While reading through Seth Godin’s free e-book recently, I noticed that Fred Wilson had dedicated an entire page of his blog to the concept of “slow capital.” I like the notion of slow capital; it strikes me as the other side of the coin of agile, capitally disciplined startups.
Since more often than not, a startup’s model and/or product will change from the point of founding and funding, early-stage startups need to have the ability to make informed progress in the face of all challenges. How capital flows into and out of a startup in order to enable such progress is absolutely critical and yet very difficult to manage.
And execution in the presence of too much capital, too little capital, or poorly applied capital defines both the health of the business and the relationship between a startup and its investors. Together, the concepts of slow capital and capital discipline provide a framework for managing this relationship.
A startup has capital discipline when it:
1. Raises just enough to execute to the next business/financeable milestone. The term “just enough” does not mean the absolute minimum. A startup could raise no capital, $20,000 or $20 million, 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.
The term “just enough” is helpful because it minimizes the amount of equity sold, demands better clarity in decision-making and sharpens a startup’s focus.
The term also minimizes the investors’ capital risk, which is good for two reasons: One, it allows them to fund a startup when there is more risk than they would otherwise take at bigger valuations and round sizes; and two, their definition of an acceptable outcome is advanced in a healthy, stepwise 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 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 further accelerates the push toward that next financeable milestone.
2. Practices a lean-oriented, customer development-focused, minimum-viable-product strategy in order to make informed, measured progress. Informed progress is the result of having requisite knowledge . Customer development and MVP strategies are, fundamentally, strategies for accelerating learning. Startups with capital discipline use the best data currently available to direct both capital and focus.
At a high level, the idea is that such accelerated learning minimizes or eliminates waste. Wasted time, wasted focus, wasted features, wasted money — all such waste increases a startup’s operational risk and its investors’ capital risk.
3. Is focused on investing to maximize the business opportunity independent of time frame. Since a typical startup’s model and/or product will change, it’s logical that some opportunities and strategies will only become apparent as a consequence of execution. Indeed, iteration, learning and improvement all aimed at maximizing the business opportunity is a process that takes time…years, in many cases.
The notion of a startup having capital discipline goes hand in hand with the notion of slow capital, which Wilson defined as having the following six characteristics:
1. Doesn’t rush to conclusions and doesn’t expect entrepreneurs to do so, either. This characteristic benefits the investor more than the startup. In general, “delay” is the friend of the investor and the enemy of the startup.
Why? Because “not rushing” allows more time to gather data and better inform the assessment of risk. Is the startup executing well? How is the competition doing? Are other investors interested? Can the startup stretch its existing capital if necessary?
All things being equal, entrepreneurs would prefer not to rush; however, not rushing is usually not an option: gotta beat that competition, gotta talk to those customers, 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, personally, I want entrepreneurs that I work with to feel a keen 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; getting to that point should take much less capital than scaling for growth going forward.
It’s generally understood that a company that’s funded beyond its stage-wise needs is more likely to execute poorly because it can afford to not choose a single path of focus and execution. Slow capital wants to find that “just right” level of funding, the one that reinforces good execution but doesn’t starve the company along the way.
This second characteristic suggests that investors “need” to put money into a startup. VC firms need to return to their investors all the money they raised in the fund plus a significant margin above that. So if a VC is investing out of a large fund, putting, say, $3 million into a company and getting $30 million out (a truly great 10x return), that probably doesn’t constitute a drop in the bucket relative to what they need to return to their limited partners. Such a VC might therefore “need” to put much more money to work in each startup they’re investing in, hoping for a much larger exit.
3. Starts small and grows with the company as it grows. Capital requirements should scale over time as good execution illuminates “where” and “when” investments will positively impact the business.
From an investor’s perspective, slow capital should be “risk-adjusted capital” because it allows investors to fund a startup early on, when there’s more risk than they would typically take at bigger round sizes and valuations.
4. Has no set timetable for getting liquid, for slow capital is patient capital. This is an especially entrepreneur-friendly characteristic of slow capital; it’s also well-matched to the current exit environment.
That said, there is an implied qualifier of making “informed progress” along the way. I have yet to see (or be) a patient investor when faced with poor execution within a portfolio company.
5. Takes the time to understand the company and the people who make it up. I believe the intent of this characteristic is to understand the more qualitative elements of what makes a company successful. Revenue, expenses and conversation rates are substantially quantitative. The culture, people, and interpersonal dynamics of a startup are far more qualitative but perhaps the most vital accelerators or inhibitors of good execution.
I would add that 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. The perspective and best practices from investors who routinely look across industries, companies and strategies coupled with a startup’s “in the trenches” view helps yield lockstep agreement as to the company’s execution and capital needs.
Stage-appropriate means more assistance for early-stage companies and less as the company grows.
7. Is consistent, transparent and disciplined capital. Slow capital doesn’t apply these principles only when it’s convenient to do so, rather they are built into the operating philosophy of the firm that puts such capital to work. This must remain true even in the presence of investor-side competition for particularly “hot” deals…no matter how hard it is to do so.
Meanwhile, transparency suggests that the data and philosophy driving investment decisions is not a black-box process that precludes the startup from understanding such decisions.
Overall, I believe we’re entering a new phase for investment in technology — call it Venture Capital For the New Decade. The venture capital supply chain is transitioning and startup execution velocity (rapid iteration, learning and adjusting in order to maximize the business opportunity) is more attainable than ever before, but it requires the right amount of capital at the right time.
And that requires a new sort of relationship between startup and investor, one in which the historic friction associated with bringing capital into a startup over time is reduced or eliminated. Together, slow capital and capital discipline provide a framework for just that sort of transparent, trust-based relationship.