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…

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3 Comments

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  1. CT 30. Dec, 2009 at 10:11 pm #

    Nice post. I agree. What’s interesting is that VCs are evolving into two distinct types — ones that *need* to invest big $$$ and ones that don’t.

    And based on a few recently announced investments, it’s almost as if the progress of the startup matters less than the investment thesis of the fund + how they view the impact of $$ on the deal. i.e. a relatively early stage startup can get big investment $$ if it wants to go down that path & is willing to spend some time talking to Valley VCs.

    Chris

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