Musings on Entrepreneurship and Innovation
Sunday, August 29, 2004
Success as the Accumulation of a Bazillion Things
Here's a nice quote of Michael Moritz from the AlwaysOn Network on the sustained success of Sequoia Capital:
It's like any successful company or enterprise, there isn't one secret, there isn't one big mystery. When you build a nice, successful, enduring company, that company is the offshoot of a bazillion little things done well or relatively well or possibly or adequately for a very long period of time. That same thing is true whether you're in a company, or in a service business, or in the venture capital business.
We almost can't help ourselves; we are always looking for the single factor solution. But, the single factor is a fantasy. Success is an accumulation. Start accumulating.
When Is Patient Capital Smart Money?
From an entrepreneur's perspective, capital never seems to be sufficiently patient. An investor, however, knows that capital has an opportunity cost. That is, for every year a dollar of capital remains invested in an underperforming asset, there is one less dollar available to invest in higher performing assets. The notion of patient capital sounds swell, but it's often associated with fools or with those who don't bear the cost of lost opportunity.
Nevertheless, experience suggests that there are times when investors aren't sufficiently patient. Impatient capital has its own opportunity cost. When investments are sold or abandoned prematurely, potentially valuable growth opportunities go unexploited. So what are the conditions under which capital is too impatient and when might a patient approach pay off?
As reported by the 2003 Inc. 500, money from friends and family accounted for more startup capital than any source other than the founders' personal assets: more than bank loans, angel investors, SBA loans, or professional venture capital. Typically without the benefit of collateral, liquidation preferences, or a clear exit strategy, friends and family capital is inherently patient. Sometimes, friends and family money is lumped in with "fools" money, but I don't think that's fair. Rather than being foolish, it's likely that financial returns aren't the only returns available to (and expected by) friends and family. Friends and family investing is subject to a "double bottom line" return where the investors bear the personal cost of foregone opportunities.
Early stage angel investors and venture capitalists are certainly more patient than credit card providers or banks that lend against short-term assets such as accounts receivable and inventory. However, it's conceivable that angels and VCs can sometimes be uneconomically impatient due to the need or desire for liquidity. VCs organized as 10-year limited partnerships are highly motivated to exit their investments within 5 to 7 years, regardless of their assessment of an asset's future appreciation. Angels - particularly "professional" angels - may feel similar liquidity pressures when the value of their investment rises as a proportion of the value of their total investment portfolio.
So, assuming the pressure for liquidity might be relieved in order to mitigate the premature abandonment or sale of an investment, in what cases does patience make good economic sense? I've touched upon two: the ability to benefit from externalities (i.e., multiple forms of payback) and the internalization of opportunity cost by the investor. (After all, it's too easy for me to be irresponsibly patient with your money.) A third factor is uncertainty about future growth opportunities. After all, if one can be certain about future growth, the value of that growth is readily capitalized into the current, saleable value of the asset. Show me uncertainty regarding future growth opportunities, and I'll show you value in the flexibility to wait and see.
Patience can be a virtue when it comes to investing, but be wary of those who preach patience but do not bear the opportunity cost of patience. On the other hand, when future growth opportunities are uncertain, the structural limitations imposed on VCs by their funding structure and the practical desire for liquidity on the part of angels can lead to less than optimal sale or abandonment of investments. Apparently, the market for investments is imperfect. That looks like an opportunity for smart, patient money.
The Reason for Being
Business organizations are purposeful social constructs. In an environment of increasing uncertainty, the purpose of the organization must be clear and unambiguous. Per Stephan Haeckel:
A reason for being expresses essential organizational purpose. It states what the organization exists to do, as opposed to what it must do to exist...it defines the essential thing the organization must deliver to justify (rather than ensure) its existence.
Such clarity provides the context necessary for coherent decision making. This isn't a new concept, just one that has increasing relevance. Alfred Sloan, the legendary head of General Motors, put it this way:
General Motors exists to make money by making motor cars.
Compare that to the typical mission statement. As Haeckel notes, "These ten words unambiguously define GM's primary purpose, its primary constituency, and its primary constraint.
If found the preceding insights to be so practical in application, I've even begun to apply them to my own business initiatives. (Physician, heal thyself!)
Over the last few years, a number of friends and colleagues have been perplexed about the business model of my Pioneer Entrepreneurs service. I can't blame them. In the absence of a clear statement of purpose, primary constituency, and constraints, I've left them to guessing. In my mind, the reason for being for Pioneer Entrepreneurs has evolved, but here's my latest articulation:
Pioneer Entrepreneurs exists to help entrepreneurs - primarily those located outside the urban mainstream - be more successful by helping them develop and execute robust growth and financing strategies. In exchange, we seek to learn about the evolving needs of entrepreneurs, to explore the use of technology to stimulate social capital and entrepreneurial learning, to earn enough from membership and event fees to cover the costs of maintaining the service, and to generate more intensive advisory and coaching relationships.
On its own, Pioneer Entrepreneurs is primarily a learning platform - subject to the constraint that it pays its own freight over time.
There is clearly room for improvement in the articulation of this statement of purpose. (It's positively verbose compared to Sloan's.) Nevertheless, I hope it provides greater clarity for the benefit of my Pioneer Entrepreneurs constituents.