Funding Innovations Part 1: Changing the Dynamics of Funding with the Peer Selection Model
In this series, we will explore innovative funding practices lesser known to the entrepreneurship world. A recent Kauffman Foundation Entrepreneurship Policy Digest reviewed ways in which entrepreneurs access financial capital. But there’s another lesser-known funding innovation that changes the dynamics of the funding process and drives more diversity in the kind of companies raising capital: the peer selection model.
The peer selection model was the brainchild of Ross Baird and Bob Patillo, of the accelerator Village Capital, who noted that there were three major barriers to early-stage innovation:
- Lack of early stage-capital for entrepreneurs
- High cost of deploying financial capital (vetting and due diligence)
- Skewed power dynamics between investors and entrepreneurs
They designed the peer selection model in 2009, which was heavily inspired by the Financial Village Bank and the Education Academic Village at University of Virginia.
The Peer Selection model consists of four main elements:
- A cohort of entrepreneurs going through an accelerator program that will compete for a pool of funding
- In-person group interactions consisting of sessions led by industry experts and experienced entrepreneurs
- Weekly correspondence by the entrepreneurs from the cohort to report on assignments regarding their business operations
- In the final session, the entrepreneurs rank each other. and the highest-ranked entrepreneurs receive funding
The model has now been in practice by Village Capital for the past six years. Ross and Bob’s goal from the beginning was to make the investment process more constructive and less extractive for everyone involved. They have aimed to accomplish this through the three main benefits of the peer selection investing model.
The focus shifts from the investor to the customer: Early-stage companies compete to create and show increased value for customers. In the peer selection model, the entrepreneurs are ranked by fellow entrepreneurs and are chosen by demonstrating the highest level of business operations.
The due diligence adds value: Instead of having a one-way stream of communication from entrepreneurs to investors until an investment decision is made, the peer selection model engages both the investors (the peer entrepreneurs) and the entrepreneurs. Entrepreneurs are immersed in a three-month process of providing continuous feedback and ranking to fellow entrepreneurs in their cohort on their criteria such as: team, product, customers, financials, and outcomes.
More women entrepreneurs receive investing: Village Capital is on average with other programs when it comes to number of women founded companies that apply to the program—15 percent. However, of the companies that are selected by their peers, 40 percent of the companies have a woman co-founder. This is a higher percentage than receive angel funding (25 percent) and much higher than the percentage that receive venture capital funding (3 percent).
Lessons Learned by Village Capital: Six Years of Peer Selection Investing
1. Problem-Based Approach
This brings entrepreneurs together and focuses the program on solving the issue at hand. The focus of each cohort that Village Capital runs is to solve a global problem—water scarcity, increasing resource efficiency of the agricultural supply chain and better learning outcomes in education. The focus of the program is to solve the problem at hand, which increases collaboration between the entrepreneurs and decreases competition.
2. Differences Across Culture
The peer selection model works differently across the world. Village Capital has used this model across 9 different countries in 4 continents. They have found that collaboration between entrepreneurs is key. This seems to come most naturally to entrepreneurs in countries where they are taught to be collaborative in the education system, such as in the US and Latin America countries.
In other countries, such as India and China, it can be more difficult to implement because it’s taught in school that business is very competitive. To overcome this challenge, Village Capital brings in respected authority figures—such as a president of a large bank—who explains that it’s okay to be collaborative. Village Capital has run six programs in India and found that once the entrepreneurs are given the permission to be collaborative, the process clicks.
3. Structure, Standards and Transparency
At first, Village Capital had little structure for the peer-selection model and let entrepreneurs design and run their own ranking process. Noticing that this took up a majority of the entrepreneur’s time, rather than reviewing and ranking each other’s business plans, Village Capital established standardized rules for the peer ranking process.
The original standards of the program allowed for too much subjectivity when entrepreneurs were ranking the businesses. They first used straight ranking, which led to entrepreneurs selecting the business that had the least chance of winning, which would in turn increase their own chance. Now, Village Capital has entrepreneurs use a matrix based on business operations criteria and weights the ranks using standard deviation to correct for outliers.
The final and most surprising lesson learned dealt with the value of transparency. The peer selection model originally kept everyone’s ranking private to avoid a popularity contest. After the first few sessions, they learned that people who lost would question the rankings and lose trust in the system.
So, Village Capital decided to make all rankings transparent to the entrepreneurs, which did two things: 1) Gave real time feedback and 2) made everyone completely accountable to the ranking of their peers.
Overall, the peer selection model offers an innovative way for entrepreneurs to be vetted, trained and access financial capital. The selection and due diligence process creates value for the entrepreneurs and investors. Finally, there is evidence that the model enables more accessibility to early-stage funding by underrepresented groups.
In the next post, we will explore the innovative funding approach taken by the Founder’s Institute: The Shared Liquidity Pool.
Find out more about other sources of financing: crowd funding, debt and equity.
Q and A on Peer Investing and Democratizing Entrepreneurship: Village Capital’s Peer Selection Model.
To learn more about Village Capital.
Find out how the Peer-Selection Model can be used elsewhere.
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