Brian Dally: I'd love to start with the origin story. So, what led you to start [00:02:00] Homegrown and what problem were you trying to solve?

Michael Davis: Yeah. The beginning of Homegrown starts a very long time ago. I was 11 years old and my parents decided to start a company. They did what many people do, which is, they went to the bank and got a startup growth loan to open the business. Of course, it was personally guaranteed. And, unfortunately, early on in that company's journey, it didn't really work out. And I got to see what happens when a business, a family business, doesn't grow and scale the way you expect. And also dealing with all the consequences personally that happen when a company doesn't work.

And so, my family spent a couple years contending with this, and during this time I'm seeing the pain of the experience they had. And fortunately they tried the same company again and it worked. It's a really nice, very profitable business today.[00:03:00]

But along their growth journey, it was terribly hard for them to get access to capital. So even when the business was generating a lot of revenue consistently, profitable, great management team, all these things you'd expect, it was still nearly impossible for them to go to the bank and get the growth capital, the expansion capital they needed to grow.

And I saw my parents frustrated about this for countless hours over dinner at Golden Corral for years. And, I think hearing my parents share their frustration for so long, probably left a little bit of an idea in my brain that I, 20 years later, came back to in building Homegrown and trying to solve a little bit of the problem that they dealt with.

Brian Dally: I get that and I think when most people think about small businesses like restaurants or fitness studios, the assumption is that traditional [00:04:00] bank financing is available. It seems like it would be. But what do people misunderstand about how these businesses are financed and why private credit can play such an important role?

Michael Davis: Yeah, so Homegrown is nearly three years old, and I can remember the first months of that journey very, very viscerally. And one of the most common questions I was asked was, can't they just go to the bank? And this is an extreme misconception.

Brian Dally: By the way, I get the same question about real estate. Because everybody thinks, oh, real estate, you can finance real estate.

Michael Davis: Just go to the bank.

Brian Dally: And you say, well, no, it's really not that simple. And that's why there's a whole market in these finance categories that are non-bank lenders or non-bank capital providers.

Michael Davis: That's correct. And there's a number of reasons why the traditional finance layer doesn't always [00:05:00] serve the needs of these entrepreneurs. Sometimes it's because, let's just pick on the banks. Sometimes it's because the banks have a credit culture where they're not allowed to take slightly higher degrees of risk.

And by the way, I'm not giving them crap. They operate in a regulatory framework. And that's their regulatory framework. But that regulatory framework keeps them from providing capital to many businesses that are very largely creditworthy. So that's one issue.

Then the other issue is the experience. So, just to set the stage here on brick and mortar entrepreneurship, it's like one of our clients, it's a coffee company. They have six locations, about 140 employees. Did you know that? People think about a restaurant, and they're like, oh, they must have 10 employees. No, no, no, no, no, it's very normal for a single restaurant to employ 60 to 100 people. [00:06:00] And, so now that entrepreneur is managing 60 people maybe at one unit. Got a lot of part-time workers, full-time workers, kitchen staff, the overhead to manage the stores at all. And now you scale that up. So you talk to a five-location operator, easily has two, three hundred employees.

Brian Dally: Wow.

Michael Davis: And now you're going to have that person go to the bank and go back and forth for five months going through a checklist and it feels dehumanizing.

Brian Dally: Right.

Michael Davis: And I think that's the other part of the equation is the actual feeling of going through the process of finding financing from a traditional kind of bank doesn't feel like it has hospitality, which you're talking to people who, their lives are about hospitality.

Brian Dally: Of course. That makes sense. There is a perception, I'm glad you voiced this. There is a perception that maybe brick and mortar businesses are inherently risky. Restaurants go out of business. [00:07:00] You do see retail outlets suffer or struggle during tough times. But how do you think about the risk management in this space, and what is it that you saw that helped you develop confidence in your model?

Michael Davis: Yes. So, you know this very well, Brian. There's the mainstream media narrative, and that narrative feeds on other mainstream media narratives. And in that information stream, there's a lot of nuance that gets lost. And when you dig into the nuance, you can almost always find an exception.

So, our unique insight was actually born from this statement of, oh, restaurants are really risky. Or, the pizza shop my friend wants to do is really risky. It's not that that narrative is wrong, it's just that it's not correct [00:08:00] all the time. That was the founding idea with Homegrown.

It was like, it's not that there isn't risk in real estate. It's not that there isn't risk in technology. It's not that there isn't risk in brick and mortar four wall entrepreneurship. There is risk, but there are zones where there is relatively lower risk. And if you can find those zones and contract with the people in that zone, you might have an opportunity. That's what we found.

So, let's go back to the restaurant example. Many restaurants are highly risky because, it's not just building out the space, or hiring the team. It's providing service that is highly unique to hundreds and hundreds and hundreds of patrons every single day. There's a lot of points where that can fail. But what happens when you look at the restaurants and you can actually assess them? You can see, how did you perform when the pandemic happened? That's something we look at, by the way.

For businesses, [00:09:00] we like to partner with companies that have a longer track record. Because instead of saying, what happens if a global pandemic occurs again? And it's all conjecture. I can actually go and do an analysis on your financials, your bank data, I can look at your customer reviews, and I can talk to you and get a more complete picture of how do you handle these dislocating events.

Brian Dally: That sounds like a series of signals and aspects of underwriting the risk or assessing the risk that might differ from how people traditionally look at financing something like this.

Michael Davis: Yeah, and I think to give a little bit of a description of Homegrown, we provide revenue-based expansion capital to proven brick and mortar businesses that have multiple locations.

Brian Dally: It's not for the first time, your example, pizza shop entrepreneur who's trying to figure it out for the first time.

Michael Davis: [00:10:00] We are not that. I would love one day to have products for the whole range of entrepreneurs, but where we are right now, we're very focused. We're not startup capital. We're not even early stage capital. We're acceleration capital. We're the capital when you have something that is working and your option is to go spend 300 to 400 hours raising equity, selling ownership in your business, going to the bank and going back and forth for five months, going to the SBA, and you don't want to do that.

We are a far better option. And the underwriting we do is because that kind of echelon of entrepreneur wants a better financial product than what they get from their point of sale system that's giving them very short term financing. They want more time to pay back. And they will tell you that I'm profitable, proven, our customers love us and I have 5, 6, 7 locations, maybe 10, 15, 20 [00:11:00] locations, and they're working. I could go to the bank. I don't want to. I would rather work with you.

Brian Dally: Yeah. So I guess you're saying, it's not that the banks won't do it, it's that what it takes to do that with a bank might be distracting and pretty painful and maybe riskier for them.

Michael Davis: Very cumbersome. Very cumbersome. And, many of them will choose to take that path. In some cases we are actually in partnership with the bank.

Brian Dally: Oh, interesting.

Michael Davis: The best operators have a capital stack. Sometimes it's cash flow. Sometimes it's equity. Sometimes it's Homegrown. There's a whole...

Brian Dally: Part of the equation.

Michael Davis: Completely. Correct. And so I think, it's going back to the old question on risk. I think what we've looked for is fundamentally, what companies where, when you have as much information as you possibly can, are you saying, why aren't they getting capital from the bank? Those tend to be the businesses that we work with. [00:12:00] And that's why our track record has been so good over the first three years or so of operating.

Brian Dally: So, let's get into the products a little bit. Because I think the product is really interesting. I really like it. I like the way that it's structured and formatted. So I definitely want you to share that with the audience here. Can you just describe how you guys structure the capital? And then, if you accept this as a form of revenue-based financing, how should investors think about that, as compared to a traditional equity investment or a traditional debt investment?

Michael Davis: It's a fantastic question. So, I'm an equity investor. When I write an equity check, I don't expect any cash flow from that investment for a very long time. Sure, there are scenarios where maybe you get distributions after a period of time, but in many cases you're not seeing any cash flow, certainly no material cash flow, for a very long time.

And by the way, to be clear, I'm [00:13:00] talking about equity investing in the context of alternatives, not equity investing in the public markets where you have dividends and everything else. I mean, investing equity into a local brick and mortar business or a startup.

That is an important part of the equation, the financial ecosystem. That's not what we do. We structured our revenue contracts - they're not loans, they're revenue contracts - almost in counter position to the experience of traditionally investing in a startup. Where, I would meet an angel investor, I was one of these angel investors, I still am, and I invest $25,000 into a startup. And I don't see anything for seven years, maybe ever, by the way.

We got our start by simply going to angel investors and saying, how much capital did you put into early stage technology companies? How many of them worked? What cash flow have you [00:14:00] received from your investments? And Brian, the average kind of response I would get was, I put about a million dollars in startups, I've gotten nothing back, and a few look really good on paper.

So it's like, okay, what if you had taken 10% of that, 5% of that, and put it into something that actually gave you cashflow immediately every month? But it's a revenue contract, so if the business slows down, you're going to get less. But on the flip side, if that business hits its growth plan and their revenue grows, you're going to share in the upside.

And that's how we started. So, Homegrown has been structured as a revenue contract that pays monthly cashflow to our investors. And here's what's important. That cashflow is coming from a company that has multiple locations. And why is that important? Well, sometimes expansions do not work. Everybody listening to this podcast or watching this podcast has probably had [00:15:00] an experience at work where you do something and it doesn't work. We know that that will happen. And so by backing companies that already have an established portfolio of locations, we get an immediate diversification, and a diversification that gives us down...

Brian Dally: You're not betting on the cash flow of the new location.

Michael Davis: No.

Brian Dally: You're saying the overall business has cash flow, has revenue coming in, and you have the right to a certain percentage of that. Is it for a certain amount of time that you have it or for a certain amount that you have it? When are they done?

Michael Davis: Yeah.

Brian Dally: And when are they done paying you?

Michael Davis: So basically, it's a capped return model. So, an average Homegrown revenue contract looks something like, I give you a hundred thousand dollars in exchange for 2% of your revenue. And you will share that with us monthly until you've paid back somewhere between 1.3x and 1.6x, give or take. [00:16:00] Okay? So, the first question an entrepreneur's going to ask is, what's the cost?

And where we position ourselves is between the merchant cash advances that are short term instant, right? They're not going to have a conversation with you to understand the nuances of your business and understand risk. They're not doing that.

They're looking at your cash flow and alternative data around the cash flow and saying, we're going to extend you credit for 14 months, but we're also going to take 15% to 20% of your sales every single transaction. So we're saying, we're going to actually talk to you, we're going to extend this credit for longer, but for that work, for that trade, we're also not going to take 15% of your daily sales. We're going to take 2% of your daily sales.

One of the things that is really important to us is risk management. And a way you manage risk is by protecting the cash flow of the borrower. And this is a fundamental way [00:17:00] that we underwrite. It's like, is this going to be a net positive for the business? And if the answer is no, we will not do a revenue contract.

Brian Dally: I can identify with that. We have said a similar thing about the way that we finance real estate projects. Because we're very concerned about the cash flow going into the collateral. And in your case, that's the engine. And if you're taking too much cash out of it, you're actually adding risk to your own investment. In the end, I agree with that.

Well, that's great. I appreciate you outlining that, because I think it's very novel. It's a really smart way to finance small business, and I think investors are going to be excited about it. They already are.

So I wanted to touch on something else that you've written about that I find really interesting. I hope I'm not misquoting you, paraphrasing you wrong, but you've put this idea out [00:18:00] there that the brick and mortar businesses can act as an AI shock absorption layer. Can you unpack what that means? And why that matters?

Michael Davis: So, my last job before founding Homegrown was at Microsoft. I'm a nerd.

Brian Dally: I worked at Microsoft early in my career as an intern.

Michael Davis: Man, we have so much over overlap.

Brian Dally: Look at that.

Michael Davis: Yeah, we did.

Brian Dally: I know. Amazing.

Michael Davis: This is layers, man.

Brian Dally: Crazy.

Michael Davis: I saw a long time ago where AI was heading. I'm not saying I knew the future. I didn't, and I didn't know the timing of it. But you could look at the signal five years ago and extrapolate out that, hey, in the next 10 years, we're going to face a really important moment in human history and in our markets where AI is going to get distributed in a way where it's widely available. And that has happened.

I remember leaving Microsoft to start Homegrown, and one of my colleagues is like, you're leaving technology to go do brick and mortar? Are you sure? Basically he was like, Michael, are you [00:19:00] crazy?

Brian Dally: Yeah.

Michael Davis: And I was like, a little bit. You've got to be a little crazy to do a startup.

But I also believed in supporting a world where AI was more distributed and where the job dynamics were different. When we have looked at the last, even just year, you're seeing evidence of very real job dislocation. Now, many people will tell you, any sort of new technological wave comes with the destruction of jobs and the creation of jobs. And that is correct.

However, you can't just say, well, some will be created and some will go away, so therefore it's fine. It's like, no, you just said, some jobs will get destroyed. What do you do here? It's our contention that coffee shops, yoga studios, restaurants, doctor's offices, and all the types of places that we back are important career points for people. They're important landing points for people. And it also offers a new type of entrepreneurship.

[00:20:00] I remember 10 years ago, constantly was hearing everybody talk about doing a technology startup. And I still hear this from the 19, 20, 21 year-olds I talk to. More often than not now though I'm hearing, I want to start a fitness concept in my city, I want to open a coffee shop. I'm hearing way more brick and mortar entrepreneurship. And we want to be a part of supporting that layer because we think it's how we respond in part to AI. It's not the totality of the solution, to be clear. The solution's going to come from many more places. But I do think what we do is a part of it.

So that's what I mean. I mean that by supporting brick and mortar entrepreneurship, creating the jobs, helping to shore up the parts of our cities that we love and that people go to, that it's one way we can respond and give people opportunity.

Brian Dally: I love that. That's awesome. Very inspiring and cool. Safe to say you're building this in a [00:21:00] pretty dynamic environment.

Michael Davis: Yes.

Brian Dally: Never a dull moment in our macro world right now. There's economic uncertainty, whether it's because of AI or other factors. There's a lot of innovation in financial products. That's for sure. The last five years, especially since COVID, has seen a real positive explosion in that. How are you positioning Homegrown to stay resilient in this environment?

Michael Davis: In one of our presentations, there's a quote that, the best downside protection is preventative medicine. We are very, very thoughtful about who we partner with and we do a lot of work to make sure that when the shocks happen, they have the financial structure, the team structure, the location selection prowess to be one of the companies that endorse. And that's one way we've [00:22:00] responded is just doubling down on risk management and being very thoughtful.

I think another thing we have done is thought very carefully about structuring of products. So, it's important, going back to cash flow, it's really important when you're partnering with a business to think about their cash flow dynamics years out, and to actually share your learnings with them.

So something we do... there's a lot we do that's not on our website. One of the things that we do is we work with the entrepreneurs and give them the insights we find through underwriting. And to try to help them think through what's going to happen in a year and what happens if that buildout that you thought was going to cost $500k, costs $700k, what's your plan?

How much redundancy do you have in your capital stack? Do you not have enough redundancy? Well then let's think about how do you build more redundancy? Because we know that a business that is performing and doing well that we have partnered with probably is pretty compelling [00:23:00] and probably has options. And, we think it's important that companies have a variety of levers to pull financially to make sure that they can survive and thrive and weather the tough times. So, I think that's some of how we respond to it.

I think one more thing, Brian, is simply that, I'm a credit head. You and I have been reading the same articles the last month about private credit and the redemptions that have been taking place. And there've been a lot of people who've been concerned about that. And so I get this question of like, how do you feel about that? And what I tell people is, that is one category of credit. We're in another category of credit.

Brian Dally: Right.

Michael Davis: That doesn't mean anyone's immune from geopolitical risk that we're seeing. Everything's connected, right? We're all in an ecosystem. But I do think that people are going to get their haircut and I think that you're still [00:24:00] going to go buy coffee. And you're still probably going to go to the gym and so on and so forth.

Brian Dally: Right.

Michael Davis: I think we're funding spend that works into the rhythms of people's daily lives, and that rhythm is protection for us. The habit.

Brian Dally: Yeah. And I think being location based is itself a form of protection. Because people still need to be in a location.

Michael Davis: That's right. And it's tangible. There are apps that I used to love four years ago that I haven't opened in a year. That happens.

Brian Dally: Now, you also, and I appreciate how hard this is to do, I did it as a entrepreneur in specialty finance, you've now done it. You've built a good investor base, pretty quickly.

Michael Davis: I love them.

Brian Dally: I like your story about how you pitched it to the angel investors, said, what if you went from a [00:25:00] million dollars in this and zero in this to like, maybe just balanced it differently. I love that. What do you think resonates with investors about this and what's brought them to you? Why are they choosing to partner with you? I mean, getting investors over the hurdle to actually back your company, of course, that's one thing, the platform is one thing, but then getting them to back the projects and the investments, I can appreciate how hard that is. What do you think has made you successful at that?

Michael Davis: Man. The beginning was super hard because it was a very, very new, it still is a really new asset class. But whenever I talked to people about this, they're like, what is this? So first off, to any of our investors who are listening, thank you for taking a chance on us.

So, the thing our investors love about Homegrown, [00:26:00] and I think the ranking of why they partner with us repeatedly, we have a really high repeat rate with our investor base. I think the reasons are, first and foremost, the regular return. So, I remember on our first revenue contract, I'm an investor in my first revenue contract, I love investing in my own work. I remember talking to one of the investors and he's like, what's the risk? Well, the risk is that this company survives for 16 to 18 months, then they go out of business. That's a risk. And he said, he's like, okay, but if that happens, I would've gotten something back. I was like, that is correct. You would've gotten something back.

Brian Dally: Some portion of that 16 or 18 months, they're paying 2% of the revenue.

Michael Davis: For sure. And many people are doing zero sum equity investing where it's truly a binary outcome, effectively. And so I'm like, hey, [00:27:00] this is probably not a binary outcome. There's a range. We think the range is, if you do the probabilistic analysis, most outcomes land in a really, really great, compelling spot.

Brian Dally: Yeah.

Michael Davis: But I think in credit, you need to be very downside focused. We are very downside focused. And I think just being very direct with investors about the risk. I don't trust anyone who's like, there's no risk. No, there's always risk. Tell me the risk clearly so that I can make my own informed decision. And so I think that was part of it. Monthly cash flow and the knowledge that even if an investment didn't work you'd get something back, was how we got started.

I think the second thing is the return. We offer what I will say is a fair and compelling return to our investors. It is risk adjusted and compelling and very good. I think anytime you have a new asset class, you need to have an early mover risk premium that you're providing.

Brian Dally: It's got to be worth it.

Michael Davis: Yes. And so we have provided [00:28:00] that. I think that's the second thing. The third thing is something less financial and more soulful. Which is the feeling you get by backing these entrepreneurs. Brian, I'll tell you, we're sitting in a great neighborhood in Atlanta. And across the street is a business we backed.

Brian Dally: That's awesome.

Michael Davis: It does great. It didn't exist six months ago.

Brian Dally: That's awesome.

Michael Davis: My money, my dollars, alongside about 15 other people, went into that unit. And I love going in there. I love talking to the staff. I'll randomly buy someone a coffee and walk away and I get to see their joy and I'm like, this is all happening in a space that didn't exist before. We've got that all over Atlanta and all over the country now.

Brian Dally: And by the way, when you can invest in a lot of different things, it's nice to put your money in something that you can feel good about, and experience yourself.

Michael Davis: Yeah. That's right.

Brian Dally: I agree. All right. So as we do [00:29:00] with every guest, and you're one of our first few guests, you're early. Love that. We like to end with a round of rapid fire questions.

Michael Davis: Ooh, love it.

Brian Dally: You can answer them with the first thing that comes to mind.

Michael Davis: I won't overthink.

Brian Dally: Yeah, you can just knock 'em out. What's a trend in private credit that people are underestimating?

Michael Davis: Brick and mortar credit.

Brian Dally: Love it. What's one red flag you never ignore when you are evaluating a business?

Michael Davis: An expansion plan that is unrealistic and highly aggressive, and that depends upon miracles to come to fruition.

Brian Dally: Perfect. How about a recent "aha moment" you've had while building Homegrown?

Michael Davis: So this is maybe less of an "aha moment" but there was an articulation of credit worthiness that I loved and I wish I could source the manager who said this, but he said something along the [00:30:00] lines of, we look to partner with companies that earned their cost of capital. And I loved that it was such a pithy way to articulate making sure that when you are extending funding to a company, you're making sure that that business has fundamentals that can actually support the obligation. I just love the way that was articulated.

Brian Dally: That's very cool. Earn your cost of capital.

Michael Davis: Earn your cost of capital.

Brian Dally: I'm going to think about that.

Michael Davis: Yeah.

Brian Dally: Any favorite books or podcasts you listen to?

Michael Davis: I love reading. I'll give you a book and I'll give you a podcast. My favorite book as of late has been The Hard Thing About Hard Things by Ben Horowitz. I have read it four times.

Brian Dally: Such a story about how he took that company public out of the ashes.

Michael Davis: Yeah. And it's realistic. That's the thing. I read it when I was at another startup. I read it when I was doing venture investing. I read it at the beginning [00:31:00] of Homegrown.

Brian Dally: It's been out for a while. It's a classic.

Michael Davis: Honestly, I keep losing track of if it's the fourth or fifth iteration. I think that's a great book.

Brian Dally: Any book that starts each chapter with a quote from a rap lyric.

Michael Davis: So good and unexpected. So that's the book. The podcast. Before my wife and I moved back to Atlanta six years ago, we were in Seattle, and around that time there's this podcast called Acquired that came out. It's very popular now. Acquired still is one of my favorites. The new episodes on Ferrari that just came out, really excited.

Brian Dally: I've heard that's good. I'll check it out. An investing habit or process that you always try to follow?

Michael Davis: I think there's been this huge push towards algorithmic everything, and I understand it, and I think it's a perfectly [00:32:00] worthwhile strategy, it works for people. I think there's something still very magical about sitting down and talking to someone. Just an unremarkable, perhaps short conversation, just to talk. And I never personally have invested anything where I can't talk to the entrepreneur at least once. Or get a significant appreciation for what it is that they've created in the world. Look, I love finance, I love math and numbers and competitive philosophy, everything, but there's something still very powerful about just talking to someone.

Brian Dally: Love it. If you weren't in fintech, this is the last one, what do you think you'd be doing?

Michael Davis: I would be back in biotech. So, early on in my career, I did a very random hard pivot into commercial strategy in early stage biotechnology and fell in love with it. And so what a lot of people, if you look at my [00:33:00] background, you'll see all sorts of things. I don't put much online about it, but a good five years was doing pretty hardcore competitive strategy and commercialization for biotechs, oncology companies. I love biotech and I love healthcare. Homegrown is such a mission for me, it's like not a job. I'm going to be doing this for a long time. But, I think in 12, 15 years, if I go do something different, it will be back in healthcare biotech.

Brian Dally: That's a great place to wrap up. I appreciate you spending time with us. Thank you very much. I think what you're building at Homegrown is tapping into a much bigger trend. I think there's expansion of private credit. Private credit is more than just software companies whose cash flows are threatened by AI.

There's such a broader world out there, and I really admire fellow entrepreneurs who have tapped into that and pushed into these places and [00:34:00] then done the hard work of finding a place to put the capital of the work and then giving investors the confidence to do that. I think it's an incredibly important part of our community.

Michael Davis: Thank you, Brian. That means a lot. You know how hard it is to build something. You've built something truly beautiful and enduring here at Groundfloor, so, it means a lot.

Brian Dally: I think you're on the same track. And I also think, the most interesting opportunities for investors lie there. They're in these spaces that people like you and I are trying to find. There are a number of entrepreneurs who I've intersected with an increasing number over the decade, 13 years now. It's fun to see how different people think about these markets and how some of the stories are the same in a lot of ways, but I think this is a really great time to be an investor. It's why we started our company, because we felt like there would be a lot of opportunity like this out there, and it's really gratifying to see it happening the way it is.

Michael Davis: You guys are [00:35:00] pioneers.

Brian Dally: We were not alone and we took a lot of arrows. But, thank you.

For our audience, you can connect with Michael via his LinkedIn. We'll include that in the show notes. You can also learn more about Homegrown at joinhomegrown.com. You can check out all episodes of this podcast and suggest a future guest for us at groundfloor.com/podcast. Please like and subscribe wherever you tune in. And thank you for joining us for Beyond the Stock Market. ​