Flint and Tinder, an upstart men's underwear brand, just raised $850,000 of venture capital from an impressive list of investors, including Tony Hseih and Fred Mossler from Zappos, Lerer Ventures, and David Tisch, formerly of TechStars. Flint and Tinder made news earlier this year when it raised $291,493 on Kickstarter, after originally targeting $30,000.

Venture capital is most commonly associated with tech start-ups, especially Internet-based businesses. At first blush, it's surprising that VCs would be interested in funding an underwear brand. But this deal highlights some of the biggest myths of venture capital. Venture capitalists, like any investors, are not looking for sexy or trendy business models. They are focused on making money. And making money is primarily about limiting downside risk and maximizing upside option value. In this context, Flint and Tinder is an attractive start-up.

Here are three reasons why these VCs invested in an underwear brand:

1. It's a Proven Business Model

Underwear has been around for, oh, around 7,000 years. Men need it, use it, and will pay for it. Internet start-ups are often the opposite. Many businesses are created without certainty that there's a customer segment willing to pay for the product or service. Some Internet start-ups don't even have a clear revenue model, and it's possible that they never will. This uncertainty has a major effect on valuation and the ability to attract funding. A business like men's underwear, on the other hand, is fairly certain. An analyst can look at historical trends around supply, demand, and willingness to pay for various features. All of these data points give an investor assurance that the product will sell. Maybe not for the premium price that Flint and Tinder is hoping for, but enough to ensure that the investors will get a return on capital.

2. It's Low Risk

Venture capitalists have developed a reputation as risk takers, but most are successful by limiting their downside risk. In this case, investors understand that there are many backstops if the business turns out to be less successful than everyone expects. Our firm, Avondale, recently invested in an ice cream company. We joke that if the business doesn't pan out, at least we can throw a big ice cream party. In Flint and Tinder's case, the investors know they can unload unsold inventory at lower prices or potentially sell the inventory to discounters if necessary. This should provide some downside protection.

3.    It Has a Lot of Profit Potential

Flint and Tinder's competitors in the premium underwear segment, including Calvin Klein, Armani, and Ralph Lauren, are selling underwear for around $19 a pair. Even though Flint and Tinder intends to manufacture in the U.S., with higher labor costs than developing countries, we have to believe that the production cost is a small fraction of that price. They hope to garner a price within the same ballpark as the premium brands, but if they don't, they have a lot of room for error, while still earning a healthy profit.

In the final analysis, this business received funding because it meets the fundamental requirement of investors: a high probability of return with low downside risk.  When you build a good business model, investors are happy to fund it.

What are your thoughts on this VC deal?  Share your thoughts and questions with us at karlandbill@avondalestrategicpartners.com.

Published on: Oct 25, 2012