Friday, December 14, 2007

In Praise of Capital Efficiency: How Being A Cheap Bastard Leads To Startup Success

Whenever a boom comes around, I read articles about how it's dangerous to be too cheap and too cautious. One saying I learned during the last boom was "You can't save your way to prosperity."

Maybe. But as you start to hear the siren song of profligacy (last time, we called it "Get Big Fast"), remember that history teaches us that capital efficiency is one of the most important traits of successful companies.

I had breakfast with a VC from a top-tier firm this morning. He told me that his firm had commissioned a research project to investigate how much capital VC firms deployed in their best investments versus the rest of their portfolio.

The answer stunned them: $2.7 million.

The investing principle of cutting your losses and letting your winners run would seem to predict that top investments would receive more capital. Instead, their research showed that the most successful VC investments typically consume far less capital than the average investment.

I'm not surprised.

One of the lessons I've drawn from studying the great military strategists of history (Hannibal, Alexander the Great, Napoleon) is that successful generals are economical in their use of manpower. They don't commit all their forces to every battle.

What sets them apart is their uncanny ability to sense the critical moment during the battle when it pays to take decisive action. It is then that they commit their reserves, turning a close fight into a stunning victory.

As an entrepreneur, think of yourself as one of these great generals. Be a cheapskate, and conserve your capital until you have eliminated enough risks and uncertainties to allow you to sense the turning point. Then step on the gas.

6 comments:

www.misanthropytoday.com said...

excellent post and excellent points made.

I've heard of some startups that burn 5-10M a year. It's funny when we still haven't heard of them yet.

We can assume, that 50% of this burn is on marketing. We can also assume that there is either a lame duck in the VP of Marketing chair (a founder with no tangible skills who thinks internet marketing is easy, lets say) or mismatch: someone with pedigree from a different industry, a former VP of marketing at Proctor and Gamble.

It will be difficult for either person to start over and realize their previous experience (if any) doesn't apply to an internet startup.

TV commercials? Nope.
Trade Rags? Nope.
Sponsorships? Ibid.
PR Hype? Not so much.

An internet startup needs traffic and converted users. Nothing speaks louder than that. If you have an internet startup: get lots of traffic. Mold your comscore rating to your demo, boost your Alexa rating... people will come calling.

At least, as long as the ad rev model is in place.

Harrison said...

A very insightful post!

What you said is especially true as the economy slows down.

Mike From Brooklyn said...

you bet.

"get big fast" was the kool aid lot of folks drank the last time around.

Been there, done that. One problem was that was the common wisdom among the VC's and was pretty much the only story they wanted to buy.

Foobarista said...

One other thing: pay attention to spending. In a company I worked at, the CEO paid close attention to things like printer cartridge expenses and other office supplies while running up huge bills on unnecessary lawyer consultations and expensive "business consultants".

We had a leadership change, the lawyers are gone, the burn is way down, and morale is way up. And we can print without getting lectured...

Foobarista said...

Oops - my comment should be "pay attention to the _right_ spending", and don't be penny-wise and pound-foolish.

Gabe said...

Perhaps one of the links in the correlation between capital conservation and start-up success is that if the start-up is in-housing a lot of thorny work (e.g., SEO; IA) instead of retaining consultants - it is not only saving money but also acquiring valuable tactical and strategic business intelligence that will help guide it in its future decisions. So being a cheap bastard is one side of the coin - the other side is that you may also become a smart cookie in the process.