The US K12 market has several unique characteristics, including: 1) Slow rates of change with elongated S-curves – i.e. level of inventions over time, 2) Reliance on fixed – and mostly predictable – public funding streams, 3) Regulatory oversight and uneven initiatives aligned to political cycles, and 4) Long procurement and implementation processes for new technology and service adoption.
This panel will discuss insights and learnings on navigating the three-sided misalignment of capital structures to support this critical sector across entrepreneurs, venture capital, and philanthropy.
The Entrepreneur’s Dilemma
All entrepreneurs face financing challenges as they seek to develop and scale products that meet market needs (one that both incentivizes new behavior and is enjoyable to use). Across K12, impact-oriented entrepreneurs have traditionally had two paths – pursue venture capital investment or bootstrap/raise money through philanthropy and grants. Neither path is without its challenges. The limitations and incentives inherent in each path present every entrepreneur with a set of difficult decisions that often pit the desire for impact against the need for scale. This dilemma is amplified when building products to solve problems impacting a smaller segment of the market (for example – students in need of special accommodations or English Language Learners) or products that require change management. We have observed an inverse relationship between the level of change management needed and the attraction VC has to it. Philanthropy will typically push for deeper/more targeted solutions, while venture capital will push to expand the total addressable market (TAM). These constraints and incentives, along with the lack of viable and sustainable alternative financing models, have impeded innovation.
The Venture Capital Challenge
In short, venture fund “math” – which puts a premium on speed, outsized returns, and exits – is poorly suited to support K12 companies.
Large exits are capped by limited buyers and market size. Annual budgets are mostly fixed and there is a defined set of customers – i.e., ~15K school districts across the country. This dynamic, coupled with long sales cycles and RFP constraints, results in more modest growth trajectories and a smaller set of possible acquirers because few companies in the space are at a size or have the balance sheets needed to do so. Exits via acquisition are typically in the 3x-5x multiple of Annual Recurring Revenue (vs 7x-10x+ for other sectors). IPOs are scarce due to the limited number of companies reaching the market expectations of revenue – ~$200M+ ARR in 2020.
The bottom line: Just 1% of entrepreneurs raise institutional venture capital, leaving the other 99% in need of alternative forms of funding to help them grow and scale products and services that can tackle schools’s most difficult challenges.
The Philanthropy Challenge
As a counterweight to venture capital investment, philanthropy has played aggressively in K-12 education. Donors are creating and investing in nonprofit organizations to support product development, professional development, change management consulting, and more. This model presents a different set of limitations:
Philanthropically funded programs typically set goals of scale and impact. They attract investees willing to accelerate growth by giving away or subsidizing their product with the hope of shifting to sustainable economics later. But that delays the “willingness to pay” test and these organizations frequently fail to find product/market/channel fit when the grants dry up.
Philanthropists are also famously averse to investing in sales and marketing activities. Most SaaS companies spend a minimum of 25-30% of revenue on sales and marketing. Philanthropy tends to shy away from this type of spending on any sustained basis.
These funder-driven expectations create their own set of challenges for founders. If a startup is, as Steve Blank suggests, a search for a repeatable and scalable business model, philanthropy makes it both hard to find repeatability (due to distortions) and to scale (due to disinterest in sales and marketing).
