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Establishing a New Venture Model - An Independent Media for Equity Fund

There are two types of media for equity players, one being leading media companies that leverage their own media directly into targeted investments. The other model is independent media funds such as German Media Pool. German Media Pool is Europe's leading independent media for equity fund, with a portfolio including the likes of what3words, About You, Sanity Group and Clark. 

In the first live talk at Media Capital with Niko and Aljoscha, partners at German Media Pool, we broke down the stages of how to raise a media for equity fund. Previous to co-founding German Media Pool, Niko was an executive in the media industry and an early pioneer in European venture capital. In media, he had global and European leadership roles at GfK and IBM. He was ITV's first media for equity fund manager and strategy advisor for RTL. Aljoscha worked at a VC and as Senior Consultant for Ernst & Young in Washington D.C. and Stuttgart.

  • How did both of you make your way into media for equity space? (01:56 - 02:53)
  • How does an independent media for equity fund operate? (03:48 -06:57)
  • Why do you think these media partners have decided to invest their assets with you? How do you go about discussing this with a potential partner? What value does it bring them? (07:49 - 11:15)
  • How did you choose the appropriate fund size and LP composition back then?  (11:42 - 13:08)
  • If we go through a practical investment example of structuring a deal, ​​at what stage in the process do you discuss the media value that the startup will receive? (14:07 - 25:05 )
  • There have been more than 38 investments today, but with some of them you do follow on investments. In a follow-on investment, how do you distribute exit proceeds to your LPs and ensure fair representation in the portfolio companies? (25:46 - 27:03)
  • Essentially, media for equity is a mixture of debt and equity investment, right? You're doing these investments as a convertible note or a SAFE note? (27:31 - 29:48)
  • How do you marry the two sides - the founder and the CMO, when the founder is more concerned with the company valuation and giving away less equity and the CMO has their own agenda about how they want to spend the marketing budget? (29:54 - 32:33)
  • Have you received any pushback from existing investors sitting on the startup cap table when doing this investment? (33:36 - 37:49)
  • When does the actual media capital convert into equity? Does the media capital convert when you sign the term sheet or is it when the media gets deployed? (38:31 - 41:11 )
  • How would a media partner essentially count the media assets that gets deployed as part of a media for equity deal? Is it revenue? Is it in-kind media, as in a barter agreement? What do we actually pay tax on? Is it actual revenue? Or is it just the equity that gets booked as an asset? (41:18 - 47:13)
  • When you started, what sort of skills were you looking at? What does a fund need in a team to make it a success? (47:47 - 49:54)
  • Do you see it as absolutely important to work with an independent agency in terms of striking media for equity deals and making sure that everything is fully transparent? (50:05 - 52:34)

Diana: How did both of you make your way into media for equity space? (01:56 - 02:53)

Niko: I worked for several years as a partner in a consulting and systems integration company - responsible for the media industry in Europe of this company. I had many years of media industry experience. But previous to that, I worked for a US venture capital fund, which is today known as Upfront. I was part of the European team and had the honour to open their Munich office, which was a huge learning experience in terms of understanding venture capital. When I co-founded the fund 10 years ago, together with Aljoscha, I combined this media experience with the venture capital experience.

Aljoscha: I was building an innovation incubator for a university. Before that, I worked for a professional angel investor in their holding company. And previous to that, I worked in management consulting. Combining all this with a project that Niko and I had together: the book Niko was working on around 2008 where I was involved as a supporter, Nick approached me with this little bit crazy idea back then: 

“You know, let's do media for equity.” I said: “What's media for equity?” He explained it to me, and luckily, I got it, and we got going. Therefore, what brought me into media for equity: Niko, the background of venture capital and the love for entrepreneurship and startups. 

Diana: How does an independent media for equity fund operate? (03:48 -06:57)

Niko: There are two ways to offer media for equity to startups. The first one - you are a media group and you offer your own media to startups in an investment model. That's the media-owned media for equity fund. 

What we do is a little bit different and probably a little bit closer to a classical venture capital fund: we are not owned by any media group, we're owned by ourselves and a couple of shareholders who supported us at the beginning with some angel investments. On one side, our media partners have framework agreements with us to supply us with their media. And on the other side, we invest in startups. We are kind of like a fund and the media partners are our LPs, except they provide us with media and not with cash. That's the independent model. Both of those models coexist in various markets. The innovators who invented the media for equity model are Aggregate Media in Sweden. They were the first ones that I know of that did this. We did it just a couple of years later for Germany. 

Aljoscha: I agree with Niko. In the structure and the ideas behind the fund, there are many similarities to a regular classical cash fund. It's quite interesting just to add to this: we started with three media groups that quickly extended to 4, 5, and 6. By year three, we were at around 20. Today, we have somewhere between 40 to 80 different media partners that we work with in Germany and several European markets. 

All of them are LPs in an Independent Fund. Interestingly enough, I would say 10% to 20% of them have their own media for equity activities that they do, independently of us, as a media-backed model. There is a link between the two and I think it makes sense that a media investor actually gets involved in an independent fund like ours, where they have maybe a larger reach, the ability to be part of a cross-media deal and at the same time, when it's more strategic, and a topic that fits with their media or their strategic goals, then they do it themselves, or even in a mix.

Diana: Why do you think these media partners have decided to invest their assets with you? How do you go about discussing this with a potential partner? What value does it bring them? (07:49 - 11:15)

Aljoscha: A media LP, a limited partner in our media fund, is looking for the same thing in an independent fund as an LP in a cash fund: they're looking for a track record, alignment of interest, investment strategy that matches their own investment strategy, a team that they trust and believe in because it's not just the hard facts, it depends on how well you work together, and there is one more thing that a regular LP wouldn't usually be looking for, but will in this case - your sales ability. 

You need to be more sales oriented because if you're trying to invest media into a company there is a whole number of criteria that need to match. But we'll get to that later. You need to sell it, not push it, that's the last thing you should do. You need to get the investment target and understand if this is something that makes sense for them. 

This is something that a media LP looks for. 

In our case, the first LPs, the first media partners we had, were looking for all this, but they were also looking for something cool, innovative, something new, they were ready to try out new things. Maybe we came at the right time, or at the wrong time but we convinced them, we don’t know this.

For our first media partners, we had to get them to believe in us as a person, not so much in the track record, because we were the second media fund in Europe and actually, the first as it turns out, according to our structure, this close to what a cash fund is structured. 

Niko: What all partners value is the fact that they are combined with other compatible media types. From our first fund, where we only had three partners, crazy to think back to that time: we had one television partner, one radio partner, and one out-of-home (OOH) partner. They were really excited by the fact that they could actually combine different media types, and provide them to startups so that there's actually more value than just them, doing it by themselves.

I think that's still the case today. We speak to our startups, we try to understand what's the perfect media mix for them and we can provide them just that tailored mix of all these different media types, which is obviously really cool and makes us get up in the morning.

Diana: How did you choose the appropriate fund size and LP composition back then?  (11:42 - 13:08)

Niko: It’s very hard to speak to partners that are supposed to provide a significant part of their business into a partnership without being very specific. 

As we were in discussions with a startup, we had an illustrative investment case, which we actually thought was going to work well. It made a huge amount of sense, it was super focused, and the founder was confident it will work. With the media partners, we used it as an actual case thinking that this is what we're going to do. The interesting thing is that once we had these three partners lined up, they didn't use media for equity as their growth strategy and that illustrative case was never used. So actually our first investment was a completely different investment.

But we learnt one thing: we needed something that people can touch and understand. It can't be theoretical or very complex, what we do has to be a real case. 

Diana: If we go through a practical investment example of structuring a deal, ​​at what stage in the process do you discuss the media value that the startup will receive? (14:07 - 25:05 )

Aljoscha: Before I answer this question, I do want to come back a little bit to what a media publisher is looking for in a fund or rather, how we structured the fund. Because it actually plays into your question, namely, the question of how you structure media for equity deals and when we get to the media value, how the process works.

When we started the fund, we were thinking like a venture capital fund structure: we brought every all the media partners into the fund, under a risk-sharing concept. Every media partner gave a commitment, we invested media from each of the partners, in different amounts, and the returns that were generated from the portfolio that was built were divided across all involved partners, according to certain keys that had been defined previously - whether they provided media or not and also mostly independent of how much media they provided. 

The idea behind this was: we bundle the media, and we bundle the risk. We did this for two years, and it worked more or less well, a little bit less well than we thought. So after a few years, we actually went back to the media partners, we completely revamped the structure and it's actually the structure that we still have today. 

To get back to your question, we went from a regular fund structure, including a certain amount of time, you know, the beginning and end of the fund, including pre-commitments that we could draw down on, including a decision process that was based on our own IC. 

An IC that we formed within the fund, somewhat jointly with the media partners, but really more of a classical fund structure and risk-sharing. We went from that to, let's call it individual funds within the fund

If you're in a fund structure, where you're bundling risk, then there has to be transparency: about what's being invested, where, and at what price point. As probably everybody knows there are varying discounts on the market to the list price. After the discount is the amount that is sold, or that you can buy or invest - these discounts became transparent in the risk-sharing structure. That's something that didn't really help us for various reasons for our investment process, or the investment amounts that we were making, therefore we completely ditch this, we went to this individual structure where we had individual media partners, as part of the fund.

We still have a cross-media fund. Let's say we have 5 different partners: two from TV, radio, and out-of-home (OOH). We decided that if they want, we'll invest for each individual TV partner, and the returns from that investment will go directly back to them. This only works for TV.

With our radio partners - we bundle them together into somewhat of a risk-sharing construct because transparency becomes less of an issue. And as a result of doing this, we had three things that actually happened. 

Now I'll get to your question about the structuring: 

the first thing is, whereas before, we had fairly limited amounts of pre-commitments, and thus investment volume that we could make available to startups - to solve this we decided to have an individual return for each individual media partner. We coupled that with a case-by-case structure where they made individual decisions: “I want to be part of the deal or not”, they're basically an IC of one, jointly with us. So IC of two: the media LP and the media manager. Because of that, the media partners kind of let's say went off the brakes. 
To give you an example: Before that, let's say the investment volume was 100. Suddenly, the investment volume went to 1000, because the media partners didn't have to pre-commit to something that didn't yet understand.

Niko: One of the hugest headaches we had with the initial structure, was that we actually tried to balance out the amount of media from different types into different startups that we had. For example, if we would invest less radio in the past deals, we thought we should now invest more radio so that we have a balance between radio, OOH and television. That was just not something that was in the interest of the startups. 

We realized that we need to have a model that works for startups. So this individualized case-by-case investing where we have the startup's interest at heart and if it made sense to do a huge amount of TV and a huge amount of radio, but nothing else, we did that. Previously we were always trying to figure out how to balance out different media types - that was just really, really bad and it didn't even work. 

Diana: To sum up, initially, you basically had pre-commitments from the media partners, and you were allocating the exit proceeds pretty much in an equal way back to the partners, whereas right now, there are no pre-commitments, you approach every company on a case-by-case basis. Is it fair to assume in terms of a legal structure -  that it’s an SPV or how do you actually sit on the cap table of the company? Is it through German Media Pool, right?

Aljoscha: So what happened as a result of this shift, when we went to a case-by-case structure, funnily enough, the investment decision became much easier. Sometimes when someone doesn't have to pre-commit, it builds trust. And with that trust, we suddenly became a very efficient structure and it was very efficient to invest and make the investment decision on a case-by-case basis with each partner. 

The second thing that happened: we essentially created an evergreen structure. We're still in the same fund and we've invested significant amounts of each of our partners.

And the third thing is that it made it much easier for new partners to join. They're obviously in a setup where they can be involved in a deal, but they don't have to be involved. 

The way that we structured this: unlike a classical fund, our LPs are not actually shareholders in our holding entity, German Media Pool GmbH. It's a purely contractual relationship and because of this, we can actually reflect this case-by-case evergreen structure for each partner within the same vehicle and still have one single vehicle with which we invest in the startups. It's always the same vehicle and there's a second vehicle for media types, such as print. They're the only two vehicles that invest in startups. So it's not an SPV structure. 

One last sentence: One of the things, maybe the most important thing in a way that also happened is we truly became independent. We didn't have an obligation anymore to invest media from each partner, because they were now on a case-by-case structure. We now and as we expanded the amount of media and the types of media we had available, we had years where we didn't invest anything or almost anything from one partner, and the next year, we invested a lot from them, but that was fine for them, because they're in this case-by-case structure where they could be part of the deal, but didn't have to be and now suddenly, for sure we had a structure where we are able to tailor each deal to the needs of the startup, but can also turn down deals. Even if we haven't invested any TV for a year. Fine. We'll invest it next year. 

Diana: There have been more than 38 investments today, but with some of them you do follow on investments. In a follow-on investment, how do you distribute exit proceeds to your LPs and ensure fair representation in the portfolio companies? (25:46 - 27:03)

Niko: When our media groups invest, that's always within one investment round. So if we have radio together with TV, in a certain series B, for example, then it's the series B waterfall that counts over all of the different investors that are part of that series B round. When we get to the distribution for series B proceeds, there, we don't make any distinction. It's just according to who put in which amounts of media and then we distribute according to that amount, there's no more waterfall within that. But interestingly, for several of our largest investments, we've invested for several years in a row in different venture rounds. So take an example About You. We invested in several rounds over several years. There we have to be particularly careful that obviously, the media groups that have been part of a certain series, A, get that distribution, that media partners who've been a part of a series B, get that distribution and so forth. But we obviously track that. It's very transparent what they get. 

Diana: Essentially, media for equity is a mixture of debt and equity investment, right? You're doing these investments as a convertible note or a SAFE note? (27:31 - 29:48)

Aljoscha: Based on our structure, we can invest both directly in a round, meaning we sign for shares and make the media available afterwards. In a way, there's a promise that we will make the media available, and if not, we will have to give back the shares. It's never happened. But this has to be part of such an investment agreement. And the other mechanism, which you just described, you call it a convertible note or a SAFE. For various reasons, because it's a service, we can actually not technically invest with a convertible note or a SAFE, but the mechanism that we use is very similar. Basically, we sign a contract that promises to make a certain amount of media available within a certain amount of time in predefined terms. And the shareholders sign an agreement that promises us a certain number of shares, for example, in the next round. It sounds like a convertible or a SAFE, but it's just not called that. 

Getting back to what I have been promising to answer three times: Structuring a media for equity deal do's and don'ts.

Number one most important aspect of structuring media for equity deal is to make absolutely sure that you're making the right media available, the right media mix, in the right amount, over the right time amount or timeframe, available to the credits. More than anything else, this is the number one aspect of structuring a media for equity deal. That's something that we've worked on for many years now. 

Diana: How do you marry the two sides - the founder and the CMO, when the founder is more concerned with the company valuation and giving away less equity and the CMO has their own agenda about how they want to spend the marketing budget? (29:54 - 32:33)

Niko: Both the CEO as well as the CMO must understand or have the feeling that the media will work for them, and will contribute to their growth. There are only two ways this can happen: either, you've already done a little bit of media and you've tested it (you've done a small TV test or a small OOH test) or you know that your category, let's say it's food additives, works very well with a certain media type, for example, television, because maybe even dozens or hundreds of brands before you have proven that there is traction with television with that category. And it's a truly mainstream category. That needs to be the foundation because there needs to be just a strong understanding - we want this company to have media. And then it's, it's usually possible to get those two different views together: both the CMO and the CEO understand that they can do more media through a media for equity deal than they can if they just simply take that cash from a VC and give that cash to an agency to spend. There is a valuable advantage to doing media for equity deal because the media partners expect or hope that there will be a multiple in their investment and they will get back more than they put in. So they're able to provide good media value.  

Diana: Have you received any pushback from existing investors sitting on the startup cap table when doing this investment? (33:36 - 37:49)

Aljoscha: Absolutely. It comes back to your first question, as they are very closely linked. As I previously mentioned - the number one most important aspect of when structuring a deal with a startup is to make sure about the chosen media type. That's a little bit wrong because it was only half the answer. It's actually the right kind of media at the right price point. 

Our job as media for equity investors is to find a balanced price point. So we have to make sure that the media that we're making available to the startup is equally or more attractive, actually more attractive, to be honest, cheaper, in a way, than if the startup were to go out and buy it on a cash basis. What we'd like to say is that a Euro spent on media for equity is more valuable than a Euro spent on cash buying media. The way that you do this, as you know, in addition to the media for equity model itself, we simply make sure that the media that we're making available to the startup is at the absolute best price point that they will be able to get on the market.

The best price point doesn't mean it's free. It doesn't mean it's 10% of the regular market rate. What it means is that we have to find a balanced price point that's fair to the media owner - meaning the actual value of the media is reflected and it's also fair to the startup - it's more attractive than what they will be able to get otherwise. If we get pushback from the existing investors, it's for one of three reasons: one, it could be because they've never had a media for equity investor on board, and they're worried that there are ulterior motives, strategic interests, and so on. This doesn't apply to us as an independent fund; the second one is always around the price, and we simply have to make sure over and over again, to show them that the price point of the media we are making available is extremely attractive, and something they would not be able to get otherwise; the third thing we have to make sure of is the deal size. 

One of the other things we learned over the years is that small is beautiful. We've learned that if you want to have a big deal, the best way to start a big media for equity deal is really small. You set up a deal with a goal: we're trying to reach 10 million in media through an investment. Then we don't do a 10 million investment, but a 1 million with an option to scale it to 10 million over the next 1-2 years. What we're achieving by doing this is we're reducing the risk that the startup takes on, that would exist with a huge deal when they're committing to something large, which may or may not work the way that they intended it to, or maybe even the business model pivots within nine months or 12 months, that has happened with some startups. Suddenly, the media is not applicable anymore. 

So we tried to emulate the media strategy the startup would have if they were purchasing the media on a cash basis, but still making sure we have all the advantages in pricing and partnering from a media for equity deal. 

Niko: In the beginning, we had more resistance from VCs than we have today. I think that we've been able to prove that it's a sustainable model and that startups have used this and ended up in very successful IPOs. And we have co-investors that we have been working with. For example, we've done two or three deals with a venture capital fund, so they're not going to have those same questions when we do the third or fourth deal with them. So it's gotten a lot easier because many VC funds have understood the value that media for equity can bring.

Aljoscha: We actually don't do a lot of deals. We even talk a lot of companies out of doing media for equity for various reasons: too early, the wrong media type, maybe they are not ready for a media investment or will never be ready. I think this builds credibility. 

Diana: When does the actual media capital convert into equity? Does the media capital convert when you sign the term sheet or is it when the media gets deployed? (38:31 - 41:11 )

Niko: It depends on whether we invest as part of a round or a convertible. When we invest as a part of a round - the first tranche of media is always mandatory otherwise we wouldn't have a deal. So when we invested in part of a round, we usually have the share allocations for that: tranche 1, tranche 2, and tranche 3, already written into the investment contract. 

What happens next is: we get the shares, either in the beginning or when the media is provided, which really varies from country to country. But one thing that Aljoscha said is really important. If in any case, we cannot provide the media, there is a clawback mechanism so that we return the shares for that piece of media, that's really important.

Aljoscha: To build on what Niko just said, I think it depends on the market and the preference of the shareholders. Our choice would always be to sign for the shares before delivering the media. It's simpler because you're part of a regular round and an investment agreement that has been signed already. Often the shareholders, especially when they are doing a media for equity investment for the first time, they prefer to have the equity convert at the end, when all the media has been delivered. It depends on the market: how common it is to have a convertible or SAFE mechanism, or what are the investors looking to do in general.

Actually, there is an in-between the two. The first we describe the signing upfront, and the second was signing after the media has been delivered. We have had some instances where we signed an investor agreement previously, and then the shares were issued, but not transferred. They were allocated to us as the media was being delivered. So let's say every six months, for example. But again, that was a preference more than structuring or legal requirements inherent to a market.

Diana: How would a media partner essentially count the media assets that gets deployed as part of a media for equity deal? Is it revenue? Is it in-kind media, as in a barter agreement? What do we actually pay tax on? Is it actual revenue? Or is it just the equity that gets booked as an asset? (41:18 - 47:13)

Niko: I think it's up to the media partner to decide how they account for the media that they provide, for sure. So this is something that the media partner has to decide for themselves. Most media partners out there, especially the ones that are investing directly their media, account for the media that they provide in a given year in a deal as revenue, and pay their corporate tax on that piece of revenue that they've contributed to the startup in that investment year. They put it into their books as revenue. That's the most common model. Other models are more refined, where one books it as revenue later, for example, during the exit, but that has to be agreed with tax consultants, and that has to be decided by the media groups themselves. That's a very tax-specific question and you should have very seasoned tax professionals work that out for you. 

Aljoscha: In a market with IFRS-based tax or accounting regulations, you're always accounting for the delivered media and as a result of this, you're being taxed at your regular corporate rates as the media is being delivered. But on the flip side, once that tax has been paid, anything that you're making above and beyond the media that's been delivered - for example, your exit proceeds will essentially be considered as actual exit proceeds. So they will be taxed at a far lower rate than your revenues normally would be. 

And then other markets, such as Germany, Switzerland and a few others, at least the ones I know, you can opt for either IFRS or HGB taxation, and under this tax regiment, you're able to defer the taxes to the point in time when there are any exit proceeds. But by deferring this, the taxes happen later. At the same time, the taxes will be paid as regular revenue. For example, investment proceeds would be taxed at 5%, and regular proceeds or income are taxed at 30%. If you delay it then you have everything later taxed at 30%. 

You can opt to tax now and have lower taxes for the exit investment proceeds or vice versa, you can opt for later, but then it's a higher tax rate on what you make. There are positive and negative aspects to this. Deciding and building a structure that allows you to do both is quite complex and expensive, as we can attest. You must have great tax advisers. But once you have it set up, which we have, you will be able to do quite a bit with this. 

Niko: This was one of the hardest, but also most interesting things in establishing a media for equity fund - establishing the tax model. We always say we work this out with the tax consultant that wrote the book. The tax consultant that works with us wrote a book about corporate taxation, which is one of the books that are in every tax office, on the shelf. And the only reason we could persuade him to work with us at the beginning was that he thought this was such an interesting model and took it as a personal challenge. Now that I think about it, it’s exciting - we have established a new investment model. And part of that is this taxation model that we use.

Diana: When you started, what sort of skills were you looking at? What does a fund need in a team to make it a success? (47:47 - 49:54)

Aljoscha: In contrast to a cash VC fund, every person in the company has to have both VC and media knowledge. We have three types of roles: the first are the persons that are more investment focused: the investment managers, and the associates - they need to first and foremost have VC skills and then learn media skills. They don't have to have the media skills upfront, we will teach them, but the ability for the venture capital needs to be there. Then, we have the media roles within the company - they need to first have media knowledge, and then we teach them the VC side of things, as they grow into the company. The last one, that's the same as in a regular cash fund - the back office functions: finance, accounting, organisation of everything- the people that make the fund run. 

Diana: Do you see it as absolutely important to work with an independent agency in terms of striking media for equity deals and making sure that everything is fully transparent? (50:05 - 52:34)

Aljoscha: So first and foremost, we're not an agency. We have always made sure not to become or be perceived as a media agency. We are a media investor, and we have a small media team, not to replace an agency role, but actually to take on the project management part, to make sure that the media campaigns go as best as they possibly can. They're like a liaison between the VC side and the media team at the startup/at the agency that the startup hires. And to answer your question, we don't partner with media agencies directly. We know many agencies, and sometimes we bring them deals where media for equity doesn't make sense or they suggest deals to us where maybe the startup wants a combination of media for equity and classical media buying or even only media for equity. At first, agencies perceived us as a competitor, but now we work together, and we help each other.

We recommend every one of our portfolio companies, before doing the investment, or as part of the investment, get an agency that will help them assess the media deal and actually implement the media deal in the best possible way, with independence in the consulting that the media agency provides. Some of the companies such as About You, and a few of the other later-stage startups, they've built a media agency within their company: they have built a team and acquired the knowledge, the skills and the tools that would be the same as what an agency would have provided to them. And that's been quite cool to see.

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