Changing My Mind on Capital

Refactoring a network of beliefs built on a largely under-examined worldview.

Originally published 15 September 2021, last updated 15 September 2021.


This is a companion discussion topic for the original entry at https://commoncog.com/changing-my-mind-on-capital/

Not sending out a newsletter this week because I finished this late — but I’ll be including it in next week’s newsletter.

Feel free to discuss this here, though. It was rather painful to write, since I wanted to get as close as possible to how I was feeling.

Aside: have you changed your mind about something recently? Did you go through some of the same phases?

Very interesting post, especially since I’m bootstrapping and my attitude is basically the same one you had pre-conversion. I think your description of what venture backed has historically meant to bootstrappers is spot on.

I wanted to build a business at whatever growth rates were a good fit for that business. Raising venture capital meant locking myself into venture outcomes — that is, growing a business rapidly, in order to return a significant multiple of invested capital to a fund within a 10-15 year period. This may well backfire. In SaaS, a relatively small number of companies achieve venture-backable outcomes. More importantly, I’ve lost count of the number of friends and seniors who’ve started companies, blew up, and then returned for maybe one more attempt. The majority of them dropped out after a decade to become employees. I didn’t want that. I wanted a series of bets that I could grow well into my 60s, and I believed that the return profile of VC economics simply wasn’t conducive to staying in the arena.

And it would be very interesting if this is no longer the case. I’m not that knowledgeable about capital markets (had to lookup what a SAFE was) — though I did read The Outsiders a long time ago and remember it being inspiring/interesting, if not nec super practical. Maybe this is something to try and understand better.

Isn’t @Dylan spending some time on finance every day? How’s that going? Are you doing it for reasons related to this post?

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Compelling post! I’ll admit that I am skeptical about taking on outside capital due to fears of loss of control (theoretically, as I enjoy my job and plan to stay in it). I have found the example of TCG Group as an alternative to raising capital compelling. A good introduction to them can be found in Organizing in the Knowledge Age. I have started reading the founder Peter Fritz’s book on this topic and have found it quite interesting so far.

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I’m like you @cedric in that I’m pretty strong on supply and demand, but weak at capital. I always justified this by saying I would just eventually hire someone who is good at it (in my theoretical future company that does not yet exist), but between your posts on the triad, the 7 powers, and the interview with Dr. DiBello, I’m pretty convinced that aversion to all things finance could really hamstring me.

I appreciate the raw openness of the post, but I just want to say you don’t sound as “stupid” as you fear you do. Having the metacognition to recognize and take stock of what you’re feeling is a sign of wisdom and maturity. Keep bringing us along on the journey, it’s a worthwhile one!

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@nate I have chosen to pause the finance studies for the time being as the coding bootcamp is taking up most of my cognitive focus. I can consume the lectures passively. But I’d rather be actually doing (or at least modelling) corporate finance choices to build up the skills / embed the mental models. And it’s probably more efficient to spend a month or so just doing finance (or at least heavily weight my time that way) after the bootcamp.

I started doing it initially because I had expected to be better at researching and understanding companies finances on the back of the MBA than I actually was. But it’s now I believe it to be more fundamental (as I think most people here are becoming / have been convinced) to being able to navigate the changing landscapes in which businesses operate.

@cedric There’s something I haven’t considered as a variable to track as part of the capital leg of the triad until listening to the recent LP Acquired Podcast with Matt McBrady. Which is the large scale QE (Quantative Easing) on the back of the GFC. My takeaway (which of course could be wrong) is that post GFC the US Fed has been purchasing government bonds which they haven’t ever done in the past. Which is literally taking away ‘safe’ assets from the market. Meaning institutions are needing to put more money into risky assets. I.e. stock & the private capital markets (this also just adds more money into the securities markets). The fed balance sheet is up 10x what it ever was pre 2008 due to these purchases.

This creates a weird situation that a better ‘performing’ economy (higher levels of employment etc) could have an inverse effect on asset prices. As it’s a signal that QE may slow down or stop. Which might end up being tied to what’s available in the private market for valuations.

This makes me feel that now is an excellent time for raising capital if you have a vehicle for it to be applied to with this extra money slushing around in the capital markets. Especially if you can parcel some of it away as a hedge against capital markets turning in the instance of decreased QE or higher interest rates. But of course this is just the gut feeling of someone who is far from believable (although I’d say Matt certainly is)!

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Could relate to this. I had been bootstrapping since 2016, but really felt the drawbacks of not having access to capital to support growth last year. Decided to raise a round for my new company.

I had been too ideological in not wanting to raise capital. When speaking to friends who had raised venture rounds for the right kind of business, I realized that they were a lot more “free” than I was – more free to experiment, more free to hire great people, and more free to just have a life outside of work. Plus the doors opened by VCs helped a ton with enterprise sales.

Also realized that venture vs bootstrap is the wrong question – it depends on the kind of business one runs, and the kind of investors one raises from (I would avoid raising from most investors HQed in Singapore, for example).

Some businesses are a good fit for venture backing (need capital to kickstart their flywheel, or operate in a competitive market with winner-takes-most dynamics), while some great businesses are not (like being a monopoly provider of a service that generates half a million dollars in profit per year, but little room for growth).

2 other learnings:

  • Founders have majority control over the business until after the seed round, and sometimes until after Series A. If there’s pressure from investors to grow at what founders feel is an unsustainable pace – they can just exercise their “no” muscle (as long as they did not make definitive claims about how much they’ll spend when raising money)
  • Most proven investors I spoke to understand that you will blow up if you try to grow too fast before your business is ready. Few good venture investors (Sequoia, Accel, Lightspeed et al) will push you to pursue growth at all costs. They cited trying to grow without reaching product-market fit as the #1 reason why startups die

Some numbers, in case anyone is interested:

  • ‘Exhaust Fumes’, or, Understanding Startup Valuations. | by Sajith Pai | Medium
  • Rough pre-money valuations of recent seed rounds. There’s typically 15-20% dilution at seed stage:
    • YC Companies ($15M-$25M+)
    • Pre-revenue, non-YC companies with “proven” founders and some traction in a “hot” market [1]: $5M-$10M. Though companies with storied teams like Arbo have raised at much higher valuations
    • Pre-revenue companies without proven founders, little traction, and not in a "hot’ market [1]: $2-5M

[1] Based on conversations with VC friends and friends who have raised money in the last 6 months – biased sample, but seems to tally with Crunchbase data

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I’d add a word of warning here to say that my lesson isn’t really about ‘raise money’ vs ‘don’t raise money’ — but instead ‘pay attention to the capital markets; capital is a tool; learn to see the current moment clearly’.

Any lesson you draw right now is likely a function of the current state of the capital markets, as well as the path dependence of whatever immediately came before. So whatever lessons you ‘learn’ will likely be inviolated the instant something changes in the environment.

I’m thinking of the last major discontinuous change in finance — which was Milken’s discovery and popularisation of the junk bond. I imagine myself as a company during the period. Could I have predicted the development and use of greenmail, the rise of the cable industry, or the creation of LBO funds? Would I have been prepared for a wave of PE that has lasted to today? Could I have adapted quickly, like Koch, and adapted high-yield bonds to become part of my acquisition playbook?

Learning lessons from the current state of the market cycle may hobble you the instant the state changes. The meta-lesson is more valuable, I think: learn to read the current state quickly, in order to adapt. I’ve ignored the capital side of the triad for most of my career. I want to make sure I don’t do so again.

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I’m late to this conversation, but recent events at my company have had me thinking a lot about capital structure and the dark side of bootstrapping.

I work at Mailchimp, which (right about the time this article was published) announced it was selling to Intuit for $12 billion. The company is entirely bootstrapped - no outside investors, no debt - so the two cofounders are each walking away from this with about $3 billion in cash and $3 billion in Intuit equity. This bootstrapping has played a big role in the internal mythology of the company and freed the company to take full advantage of a couple lucky breaks roughly 12 and 7 years ago that really accelerated growth. (Break #1: building a compelling freemium product right as that was becoming a new model; break #2: advertising on the Serial podcast.) Somewhere in that process the company became ludicrously profitable and started growing revenue at about 40% per year.

Conversations about VC capital often focus on unnatural growth and cheap access to capital - but Mailchimp ran into very much the same issues anyway, and without any of the sorts of accountability structures that would have been required by outside investors. The company has tripled in size since I joined five years ago (and the development organization has more than quadrupled). It takes a very long time to make decisions or change directions, and the company is surprisingly reluctant to do prototyping or experimentation before deciding on a technical direction.

My takeaway from all this is that a wise executive is able to take full advantage of low costs of capital wherever they are found, and to be shrewd in spending that capital even in times where capital is readily available. The “bootstrap” or “VC” model of funding seems to be good at teaching one side of this without necessarily teaching the other.

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@peter, I’ve done two things as a result of your reply. I bought a copy of Inside Intuit (for reasons I might get into in a different thread), and I spent around 30 minutes reflecting on your reply on a long walk I took today.

I think you made a really good point when you said:

Conversations about VC capital often focus on unnatural growth and cheap access to capital - but Mailchimp ran into very much the same issues anyway, and without any of the sorts of accountability structures that would have been required by outside investors. The company has tripled in size since I joined five years ago (and the development organization has more than quadrupled). It takes a very long time to make decisions or change directions, and the company is surprisingly reluctant to do prototyping or experimentation before deciding on a technical direction.

Growth is growth, regardless of whether it’s funded by retained earnings or external capital. And growth does tend to break things.

Thank you for sharing your experience — you really made me think.

I’m also mindful of Rob Walling’s podcast on the acquisition, found here. (Also, @nate, just a shoutout to say that I noticed your question on the podcast a few weeks ago :wink: )


As an aside, I thought this piece by Jerry Neumann on venture capital history is worth reading. Neumann posted it on Twitter recently as part of a reflection on the retirements of a whole generation of top-tier VCs.

The history repeats itself crowd thinks that that there must be a bubble sooner or later. “Now?” they constantly ask, “Is it a bubble now?” as if history has to repeat whatever was most memorable about the last time. History may repeat itself, but there’s an awful lot of history that this particular venture capital cycle could repeat.

Astute observers should see many parallels to what’s happening today.

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Aw shucks, thanks.

It’s just another stanza in something I’ve been thinking about for the better part of a decade - “I [want/don’t want] to do X, so I [will/won’t] do Y because that will force me to be more serious about doing X”. Why not just do X, or focus on things that optimize X?

Speaking for myself, I think Mailchimp missed a gigantic opportunity by not bringing in a respectable board of directors ten years ago. Our strategy and accountability structures are weak, and we’re far more willing to throw money at a problem than design an experiment to test a hypothesis. I think that with a few small tweaks to our structures we could be at a valuation 5x what the company sold for, and without a need to sell.

(Related: a friend shared with me yesterday that this is a pattern he sees with a lot of founders. They realize they’ve run out of goals and they no longer know how to raise the bar on their ambitions, so they sell their company, start a charitable foundation, and get to feel good for the rest of their life about giving money away whether they’re good at it or not.)

Thanks for mentioning that Rob Walling podcast - I’ll give it a listen and share any other thoughts it gives me.

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This is a really interesting post. I’m a founder of a series B company, and without getting too much into the details capital was critical to getting to where we are (although in retrospect I wish I had discovered this blog earlier as most of our painful lessons were in the area of organization design).

In general I think capital is a common thing to have hangups around, because there are so many moral stigmas flying around it. That said, venture capital is a pretty diverse pool. We’re an open-source company, and there are investors who have built their careers around only investing in open source (and these are who we sought out, because open source is different enough that we wanted investors who get it). Same for crypto, ML, data, hardware, fintech, etc, etc etc.

Some notes:

  • YC follow-on investors tend to be much less control-oriented than the average VC firm
  • “Koch Industries, but for software” is a good tagline. I wasn’t familiar with Constellation until now; another couple models that come to mind are Dell (there was a good article in I think Fortune about this recently), or Vista Equity.
  • In addition, there’s way more of a market for early-stage VCs to sell their shares than there was a few years ago, so I don’t think you should see the 10-12 year cap as too hard.
  • Putting together a cap table just means articulating your value prop and finding folks it resonates with. “My life’s work is organization design, this company is a vehicle for doing that, and I intend to do this for the next 30 years” is a pretty powerful pitch.
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Interesting to look at this through the lens of “Are you playing to play or playing to win?”

Not considering taking capital is playing a harder game. But it’s also interesting that the circumstances change. 10-15 years taking capital would have higher costs and the decision to not take capital may have meant you were playing an easier game.

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