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:
- it raises just enough capital (plus or minus some margin of error) to move the business to the next (financeable) milestone
- it practices a lean-oriented, customer-development / minimum-viable-product strategy in order to make informed, measured progress
- 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…
- doesn’t rush to conclusions and doesn’t expect entrepreneurs to do so either
- flows into a company based on the company’s needs, not the investor’s needs
- starts small and grows with the company as it grows
- has no set timetable for getting liquid: slow capital is patient capital
- 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.