I’m sorry I can’t fund your school sales company, but my friends can…

For about the last decade, a lot of well meaning people paid venture style valuations for school sales companies. Every once in a while one of these companies would work out, but these home runs only returned 10x because of the low exit valuations and high prices paid by these investors.

Typical venture requires home runs to return the whole fund. A $100m fund might make 10 entry stage $5m investments and another $50m in follow ons as it’s companies mature to keep their original stake or increase it. So with a top return of 10x, this math ceases to work, especially considering other options in education like investing in companies selling to enterprises or consumers.

The market has adjusted and recognized that the most consistent buyer of mature school sales companies, private equity firms, pay 5x revenue for companies that are cash flow positive and growing 20%+ per year. This has caused many funders to leave the market for school sales companies and the remaining to be looking for the more typical 20–100x returns that make funds work. Since there is no reason to believe that exit values will increase, that means valuations will decrease by 2–5x. So while an enterprise company doing $1m ARR may receive a $20m valuation, your school sales company is likely to receive a $4m to $10m valuation at the same revenue stage, causing much more dilution if you want to raise similar amounts of money.

This has a couple of ramifications.

1 — don’t spend a lot of time with generalist investors with your school sales company. They generally don’t like you and will waste your time.

2 — do make the rounds with education insiders like reach capital, owl ventures, gsv, rethink, and learn capital because it’s always possible you get a partner excited. They have gotten savvy about returns and you will receive the valuations above, but may provide a bit of startup capital that you need and a ton of industry expertise.

3 — there is a funding model that has been used in other sectors which I think has really big potential for school sales companies — revenue based financing, but it requires a bootstrap mindset.

Most companies, even good ones at $1m ARR in school sales have difficulty raising money. So what should you do? Build a cash flow positive business.

I am not saying this is fair or a great experience, but I do want to see as many good products getting into schools. I think the mythology that school sales companies are just like other venture investments is very destructive. It sets expectations incorrectly on both sides, leading to needless bloodshed.

I don’t invest in school sales companies, but one of my investments, mystery science, pivoted early from a consumer to a school sales model. They did a great job of building a self serve sales model for schools which has allowed them to grow quickly and profitably. My investment was early so while there won’t be a venture sized return, it will be fine. They raised very little money and the founders are in firm control of their future. There product is used by millions of students. This is really the right way to do things.

It is a normal founder bias to say ‘yes, but I am different’. I detail the base rate (the normal outcome) above because if you decide to do this anyway, you will do it with your eyes open.

Here’s where revenue-based financing comes in. The idea is to make much riskier loans to companies than any bank would touch, focusing on IRR’s in the 15–20% range. That means that if you borrow $100k, you pay back $120k that year or $140k the following. These funds typically will lend up to 1/3 of current revenue. That means that if you are at $1m in sales, you could borrow another $300k to accelerate sales, finish product, etc.

Why would you want to take debt? Well, first, debt is non-dilutive so you still own the whole company. Second, debt is good if you can’t do a normal VC fundraise and need more capital to get to breakeven. Let me know what you think, and I will make the connections.