Slow Capital and Capitally-Disciplined Start-ups PART 2

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In the last post, I framed up the relationship between the “Slow Capital” concept and the characteristics of a capitally-disciplined start-up.

This post describes the implications of each high-level characteristic of both concepts because I think they’re closely coupled the MOST IMPORTANT behavior in a start-up.

I believe that perhaps the most important behavior required of early-stage start-ups is a capacity for informed, forward progress in the face of all challenges.  How capital flows into and out of a start-up in order to drive such progress is absolutely critical in today’s start-up environment because of the risks associated with too much / too little / poorly-applied capital.  An overview of “informed progress with purpose” will be the next post after this one.

Why is progress so important?  Based on my personal experience, I firmly believe that 99% of the time in a start-up, the model and/or product you initially founded and funded the company on will change.  It may simply evolve a bit or it may not remotely resemble where you started…but it will change.  Funny things happen while hacking and slashing your start-up’s path to success.

If such fundamental change is natural, your start-up better learn, evolve, adjust, invest and execute as crisply as possible.

Let’s peel the onion a few layers on the implications of each high-level characteristic of a capitally-disciplined start-up:

It raises just enough (plus or minus some margin of error) to move to the next business / financeable milestone

  1. First, a hangover still lingers from the days when software companies could raise 7-figures before building a product and even consider how to sell that product or develop a little customer feedback. Today, raising money to pursue a “if-we-build-it-they-will-come plan” is generally un-fundable in my opinion.
  2. “just enough” means the minimum amount required but not “absolute minimum.”  So the raise could be none, $20k or $20million depending on stage and state.  Different stages and situations present different capital requirements; of course, different stages require different business proof points and validation as well.
  3. “just enough” is also helpful because it minimizes the amount of equity sold, demands better clarity in decision making & sharpens focus within start-ups.
  4. “just enough” also minimizes your investor’s capital risk; this is good in two ways: (a) it allows them to engage with (fund) your company when there is more risk than they would otherwise be comfortable at higher raises & valuations; (b) it advances the notion of an acceptable outcome for investors in a healthy, step-wise manner.  In other words, the more one raises, the larger the outcome must be in order to make a venture firm’s economics work.
  5. Finally, this characteristic is highly aligned with early-stage programs such as Y-combinator, Tech Stars, and Capital Factory.  In these cases, “just enough” capital is augmented by mentorship and business guidance that should further accelerate getting to that next business milestone.

it practices a lean-oriented, customer-development / minimum-viable-product strategy in order to make progress with purpose

  1. I’m not going to summarize each of these important concepts; please search and read the associated posts…there is a tremendous amount of quality discussion out there on these topics.
  2. In any case, in order to make informed progress with purpose, one must be INFORMED. Customer development and MVP strategies are, fundamentally, strategies for accelerating learning. The biggest challenge in making progress is clearly defining where you’re going and why.
  3. At a high level, the idea is that these practices minimize or eliminate waste.  Wasted time, wasted focus, wasted features, wasted money…all such waste increases the operational risk within start-ups.

it is focused on investing to maximize the business opportunity independent of timeframe

  1. if you accept my assertion that 99% of the time your model/product will change, it’s logical that some opportunities and strategies become apparent only as a consequence of execution over time.
  2. You might have to find, open and walk through one door before the door to your huge opportunity becomes apparent.
  3. This sort of process takes time…years, in many cases.

I think the notion of a start-up having capital discipline goes hand-in-hand with the notion of Slow Capital.  According to Fred Wilson, Slow Capital…

1. doesn’t rush to conclusions and doesn’t expect entrepreneurs to do so either

  1. This is an interesting statement because, in general, “delay” is the friend of the investor and the enemy of the start-up.
  2. Let’s not call it “delay” because that sounds negative; let’s call it “not rushing.”  “Not rushing” allows time for other cards to be turned over: is the start-up continuing to execute well?  How is the competition doing?  Are other investors interested in this start-up?  Can the start-up stretch their existing capital if necessary?  Not rushing allows more time to answer these questions and better inform the assessment of risk relative to a start-up.
  3. All things being equal, entrepreneurs would prefer not to rush either.  That said, in the vast majority of cases, not rushing is NOT an option: gotta pay the rent, gotta beat that competition, gotta finish that feature and get it tested and deployed.  I’ve never known a successful entrepreneur that doesn’t feel like their hair is on fire and if THAT THING doesn’t happen in the next 30 seconds the world may well end. Frankly, I want the entrepreneurs that I invest in to feel that sense of urgency.

2. flows into a company based on the company’s needs, not the investor’s needs

  1. a company’s capital requirements change over time as the model and product are proven out and the go-to-market strategy is fully understood.  Of course, the best time to add significant capital is when a start-up can demonstrate that capital is basically the only thing gating scale and growth; getting to this point should take much less capital than scaling for growth going forward.
  2. From the previous post on this topic:  What sort of needs do investors have to PUT money into a start-up?

VC firms need to return to their investors all the money they raised in the fund plus a significant margin above that.  Therefore, if your VC is investing out of a large fund, putting $3m into a company and getting $30m out (a truly great 10x return) probably doesn’t constitute a drop in the bucket relative to what they need to return to their limited partners.  Therefore, firms with large funds really “need” to put at least $10m-$20m into that same company and hope for at least a $100m-$200m exit in order to have a chance at a “good” return over the life of the fund.

3. starts small and grows with the company as it grows

  1. this point is very related to point #2 because capital requirements should scale over time as good execution illuminates the areas and timing where investment positively impacts the business.
  2. “slow capital” is (certainly should be) “risk-adjusted capital” because it allows investors to fund your company earlier in its life than otherwise — when there is more risk than they would typically take at higher raises & valuations
  3. If the investor continues to flow money into a start-up as it executes, increases it’s valuation, and raises money from other investors…then they should own more at a lower cost because of the risk they took by getting in earlier.
  4. Finally, while I really like this concept, it’s hard to do when there is significant competition deals. Why? Because increasing the valuation and size of funding are the weapons that firms use to fight such competitive battles.

4. has no set timetable for getting liquid: slow capital is patient capital

  1. The #4 characteristic above says it all.  This is a very entrepreneurially friendly characteristic of Slow Capital; however, I believe that it has an implied qualifier of making “informed progress” (next post) along the way.  I have yet to see (or be) a patient investor who is faced with bad execution within one of their companies.

5. takes the time to understand the company and the people who make it up

  1. clearly, this goal of this characteristic isn’t to create a warm, fuzzy, “let’s go have some hot chocolate together” sort of moments.  Although, I suppose that could be a consequence.
  2. I believe the intent of this characteristic is to understand the more qualitative elements of what makes a company successful. Revenue, expenses, cost of goods sold, conversation rates are all substantially quantitative. The culture, people, and interpersonal dynamics of a start-up are far more qualitative but still critical (perhaps the most critical) accelerators or detractors of good execution.

I also mentioned that I thought a couple of concepts were left out of the Slow Capital Discussion… Slow Capital ALSO…

6. comes with stage-appropriate strategic and operational assistance

  1. it’s hard to do this well if you’ve never been an operator.
  2. Stage-appropriate means more assistance for early-stage companies and less as the company grows…but in all cases, such assistance must have substance and follow-through in order to cut through the “we’re smart money” cliché that is carelessly thrown out time and again.
  3. If nothing else, the perspective and best practices from investors whose job it is to look across industries, companies and strategies can provide unique insight when coupled with a start-up’s view from “in the trenches” of their day-to-day business.
  4. While this can be a slippery slope if the investor does not spend enough time to fully understand the business dynamics for companies they’re trying to assist, this sort of involvement can ensure there is lock-step agreement on the company’s execution, business requirements and capital needs (see characteristic #2).

7. …I’m sure there is another characteristic…more soon.


Slow Capital and Capitally-Disciplined Start-ups

I was recently reading through Seth Godin’s new free ebook (you should get it … it’s 90% great stuff) and saw Fred Wilson’s page on Slow Capital.  I remember reading his original blog post on slow capital and thinking it was a bit motherhood-and-apple-pie at the time… but seeing him dedicate his one page in Seth’s big-ideas book to this concept made me consider it a bit more.

I like the notion of slow capital.  I think it’s the other side of the coin of agile / lean, capitally-disciplined start-ups.

updated 1-04-10 a quick side note:  Increasingly, I’m not a fan of the term of “capitally efficient” applied to start-ups because I think the notion of efficiency is closely coupled to the concept of “minimal” and I think there are plenty of situations that start-ups need to raise / spend / invest more capital if they are doing it in a purposeful, disciplined way. For example, a sudden, threatening appearance of direct competition necessitating an increased investment in development.  And, remember that in almost every case, people (head count) will be your largest expense within a start-up; adding employees too early is very inefficient.

In particular, I think there is a direct relationship between the stage and the need for capital efficiency. To be clear, the younger the start-up the more benefit there is to spending as little as possible; so, in this case, the term “efficiency” makes sense.  As a start-up matures and begins to put good execution and product/model experience successfully behind it, “capital discipline” is a more appropriate notion.

A start-up has capital discipline when:

  1. it raises just enough capital (plus or minus some margin of error) to move the business to the next (financeable) milestone
  2. it practices a lean-orientedcustomer-development / minimum-viable-product strategy in order to make informed, measured progress
  3. it invests to maximize the business opportunity independent of timeframe

I think the notion of a start-up having capital discipline goes hand-in-hand with the notion of Slow Capital.  According to Fred Wilson, Slow Capital

  1. doesn’t rush to conclusions and doesn’t expect entrepreneurs to do so either
  2. flows into a company based on the company’s needs, not the investor’s needs
  3. starts small and grows with the company as it grows
  4. has no set timetable for getting liquid: slow capital is patient capital
  5. takes the time to understand the company and the people who make it up

This style of investment is considerably more time-and-place appropriate today than the big first rounds and if-we-build-it-they-will-come operating plans of the late 90’s and early 2000’s.  Furthermore, I like that there’s a rich subtext to each of Fred’s statements that describe Slow Capital.

Take #2…what does this even mean? What sort of needs do investors have to PUT money into a start-up?

Here’s a swag at a bit of context to this statement: Typically, when VC firms raise a fund, management fees are typically 2% annually.  For example, if you have a $900m fund, that’s $18m per year in management fees (over a 10-year fund) that must be PAID BACK to the limited partners according to a disbursement plan.  To avoid a discussion of internal rate of return (IRR), imagine that the firm wants to return AT LEAST 30% on the fund.  That means, for $900m invested, at least $1.35 billion should go back to the limiteds over ten years.

So what?  Well, if you’re shooting for returns of that size, putting $3m into a company and getting $30m out (a truly great 10x return) doesn’t constitute a drop in the bucket relative to what you need to return to your limited partners.  Therefore, folks running very large funds really “need” to put at least $10m-$20m into that same company and hope for at least a $100m-$200m exit in order to have a chance at returning the $1.35b over the life of the fund in our example.

THAT is an example of “investor’s needs” – and it may or may not have ANYthing to do with the needs of the start-up…and in most cases, results in something that adds a significant amount of risk:  over-funding the company.  And while it takes two to do the funding tango (both start-up and VC saying ‘yes’), it’s generally understood that an over-funded company is more capable of funding / accommodating sloppy execution instead of being required to choose a single path of focus and execution.

I also think there are a couple of concepts missing from the notion of Slow Capital.

More on this soon…

Product versus Services Orientation in Start-ups

When early-stage companies operate with new products or in nascent markets, there can commonly be strong pull from customers to behave like a services-oriented business to gain favor within customers, educate the target market, or rally support from the business’s ecosystem partners.   And providing more instruction / hand-holding / customization can feel like the right thing to do when customers don’t understand your business’s value proposition, how you may drive their future success, or how you might enable them to cause (or avoid) disruption and disintermediation.

I believe that carefully thinking through this very typical situation can help start-ups avoid a common trap and better focus on executing towards long-term vision.

My bias favors product-oriented businesses even though there are plenty of examples of successful services-oriented businesses. I tend to agree with the common saying that service businesses “add” where as product businesses “multiply” comes from the (difficult & expensive) human-capital requirement to scale within service-oriented companies.

First,  three quick definitions:

Product-orientation: a business that generates the predominance of its revenue from products it has created.  The selling motion may be varied (direct, indirect/channel, or SaaS) but the “thing” that is sold is something that is made once and sold over and over again. This includes subscriptions to web-based data/analysis products that change in content but are, in essence, the same thing delivered repeatedly over time.

Service-orientation (NOTE:  no “s” at the end of service):  To me, this is just the concept of being customer-centric or having a “the customer comes first” attitude in your business.  In general, this is a healthy attitude and you can be service oriented no matter what type of company you are…I bring it up here for the sake of distinction with the next term.

Services-orientation:  a business that generates the predominance of its revenue from selling human-delivered work, expertise, and process directly to customers.  The selling motion is typically direct and relationship-based and the “thing” that is sold is typically customized and unique to each customer’s requirements (which tend to be jointly developed and agreed to as part of the selling process).

Product-based businesses include software companies like SolarWinds,, Google and Microsoft.  Some of these product-based companies have a services team that ensures the products are “consumed” and/or implemented correctly for their customers.   Services-based businesses include ad agencies, PR firms, graphic designers, video production businesses, IT consulting firms, and even tax-preparation companies.  Most services-based companies leverage or depend on a variety of products (their own or created by other companies) to do their job.

Below are a few A-B examples of how I believe the two different orientations can cause a company to behave. Hopefully, they can be instructive in pattern matching how your business is behaving or being asked to behave by customers in your target market.

What your customers are paying you for:

  • A product-oriented company is (duh) being paid for a product; while the product may include a bundle of “components,” it is created or defined once and sold over and over again.
  • A services-oriented company bundles time, materials, expertise & technology into an offering that is customized for a particular customer.

How you price what your customers are paying you for:

  • Product-oriented companies strive to have a single price or pricing tier (free, silver/gold/platinum) that appeals to the broadest range of customers possible.
  • Services-oriented companies delineate the time, materials, expertise & technology that make up each unique offering in order to ensure that each engagement can be piece-wise profitable and that the price can change as the project scope inevitably changes.

How the sales function engages with customers:

  • Product-oriented sales tend to own the customer over long periods of time, re-engaging those customers to “up-sell” as new products are delivered. Education and expertise may be provided as part of the sales process.  Other support roles (Sales Engineers, Professional Services) may exist, but the sales manager is the quarterback.
  • Services-oriented sales tends to focus on initially winning a customer / engagement only to hand off that customer, post-win, to an account management roll that owns the customer as the project is delivered as well as for future extensions to the original deal.

How the business invests in “what you’re selling:”

  • Product-based businesses invest in building the product ahead of revenue
  • Services-based businesses have invested in people but generally do not proactively invest in solutions for their target market; instead such businesses define the solution in real-time as part of the sales cycle and think in terms of “work for hire.”

When you say “yes” and “no” to customers:

  • Product-based businesses should say yes when customer’s requirements align with the product’s capabilities; when customer’s requirements fall outside of the business or product focus, there must be sufficient discipline to say “no” to the potential revenue associated with that opportunity.
  • Services-based businesses must find a way to increasingly say yes to potential customers. This is true because in relationship-based sales of expertise and capabilities, trusted vendors will be asked to do more and more.  Figuring out how to say yes, profitably, is core to growing a services-oriented business.

How your business scales:

  • A product-based business scales by creating an ever growing/evolving product set and selling it multiple times, broadly to many different customers
  • A services-based business scales largely on the backs of people and relationships; winning and servicing an increasing number of customers requires an increasing number of people with very little exception.

let me know if you agree or not…