Invest1 publisher2 min readPublished
General Catalyst wants founders to stop funding sales and marketing with equity
The firm's case rests on one comparison, that Microsoft's founders held almost four-fifths of their company at IPO while most founders now hold under a fifth.
The Investor · Invest desk
What happened
- General Catalyst argues that subscription pricing moved customer lifetime value onto the company balance sheet, so the faster a business grows the more cash it burns acquiring customers it will only be repaid by later.
- By the firm's account most founders own less than 20% of their companies by the time of the IPO, and some own less than 5%.
- It says debt, ARR financing, credit lines and revenue-based financing are cheaper but unsuited to sales and marketing, because repayment falls due on a fixed schedule while the payback on customers is variable.
- The result, the essay says, is that almost every company funds its entire sales and marketing budget with equity and gets no leverage on that spend.
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Why it matters
- constraint If the growth budget is an equity budget, the growth rate is set by how often a company can price a round, and General Catalyst says feeding customer acquisition that way has become slower and more expensive since rates rose.
- decision Companies that found product-market fit in the abundant years are choosing to hold cash and get near their old valuation before raising again, and they grow more slowly while they defend that mark.
- exposure A fixed-repayment facility leaves the company holding the loss if a cohort never pays back, and the firm says that is exactly what disqualifies those products as risk capital for this use.
Microsoft's founders held almost four-fifths of their company at IPO [6]. Divide the modern figures into that and the change has a size: a founder listing with 20% keeps a quarter of what they kept, a founder at 5% keeps a sixteenth [15], a gap of more than 60 percentage points [16]. General Catalyst calls it arguably the single largest wealth transfer from founders to growth equity investors [7].
The essay is precise about why the cheaper alternatives go unused. "Using debt for S&M can create an asset-liability mismatch, which encumbers the company with downside risk (not too distinct from what we saw in the recent events with SVB)," General Catalyst wrote [11].
The case is the firm's own, published on its site [18], and it is written from the investor's side: "Now, more than ever, we believe there is a need for a source of capital that is not beholden to equity valuations and allows companies to continue to invest in growth without negatively impacting their balance sheet" [9]. General Catalyst did not disclose what such capital would cost [17].
Whoever underwrites a sales and marketing facility takes the variance in the payback, and variance is the thing equity is priced to absorb [13]. If it is priced honestly it prices near equity, and what the founder buys is the ability to keep spending without setting a new valuation. I'd expect the first real products to be priced that way. The counter-thesis is that cohort data from mature subscription books is now clean enough to underwrite tightly, in which case the spread over ordinary debt is thin and the firm is right on cost as well as on risk [10]. One founder publishing the all-in realised cost of both routes, on the same customer-acquisition budget, would settle which it is.
What to watch
- Terms for any sales and marketing facility the firm actually backs: pricing, tenor, and who absorbs a cohort that never pays back.
- A company disclosing that it funded a customer-acquisition budget with something other than equity, and at what all-in cost.
- Whether IPO prospectuses keep showing founders below 20% as more subscription-era companies list.