Staying True to Your Values: Learning from Substack's Crowdfunding Decision

Exploring the consequences of prioritizing short-term gains over long-term trust and transparency in the startup world, as illustrated by Substack’s recent fundraising approach.

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In a startup’s journey, founders face many challenges and difficult decisions. While it’s easy to maintain integrity and transparency when things are going smoothly, the true test of a founder’s character emerges during the most trying times.

As we persevere through a challenging economic environment, now is one of those times. VCs have pulled back, with venture investments in Q1 2023 falling to levels not seen since 2019. The IPO market is frozen. M&A is the playing field of bargain hunters taking advantage of distressed startups with nowhere to turn.

As you navigate this perilous path, you may have difficult decisions ahead. Unfortunately, the temptation to take shortcuts is most powerful at these moments.

Substack’s moment of truth

I keep thinking about this temptation as I ponder Substack’s recent decision to raise $5 million from its community of writers and fans. To be clear, I believe in the power of community and love the concept of crowdfunding. But these concepts should only be implemented with transparency and respect for the community, in alignment with the founders’ espoused principles.

Substack decided to take a different path. There are three crucial ways in which Substack failed the integrity test in their crowdfunding effort:

• In an era of rapidly falling valuations, Substack chose to raise this round of funding as an extension of their Series B, which they closed in Q1 2021. That round of funding, in which they raised $65 million, was at a post-money valuation of $650 million. The Substack community investment is priced based on this post-money valuation. This pricing does not reflect the reality of valuations in this current economic environment.

• Substack didn’t share their 2022 financials. Why? According to Substack, because they didn’t have to. They did share 2021 financials, as required by the SEC, which showed NEGATIVE revenue of $5 million, as payments to writers exceeded Substack’s share of subscription revenue. The net loss of $23 million, 10x their 2020 loss, isn’t very reassuring either. While Substack may not have been required to share their 2022 financials with the community, if they had told a dramatically more positive story, I suspect they would have.

• They didn’t issue any forward-looking financial projections. Of course, given that they didn’t provide 2022 financials, this is no surprise. But ultimately, it speaks to the dearth of information provided.

We should also consider these facts in light of the news that Substack tried to raise a fresh round of venture capital in 2022 but ultimately had to end the process due to a lack of interest. Sophisticated, accredited investors looked at their financials, their last valuation from their Series B, and decided to pass.

There was another choice

I’m sure that this crowdfunding campaign was the fastest and cheapest route for Substack to raise an additional $5 million. They didn’t have to spend money on lawyers to paper a new round of funding, invest in updating their valuation assumptions, or spend time arguing with existing investors on pricing.

But valuing speed and efficiency over fairness and transparency with a less sophisticated group of investors speaks of desperation and a bending of their commitment to their community of writers. All of which heightens my sense of risk in investing in the company.

If Substack still has a venture-scale opportunity ahead of them, then they should have taken the valuation hit necessary to raise institutional funding to support their growth strategy. The right time to raise a community round of funding would have been after new investors had weighed in on the appropriate valuation and terms based on proper due diligence.

If Substack doesn’t have a venture-scale opportunity ahead of them, they likely couldn’t raise additional venture capital at any price. If that’s the case, they should focus on finding a viable path to Default Alive – a term used to describe a company that can sustain itself without additional funding. And they certainly shouldn’t be taking $5 million from their community.

Play the long game

You may be staring at your funding challenges. Your runway is getting shorter. Your attempts to raise fresh funding from investors may be stalled. You have difficult decisions ahead of you regarding your valuation, your current cap table, and what concessions you might need to make to bring in additional capital and extend your runway.

The temptation to navigate that path in a less ethical way to try to optimize short-term economics will be all around you. Be aware of this risk and steer away from it.

Our careers last a long time; once trust is broken, it’s tough to rebuild. The way you treat your employees, customers, and existing and prospective investors during challenging times speaks volumes about who you are and what you value. So, as you make these tough decisions, keep your long-term goals and values in mind, and act accordingly.