people are going to pay back really well,” Girouard sums up. “Our notion is that if you invest not in one person, but in a portfolio of people, you can generate a good return. And in our world you are not necessarily a passive investor, as if you were putting $1,000 into IBM and hoping for the best. You can actively participate and help the person do well.”

In fact, the funded participants I talked to said that the network to which they’ve been admitted as upstarts is at least as valuable as the money itself. Mor, of Ziibra, says his Upstart connections helped him get his startup into Boost, a San Mateo, CA-based incubator funded by the Draper family. “I needed the money, but you can get money anywhere,” Mor says. “You can’t find people to give you advice—that’s much harder.”

Upstart Brandon Chicotsky, founder of BaldLogo.com

Upstart Brandon Chicotsky, founder of BaldLogo.com

Brandon Chicotsky, an upstart educated at UT-Austin and NYU, is the founder of an “animate social marketing” business, BaldLogo.com, that offers advertisers the chance to emblazon their logos on the heads of bald men like himself. He’s using the $15,000 he raised on Upstart to wipe out half of his student debt, and says his backers have helped him review pitch decks and sent offers of future business partnerships.

“Backers are seeking energetic and bright workhorses in the startup environment,” Chicotsky says. “That’s what I am. I’m excited by the opportunities my new mentors have for me.” Which touches on another interesting point: If you’re an investor, there may be no earlier way to get an early look at tomorrow’s hot startup founders than to invest in them just as they’re leaving school.

But if you were able to subtract the network effects, would getting funded on Upstart still pencil out as a good deal for the upstarts? It’s hard to say. Chicotsky says that by paying off student debt, he has “basically traded one interest rate for a better one.” But he won’t know that for sure until 2022, since the total amount he ends up paying to his Upstart backers over the next decade will depend on the success of BaldLogo and his other future ventures.

In an interview, I put it to Girouard that a jaded observer might look at the Upstart model and think of a very old parallel: indentured servitude. If you remember your history, that was a system under which hundreds of thousands of young workers—mostly males under 21 from England and Germany, with dreams of starting their own farms or businesses—got free passage to the American colonies in return for several years of labor.

Girouard, naturally, bridled at this comparison, calling it “completely upside down in terms of the logic.”

“If you think about having a fixed-rate loan that requires you to have a job at all times so that you are capable of repaying, that is the definition of servitude,” Girouard says. “Ours is the opposite. You have the freedom to do what you want, and you merely share some of the upside or the downside with other parties.”

The fact remains that the upstarts are responsible to their backers—if not as servants, then as investment vehicles. But the same thing is true, roughly, of startup founders who sell equity to venture or angel investors. Which bears out Upstart’s tag line: “The startup is you.”

The leap Upstart is taking is smaller than it would have been if predecessors like Kickstarter, Lending Club, and Kiva hadn’t paved the way in the world of creative financing, Girouard says. Still, the idea is “very new and different, and it takes startups like us to prove the concept,” he says. “We don’t have a lot of track record. But the backers in our early stages believe in the model, and they have an interest in helping these young adults do awesome things.”

Here’s a video produced by Upstart.

Wade Roush is a contributing editor at Xconomy. Follow @wroush

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  • http://twitter.com/sardire Steve Ardire

    Yeah Indentured Servant 2.0 business model !

    • http://www.facebook.com/jarrod.wageman.7 Jarrod Wageman

      No shit. I read this part “In return, these “upstarts” agree to pay backers a slice of their future income—up to 7 percent per year for 10 years.”

      So, if the “venture” fails, the entrepreneur and co-founders have to payback 7% of income for the next 10 years?

      That is an investment I would not take.

      A smart idea on part of the founders of the Upstart fund though in my opinion. I wonder how many would default on their payback obligation after they go broke trying to keep their company afloat.

      Yeah, yeah. Haters gonna hate.

  • http://twitter.com/shuimaojin shuimaojin

    Bald logo – great – hope more inspired young leaders are supported in their dreams

  • Jimdandy

    Indentured servant 2.0 is right.

    • jj the jj

      Especially when failure rate (even with mentor support) still exceeds success. And furthering the individuals odebt. Seems opportunistic (and unethical) on Girouard’s part.

  • http://www.facebook.com/john.j.adams.986 John J. Adams

    The one problem I see even in my own city is too much support for young entrepreneurs and too little for middle aged or older ones that have been there, failed been there again, fail, and now are there and are profiting but cannot find support to get to the next level because many investor resources are focused on that young/startup segment. The government only helps that segment. It is actually a very strange thing to me. I think I would prefer to put my money and resources into a growing business than a total unknown and untested and most importantly no-experience entrepreneur.

    • http://www.facebook.com/shannon.gass Shannon Gass

      Thank you. The first comment I felt needed to be made, has been. As a middle aged person, I can attest that life opportunities are often wasted on the youth, and the approach of only rewarding 20somethings with the right “credentials” begs the question of why do we fail to reward talent. Ah, that’s right, it’s not about talent, but about the newest sort of actuarial table, eh? Betting on future earnings… do you have a formula for children, yet?

  • http://www.socialbakers.com/ Michal Smetana

    “Venture capitalists have long said, ‘We invest in people, not ideas or businesses.’ Well, not really. We are the first people really doing it.” The first part of this statement is so much true. Venture capitalists always say that they invest in people, but in reality they invest just in the ideas these people come up with. Lets see, how this one will turn out.