A Hypothetical Term Sheet…

For A Hypothetical Company… With A Hypothetical Strategy… Under A Hypothetical Set Of Circumstances…

Even successful venture-backed companies end up with equity cap tables that are game-theoretically determined: the team owns 30%, investors own 70%, and investors control the company.

If, after reaching this point, the company still needs more capital, existing investors take dilution, not the team, whose equity percentage is maintained at 30% through the creation of new shares for successive employee option pools.

This may be the optimal outcome for capital-intensive companies, especially when the founding team plans to exit after 5–10 years, is happy with a small percentage of a huge thing, and is comfortable diluting non-executive team members to tiny stakes, while playing power politics with outside investors as a routine part of business decision-making.

But it stands to reason that this may not be the optimal outcome for capital-efficient companies, especially when the founding team plans to stick around long term, sees no reason why they can’t motivate the entire team, not just executives, with meaningful equity stakes, and don’t want to continually persuade outside investors on the merits of contrarian ideas in order to receive permission to execute on them.

Capital-efficient companies are the oppressed minority of the venture world. They are assumed to have less potential and be less ambitious. The assumption being that if they had more potential and were more ambitious, they would come up with more ways to deploy venture capital to generate returns…

But it may be that capital-efficient companies have a number of inherent and unique advantages, which the current venture model does not adequately value or capitalize on: a team incentivized by equity and profits might stick together longer, innovate more, take more and more intelligent risks, make better decisions… The list goes on. How might a new game be played that leverages these strategic strengths to the max?

What follows is a questioning and reimagining of the venture model:
— A sketch of how the Existing Game is played today, and how it plays out…
— The suggestion of a New Game based on a new alignment of incentives…
— A hypothetical term sheet, for a hypothetical company, under a hypothetical set of circumstances… to imagine how The New Game might play out…

The Way The Game Works Today

Before suggesting another way of doing things, it is important to understand how the game works today…

Before investors own 70% and the team owns 30%, investors push startups to raise up-rounds on an 18 month cycle because when the team owns the majority of the cap table, the team takes a majority of the dilution in every round. During this period, investors emphasize growth over profitability, because large net-losses allow them to increase their ownership stake by buying more while taking less relative dilution.

Even if an inside investor can’t participate in an up-round, they still encourage fundraising not only because they get a mark-up, but presumably because the new capital and the new capital partners increase the likelihood of the business ultimately being valuable, and makes complete failure less likely. In the event of a premature and suboptimally priced exit, the liquidation preference on their preferred stock protects them from downside, so more risk is generally better.

Once investors own 70% and the team owns 30%, incentives shift. It is no longer in the interests of existing investors to put in or raise more capital from outside investors unless:

A.) without it, the company would fail, putting their investment at risk, or…

B.) with it, with a relatively small amount of capital they can increase their percentage relative to other existing investors, or receive a huge mark-up on their existing investment from new investors: appreciation net-of-dilution, or

C.) new capital comes in the form of a fund-returning exit (either through a buyback, a secondary transaction, an acquisition, or an IPO) that they can’t optimize further within their 5–7 year investment timeline.

Let’s imagine that a single investor owns 70% of a company and the team owns 30%, and the team wants to raise more capital:
— If the investor doesn’t believe the company needs more capital, simple: they block the fundraise.
— If the investor agrees that the company needs more capital, they can make the fundraise as small as possible, and exercise a right of first refusal to provide the capital themselves. But after the funds are provided, maintaining their 70% stake at great cost, their incentive is to pressure the management team not to need more funds by getting to profitability, or to sell the company as soon as possible (option C above) — unless they are still extremely confident that continued unprofitable growth is still rapidly growing the value of their equity, appreciation net-of-dilution.
— If the funds are provided by an outside investor and the inside investor experiences dilution down to, say, 55%, then the inside investor is only going to be happy given conditions A or B, above. Otherwise, the inside investor may prefer to explore option C instead of raising another round.

It is rare for an inside investor to confidently value the appreciation of their own equity over time, indeed, their LPs tend to be wary of fund managers granting themselves markups, so most rely on outside investors regularly setting or validating their price by leading subsequent rounds. Indeed, it is worth pointing out that most investors aren’t investing their own hard-earned capital, but raising large funds to increase their management fees, then playing with other people’s money: they’ve aggregated risk capital…

The team’s incentives are a little bit different: the overall team equity % will neither increase or decrease. New equity grants will be on a new vesting schedule, so those who expect to get re-upped with new grants and who are comfortable with the new timeline will be in favor of raising capital, as presumably it increases the trajectory of the company, and increases the price at which they can sell shares in secondary. Founders and senior executives, for example, are usually protected with new grants, and shares are created for new hires, but the rest of the team usually gets diluted to tiny percentages, because they get dilution without a re-up. As technology companies rarely pay dividends, and as option vesting accelerates in an acquisition, there is an enormous incentive to raise as much venture capital as possible, and either sell the business or IPO as soon as possible, then exit the business. In the famous examples of founder-led post-IPO companies — Google (until recently), Facebook, Tesla — the CEOs received a number of ownership and control concessions, but the rest of the founding team didn’t, and hence, they left.

In summary, with the way the game is played today:
—Investors want to deploy large funds to justify large management fees and own large stakes… So in the early stages of a company, they want growth not profitability… Then in the later stages of a company, once they own large stakes, they want to exit for the maximum price they can get within their 5–7 year investing timeline… If they can’t increase their ownership stake further and they aren’t confident that an additional financing will increase appreciation net-of-dilution, they will finally focus on profitability…
—The team gets diluted down to 30%… Founders and executives own 2/3rds of that… They also realize that they are just managers, this isn’t their business anymore, it is the investors’ business… The team starts to care more about their salaries and benefits, than their equity… I call this venture socialism, and I question the subtle corruption of founders and executives selling out their teams, who don’t get continually propped up… As far as the team’s equity goes, more capital means higher valuations and more secondary demand for their shares… It also means a lower risk of absolute failure and a higher chance of an exit…

This combination of investor and team incentives results in insane risk-taking behavior. Unless the business model is a bullseye and all the team has to focus on is scaling a rocketship success, the chance that something goes wrong increases dramatically. Any deviation on performance results in a broken cap table with broken expectations and broken incentives. Innovation is strongly disincentivized beyond scaling the initial idea. Talent is incentivized to leave after pushing towards an exit on a 5–7 year timeline, which can’t be good for the business long-term…

Inventing A New Game: A Bet That Motivated Teams Building Capital-Efficient Companies With Aligned Long-Term Capital Partners Will Outperform In The Long Run

The corporation is a 16th century Dutch and British invention, one of the most important inventions of all-time, and it is an alignment technology. It creates a security — the shares of the company — that aligns capital and labor to build value over time, and mechanisms by which the board can govern the management, and the management can govern the company... This is the best alignment technology known to man and has created most of the wealth in the world.

But it seems to me that we aren’t thinking carefully enough about how to innovate within this framework. The framework is flexible: not all corporate structures result in equal alignment. If you believe that the most aligned incentives result in the best performance over time, then you should constantly be asking how you can further optimize in this dimension…

The Existing Game is designed for capital-intensive businesses. In capital-intensive businesses, capital takes most of the risk and creates most of the value. Therefore, The Existing Game motivates capital, not labor. In capital-efficient businesses, labor takes most of the risk and creates most of the value. Therefore, if The New Game motivates labor in capital-efficient businesses proportional to value-creation potential, then it will out-perform.

I am, of course, using the term labor not in the communist-sense of the workers vs. the management, but in its capitalist-sense: as, in a well-managed company, labor is organized and rewarded in a meritocratic hierarchy...

When capital-intensive teams worry about dilution, VCs tell teams not to focus on the percentage of the pie that they own, but on motivating capital to invest in the company so that they can make the pie bigger for everyone.

But the same rhetoric works in reverse for capital-efficient or profitable teams: teams can tell their investors that they shouldn’t focus on the percentage of the pie that they own, but on motivating labor to keep investing in the company so that they can make the pie bigger for everyone.

If the capital-intensive argument is that investing large amounts of capital shifts the long-term trajectory of the business, resulting in compounding returns over long periods of time…

The capital-efficient argument is that keeping a truly great team together results in compounding returns over long periods of time… the example that comes to mind is Pixar.

The Existing Game is designed for many capital partners to participate at different stages in a company’s lifecycle, setting and validating the price for the market. This is market-optimal because only the most confident funds (Sequoia comes to mind) with the best track-records can convince themselves and their LPs that they should keep doing inside rounds and even then, once they reach 70%…

This is obviously incredibly inefficient from the point of view of the founder’s time, and creates incredibly distorted incentives at every level. But a for certain type of business model, it works — and has undeniably created a huge amount of wealth. However, is it right for every business? Indeed, will it ruin businesses that otherwise could have been worth billions of dollars in a different incentive-regime?

Whereas The Existing Game is designed to align a large number of parties around an exit in 5–7 years, The New Game is designed to align a small number of parties around building value long-term, measured in decades.

The New Game is designed to consolidate ownership and control in a team of owner/operators, who finance their business with as few long-term capital partners as possible, ideally just a single investor who invests across multiple rounds.

The New Game is designed for capital-efficient businesses: businesses that either are already profitable, but have identified an opportunity to deploy more capital than they can self-finance in the short-run to drive returns in the long-run… Or businesses with strong margins that will soon be profitable, or could be profitable if they reduced high ROI R&D investment.

The ultimate capital-efficient business is profitable from Day 1, never requires investment at all, and can finance all investment activity with profits: a cash cow that compounds capital at an incredible rate over time. Equity in a business like that should not be sold, as a general rule. If it is sold, it should be sold only at extremely favorable ownership and control terms, and only to a strategic investor.

But there are many extremely capital-efficient businesses that do require, or would benefit from, capital at key points in their strategic timeline, but which are in control of their unit economics and are designed to generate profits.

In fact, a capital-intensive business can transform into a capital-efficient business once it figures out its product, unit economics, distribution strategy and business model. If this transformation is made before control is lost, it should be used to take back control and ownership over time, because the business can now reinvest profits instead of raising capital. Profits can either be reinvested in the core business to make it more profitable, scalable and defensible, or in new investments…

The term “strategic investor” has come to mean “corporate investor and potential acquirer,” but I mean it in the broader sense of game-altering. As much as venture capitalists press entrepreneurs on what makes their business unique and defensible, most investors do not have a good answer to their own question. They do not have differentiated “value-adds” and their participation does not truly alter the trajectory of a business for the better, beyond the capital itself. If a company has to rely on a VC’s, it doesn’t have its own network. If a company has to rely on a VC to negotiate, it can’t negotiate for itself. If a company has to rely on a VC’s brand, it doesn’t have its own brand. So the truly great companies don’t need a VC for any of these things, although they may avail themselves of support when offered…

Which begs the question, what makes an investor truly strategic, such that an entrepreneur in possession of an extremely capital-efficient business would sell 30% ownership?

Three scenarios come to mind.

Scenario 1. In which the investor has relationships with certain buyers that are so strong and hard to replicate that the investor is essentially a gate-keeper, so selling equity to the investor results in a dramatic increase in the long-term revenue trajectory of the business. The example that comes to mind is a Tier 1 celebrity investing in a business, and then aggressively marketing it to their fans over and over again for years (not just one tweet). But one could imagine a mining tycoon able to open doors to every mining company in the world, which, to a mining technology company, might be worth it if there is no other / better way to get access…

Scenario 2. The “genius” scenario: in which the investor is a true genius and is committed to spending a meaningful amount of time above and beyond just showing up for board meetings, being a true strategic thought partner, such that his/her involvement in the business adds non-linear value in a similar way that another co-founder would. The person that comes to mind is, naturally, Peter Thiel, the man, the myth, the legend... Given that he is one of most intelligent, well-read, well-connected, and broadly-experienced men alive, if he were to get involved in this way (which he obviously does not do even with every FF investment) might result in non-linear insights across dimensions — product, growth, management, corporate strategy. The well-connected part might result in non-linear intros, but overall strategic access is different than the industry access in Scenario 1, and isn’t the main point here.

Scenario 3. The “aligned” scenario: in which the investor is deeply aligned with your values and vision, and is willing to give you access to capital on your terms, while letting you retain undisputed majority ownership and control.

What I like about Scenario 3 is that it doesn’t rely on the investor having any unfair advantage other than being truly trustworthy and aligned; they are being rewarded, in a way, for their character, and their respect for the entrepreneur.

Let Us Imagine A Hypothetical Term Sheet…

… For a hypothetical company… Under a hypothetical set of circumstances… In an imaginary world, exactly like our own… in which there is a company raising a Series A.

Today, the team owns 55% of the equity, VCs own 22.5% (most purchased with $3M in capital at a $17M pre-money valuation), and Angels own 22.5%, (most purchased with $2M in capital at a $5M pre-money valuation). The CEO has board control but VCs have veto powers on most corporate actions via preferred voting rights.

For example, the CEO can’t buy back shares or issue options or create options or raise debt or raise equity without preferred vetoing the action. Basically, his (this hypothetical CEO is definitely a him/his straight male, age 30, balding slightly), hands are tied (not in a sexy BDSM way). Consent is required for every meaningful corporate action (no consent jokes allowed). (Indeed, sometimes the CEO worries that with a dynamic like this, consent may be required for even more things in the future: maybe someday even his public free speech will be regulated!)

The company is on track to end Q2'20 with a $3M run-rate, 40% contribution margins, and -$70K in monthly Net Income (burn), with a year of runway according to plan, but expects to be profitable sooner, by the end of the year.

Because the company has recently transformed itself from a capital-intensive to a capital-efficient company, it plans on using profits to grow, but, to be prudent, wants to strengthen its balance sheet slightly... Therefore, the company has determined that the best use of the majority of the capital it raises in its upcoming Series A is the consolidation of ownership and control…

Someday the team would like to own 70% of the equity, with a single investor buying the other 30% of the equity, with the other VCs and angels bought out at markups. The CEO would like board control, with the only two veto powers retained by preferred shares being 1) the ability to block an acquisition or IPO, and 2) an observer seat to ensure good fiduciary governance.

Given that investors are willing to invest at a $30M pre-money valuation (a mark up from the previous post-money valuation of $20M), such an outcome cannot be engineered in a single round… But a well-engineered round can not only make progress towards this outcome, but create a stucture in which such an outcome is inevitable and all parties’ incentives are re-aligned around it.

Three questions arise:
1. How to structure such a round?
2. How to facilitate buybacks over time, assuming not all investors will wish to sell immediately?
3. How to enable future fundraising while preserving the 70/30 ratio?

How to structure such a round?

Let us suppose the Series A investor invests $3.5M on a $30M pre-money valuation, resulting in a $33.5M post-money valuation with just over 10% equity dilution.

With that capital, the company keeps only $500K as primary capital, using the other $3M to do buybacks at a $15M valuation. Assuming that sufficient demand exists from existing shareholders for these buybacks, this results in 20% equity appreciation .

Therefore, the bottom-line impact of the round is:
— 10% equity appreciation. Motivating to all remaining shareholders, but especially motivating to the team, which now owns roughly 60.5%, up from 55%.
— $500K in primary capital, extending pre-profitability runway and strengthening the balance sheet.
—A new, motivated Series A partner, that owns 10%.
— Happy, loyal investors who exited at a profit.
— A 167.5% valuation markup from the last round to motivate remaining shareholders ($20M to $33.5M post-money).

Now the cap table looks like this: 60.5% team, 10% Series A investor, 29.5% other investors, mostly VCs…

Terms
The Long-Term Capital Partner (LTCP) that is leading the Series A agrees to the following terms:
— No control. The LTCP shall gain 1 Board Observer Seat to maintain accountability and ensure good governance, as a check on fiduciary responsibility. Existing Board Observer seats shall be unwound. Existing preferred share voting rights shall be unwound, except for the ability to block a sale. Preferred shall retain a 1X liquidation preference.
— Future Financing. See “How to enable future fundraising while preserving the 70/30 ratio?” below. Basically, the LTCP has a ROFR on all future rounds, but the 70/30 ratio is always maintained. If the LTCP passes on an opportunity, then team can raise money from a new LTCP (LTCP 2) and either buy back or facilitate secondary with LTCP 1 at the pre-money price, or create an option pool, to maintains the 70/30 balance overall.

Consent
What’s in it for the LTCP? The ability to own 30% of a company that the investor believes may be worth billions of dollars someday. This is partly a bet on the specifics of the company, but partly a bet on incentives: it is better to own 30% of a company where the team owns 70% than 70% of a company where the team owns 30%, because the team that owns more will outperform, so you’ll own a smaller piece of a larger pie, outperforming in absolute returns.

What’s in it for the team? The ability to maintain ownership, control and optionality on future rounds.

What’s in it for existing investors? Leadership from a LTCP and the ability to get liquidity at a mark-up either now or in the future, without being coerced. The alternative to consenting is coercing the team to continue to operate in a paralyzed structure with no leadership, as the team can’t be coerced into doing a deal it doesn’t want to do if the company is on its way to profitability and doesn’t need capital…

How to facilitate buybacks over time?

After a Series A in July ‘20, let’s suppose the company performs according to plan, achieves profitability with a $5M run-rate and 50% contribution margins by EOY’20, and continues its trajectory towards $15M run-rate, 60% contribution margins, and millions in net income by EOY’21, with plans to grow to a $100M run-rate by EOY’23.

A year later, in July ’21, the company decides that it has created a sufficient increase in value to justify a further consolidation of ownership and control. So it turns to the long-term capital partner that led the Series A and asks it to lead the Series B.

Whereas the price of the Series B depends on a combination of business performance and market forces, the size of the Series B depends on the willingness of existing investors, mostly VCs at this point, to sell at an agreed upon post-round buyback price.

Let’s assume the following: a $30M Series B on a $100M pre-money, for a $130M post-money with 23% dilution. Then the company uses $29.5M to buy back existing investors willing to sell at a $100M price, for 29.5% appreciation.

Therefore, the bottom-line impact of the Series B round is:
— 6.5% appreciation, $500K in primary capital.
— Happy, loyal investors who exited at a 5X average profit.
— A 373% valuation markup ($33.5M to $125M post-money).

Now the cap table looks like this: 64.4% team, 33% Series B investor, 0% by other investors… To get to 70% owned by the team and 30% owned by the Series B investor, an option pool is created.

What if the other investors won’t sell 100% of their stakes? Then proportionally less can be raised in the Series B, and the team and the Series B investors can dilute the other investors with a combination of primary investment and an option pool. This can still be a win-win-win if the Series C is done at a much higher valuation, but ultimately, some structure like this prevails…

How to enable future fundraising while preserving the 70/30 ratio?

After a Series B in July ‘21, let us suppose that the company continues to perform to plan, and is on track to achieve a $100M run-rate by EOY‘23.

Let us assume that in July ‘23, this capital-efficient company changes its mind and decides to become capital-intensive for a short period of time, because it has figured out a way to deploy capital in the short-term to dramatically improve its trajectory in the long-term.

At the Series A this wasn’t the plan, so the team focused on ownership and control consolidation, but they knew that in the future, things might change, so they negotiated the following terms with their long-term capital partner (LTCP).

In the event that the company decides to raise money, the LTCP shall have a ROFR on those terms. If the LTCP always exercises their ROFR, then all additional investment is conditional on a new option pool to keep the team at 70%. In other words, it is always against the LTCP’s interests to lead another round unless they truly believe that the dollar value of their equity will grow far faster as a result of the increased cost of maintaining their ownership position at 30%.

But if the LTCP passes on the opportunity, the company may transact with a new LTCP. Let’s call these LTCP 1 and LTCP 2. The company shall have the right to buy back shares from LTCP 1 at the pre-money valuation of the new round, to maintain a 70/30 overall ratio.

For example, suppose that the company decides to raise $100M on a $900M pre-money valuation, for a $1B post-money valuation and 10% dilution. LTCP 1 passes. LTCP 2 agrees. Now the cap table looks like this: 63% Team, 27% LTCP 1, and 10% LTCP 2. To get back to 70/30, the team can take $63M of the $100M raised to buy back 7% of LTCP 1’s stake (which would accrue 100% to the team and not to LTCP 2, via a new option pool), leaving the other $37M available for primary capital, resulting in a cap table like this: 70% Team, 20% LTCP 1, and 10% LTCP 2. If the company needs the full $100M for primary capital, then a larger amount needs to be raised, and the figures can be played with. Alternatively, a cleaner way of handling it is for the $100M in primary to be paired with an option pool to get the team back to 70% and LTCP 2 buying 7% of LTCP 1’s position in a $63M secondary transaction. In either scenario, the principle remains the same.

QED: the company retains its ability to raise future equity financings, the LTCP retains its ability to maintain its stake, or forgoing its ROFR, will be bought out at a fair market price.

The key concept is that the company controls all the exits, and the only exit is a buyback. If team members leave, the company buys them back. If team members want liquidity, they have to convince the board (controlled by the CEO) to do buybacks. If the LTCP wants to exit, they need to either ask the company to buy them back and negotiate a price, or ask them to raise a round with a facilitated secondary.

This leaves the very attractive long-term possibility open of the company buying back the LTCP at a very high valuation when they want to exit someday, and eventually owning 100% of the company.

Reprise: The Advantages Of Long-Term Alignment

The great libertarian maxim that “people respond to incentives” isn’t just a platitude, but a profound truth worthy of meditation…

Greed is a natural motivator for capitalistic activity, and I (and by “I”, I mean, the hypothetical CEO) wouldn’t be able to do my job if I didn’t understand my own, and understand others’. I don’t see it as dirty, at all. Greed is just another word for desire. Desire is synonymous with passion. Passion is synonymous with love. The only difference between the “dirty” and the “pure” emotion is the alignment of interests.

That is, when the painter paints, there ought to be a selfish desire to both sell the painting, gratify personal expression and satisfy aesthetic sense. But usually there is also some inherent love for beauty, or a desire to bring something into the world, or for the mortal, through the art, to transcend… The dirty is aligned with the pure.

The same could be said for sex. When the selfish desire for sex is combined with a transcendent relationship, we bless it and call it love. If you don’t have the lust, the love is weak. If you don’t have the love, the lust is weak. You need the two together. And for politics: the politician should lust for power, in order to use it to advance certain values…

In some relationships, we don’t want or need long-term alignment. I don’t need long-term alignment with a restaurant to buy dinner there, for example. It would be impractical and irritating if every restaurant required commitment beyond the transaction of the evening… (Although there is probably an idea there…)

Indeed, in the same way that fiat currency reduces the transaction cost of constant bartering, creating incredible efficiency gains, we might measure progress in the increasing number of transactions that are available to us that do not require long-term alignment. This is part of the crypto thesis: trust isn’t required.

But as the vast-majority of our relationships become transactional, require no trust, and communicate through the price signal, our most important relationships will never be this way, in fact, they’ll be just the opposite.

Long-term partnerships make the world go-round. This is a Coasian insight. Long-term partnerships outperform short-term transactions on a host of dimensions. A shopping mall can’t raise a child. A decentralized marketplace of buyers and sellers can’t design and build the next great airplane without a small, centralized, aligned team to coordinate them. A nation’s grand strategy can’t be delegated to a crypto protocol…

There is a reason why private markets exist. In private markets, insider trading is legal and encouraged, but transactions are far less liquid and efficient. I used to believe that in the future, every startup would IPO from Day 1. But I’ve changed my mind on that. The advantage of private companies is that they can align a tightly-knit group of long-term partners: a team of owner/operators with one or more long-term capital partners.

If you believe that more-aligned incentives will result in longer-term and higher-performing partnerships, and you run an ambitious but capital-efficient technology company, then you may start asking the questions I started asking…

— Does the same game that makes sense for capital-intensive companies make sense for capital-efficient companies?
— What are the inherent and unique advantages of capital-efficient companies?
— Does our current venture framework align incentives in the best possible way for capital-efficient companies?
— How might a new game be designed that results in a win-win-win for all parties: the team, new investors, and existing investors?
— If a capital-intensive company transforms into a capital-efficient company, is it possible to convince existing investors that the team reclaiming the cap-table is in their bests interests?
— And given that this new game isn’t widely understood, is it possible to find a long term capital partner to make this hypothetical scenario an actual scenario?

The cost of starting a company has gone down over the last half century, although arguably the cost of scaling has gone up in some ways. Still, there is a complicated capital markets history that explains why, even as operating costs have gone down, the amount of capital deployed and the true cost of capital has gone up. I will explore this paradoxical phenomenon in a future post…

But I will leave you with this thought…

IF more teams focus on building profitable, defensible and scalable monopolies with as little capital as possible, they will realize surprising things: evolution is more receptive to time than to money, defensibility is an emergent property, and efficient scaling attributes can be designed into business models. Lastly, maybe a lot of time and money is wasted by being shy about sales while we wait for an initial product, which is always weak by definition, when services can be sold profitably from Day 1, and used to finance product-development.

Having realized these things, maybe the CEOs of these teams will start changing their corporate strategies, and looking for capital partners willing to play a new game.

In the long run, this new game is a bet on teams. It’s a bet on David vs. Goliath. On small teams with less capital being able to outperform large teams with more capital, on certain key dimensions. Small teams are more agile. Small teams are more creative. Veteran teams out-execute. Owners out-execute employees.

Private, closely-held, profitable businesses, built and run by small and elite teams of owner/operators, will have better answers to the two rate limiting questions to long-term growth: what should we do with more money and what should we do with more talent?

This is paradoxical because capital-intensive companies have to answer these two questions earlier on in their lifecycle. That’s their VC pitch: give me money and I’ll hire these people and use it in these ways…. But their game-theory forces them to stick with their initial answer — they’re locked in; it becomes harder and harder to pivot, or to create new businesses or even lines of business.

Even in the rare and miraculous cases where their initial answer was correct and they executed brilliantly, the incentives built up by external capital instead of internal profits result in an exodus of talent after their initial success — they are one-hit wonders.

In the rarest of cases like Google, there was the ambition to build a holding company and use capital to experiment on a massive scale. But even there, the incentives and the culture seem somehow so distorted that I question the ability of Alphabet companies to outperform their startup competitors…

I’m arguing for an experiment. I want to do something that has never been done before. I can’t point to examples from the future, only to examples from the past. But as far as past examples go, Thorndike’s Outsiders is full of them…

But I believe it is possible for a small team to build a profitable, scalable, defensible monopoly. I believe it is possible for that team to still own 70% of their company at scale. I believe it is possible to incentivize all the capital required to get to scale with 30% of that company.

I believe that ownership is more motivating than salaries and benefits, and will attract the best talent in the world to that company, align it better than any other form of compensation, and create a healthier culture.

I believe that an emphasis on density vs. specialization — that is, a small team of generalists vs. a large team of specialists — will result in lower coordination costs, a better culture, better decision-making and more innovation. A partnership model incentivizes density.

I believe that a profitable private partnership has the potential to be far more revolutionary than a venture-backed company that IPOs, even if it becomes profitable. A private company with a smaller team with large amounts of equity can out-innovate and out-invest and lead with values instead of with quarterly earnings.

Hypothetical possibilities don’t change the world. Ideas change the world when people commit to them.

I’m committed to this idea.

But I need other people to be crazy with me.

And to go all in.