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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
- 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.
- “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.
- “just enough” is also helpful because it minimizes the amount of equity sold, demands better clarity in decision making & sharpens focus within start-ups.
- “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.
- 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
- 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.
- 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.
- 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
- 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.
- You might have to find, open and walk through one door before the door to your huge opportunity becomes apparent.
- 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
- This is an interesting statement because, in general, “delay” is the friend of the investor and the enemy of the start-up.
- 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.
- 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
- 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.
- 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
- 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.
- “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
- 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.
- 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
- 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
- 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.
- 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
- it’s hard to do this well if you’ve never been an operator.
- 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.
- 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.
- 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.