Francis Pedraza
May 17 · 36 min read

Editor’s Notes: The CEO in this post discussed A Brief Market History Of The 19th and 20th Centuries: Profitable Entrepreneurs, Private Equity Industrialists, and Competitive Venture Capitalists, The Art Of Building capital-efficient Businesses In The Capital-Intensive Markets Of The 21st Century and What customers want.

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Sailing Against The Wind

Piloting A Company On The High-Seas Of Capital-Driven Markets

Capitalism is still young. Men have been trading throughout human history, with coin for millennia, but modern finance only began in 15th century Italian banks, the modern company is a 16th century Dutch and British invention, and the industrial revolution began in the 18th century.

In that classical period of market history, labor was the landscape, because there was more labor in the world than capital. The 20th century was a century of transition. But in the 21st century, we have fully entered the modern period, and capital is the landscape. Capital has compounded for centuries, and, in spite of world wars, revolutions, and redistribution, liberal game-rules, like property right protections, have prevailed sufficiently, allowing society to amass incredible wealth... all of that capital is now seeking a return.

Like the dam of heaven broken-loose, the earth has been flooded, there is less and less dry land, and while the water of liquid capital seeks the low places, labor seeks the high…

As capital floods the world, to start a company is to be like Noah, like Colombus… and set sail for land. It is in the undiscovered high places of the world, that have not yet been settled, that we may yet find opportunities to build landed wealth by our own efforts, with our own labor, free from the curse of capital-driven competition.

But to get there, we need to sail. To sail against the wind of the market, on the high-seas of capital-driven markets, and to discover before others the land of opportunity that we seek...

Many captains seeks their fortunes on the high-seas… Some are naval officers commanding vast armadas… Others are agents of distant employers, paid to explore… Beware pirates, exploiting the discoveries of others… But there are, as yet, a few independent adventurers, who may have borrowed money from distant capitalists, but whose captain and crew, loyal to each other, have ventured of their own accord, seeking the promised land…

And these, being outnumbered, must escape the high-seas of capital-driven markets as soon as possible. As every independent captain knows, if he sails too long before finding land, his crew will either starve or be swallowed in the sea. So he must return to port to seek capital to resupply: done once, he survives, done twice, he endures, but done one too many times… then he, his ship, its crew and its cargo, will be foreclosed upon, pressed into service.

Even if he finds land, have others found it first? Will he be able to defend his discovery? A territory, once claimed, must be defended against all comers to retain sovereignty. And the defense of a territory, too, requires capital.

Then, how, how, to remain independent…? Has the world been captured…? Or is it yet fertile…?

Upon these high-seas, can one still make for himself a name, as names were made before him? Can new lands be discovered, and new wealth be created, not just for capitalists and their agent captains, but for independent captains and their brave crews? Or does all new wealth merely trickle down from old wealth?

Have all rents been claimed and all lands explored? Are we still in an age of discovery… ? With yet virgin territories to be found… ?

These, the captain asks at night, looking up, questioning the stars for guidance…

A Brief Market History Of The 19th and 20th Centuries: Profitable Entrepreneurs, Private Equity Industrialists, and Competitive Venture Capitalists.…

I often wonder what men like Coolidge, Tocqueville, Lincoln and the Founding Fathers would think if they saw America today. How would it update their mental models to see how the grand experiment played out? Surely, one of the primary insights must be how the structure of civil society is, in fact, dependent on the structure of capital markets and the emergence of industrial complexes, which Eisenhower, wise but too late, was the first to warn of, upon his departure…

There have been revolutions, wars, and rumors of wars — hot, cold and civil — not just in various industries, but in the capital markets and the information markets overall, and we would do well to not loose sight of these evolutionary histories, for they help us understand the world today, and imagine how it might be different…

The first great industrial era in America followed the Civil War. Before then, in the 19th century, when Tocqueville was writing, there were a multitude of farmers, ranchers, trappers, lumberjacks, miners, distributors, millers, builders, bankers, shopkeepers, tradesmen and craftsmen in America. In today’s terms, there were many SMBs and freelancers, a growing number of mid-market companies, but very few enterprises.

What was beautiful about that world, is that it was easier to be profitable and independent, and to live by classical financial virtues like Prudence, Perserverance, Thrift and Emersonian Self-Reliance. A trapper could fancy himself after Daniel Boone… A pioneering farmer journeying to the frontier to stake out, for himself and for his descendents, a homestead — could pride himself in following in the footsteps of Lewis & Clark… Someone burned by life in the big city could flee to become a logger in the North, or a weatherbeaten cowboy in the South, with a pistol always ready at his side, fiercely independent and ready to defend his land with “Remember the Alamo!!” at his lips… What Weber later called the Protestant Work Ethic was preached by Franklin: “A penny saved is a penny earned.” The spirit of enterprise could be found in every family and small town in America, and the wisdom of the age was to save money and reinvest it in the wealth-producing assets that you owned and operated.

What was ugly about that world is that it was hard, and it was hard because everything was scarce and thus expensive, there was a lot of competition, but it was hard to consolidate and scale, as we lacked the financial capital, mechanisms, and imagination to consolidate, to do a “private equity rollup,” and primitive machines made industrialization cost-prohibitive… Local monopolies existed but there were very few regional or national monopolies, and no global ones.

Then, after the Civil War, industrialization accelerated, and men like Ford & Edison, Rockefeller & Carnegie, J.P. Morgan and Andrew Mellon inherited the earth. These three pairs represent different archetypes: the inventors, the industrialists and the financiers.

Although there was plenty of cross-over. Mellon cornered the market for Bauxite, then developed a financial empire on this industrial base. Carnegie and Rockefeller invented new techniques and both had external capital partners — notably Vanderbilt, in Rockefeller’s case, who was himself a hybrid entrepreneur-industrialist-capitalist — before buying them out. But they were primarily industrialists, Carnegie in steel, and Rockefeller in consolidating and expanding the markets for oil extraction, refining and distribution...

But, to simplify: men like Ford & Edison invented new things and turned them into big businesses, Rockefeller & Carnegie industrialized the manufacturing and distribution of existing commodities, and Morgan & Mellon financed both the creation of new industries and the consolidation of existing ones with risk capital in exchange for debt and equity securities.

Simplifying further: Profitable Entrepreneurs, Private Equity Industrialists, and Competitive Venture Capitalists.

Remember, capitalism was still young, so capital was relatively more scarce and expensive than it is today, and labor relatively more abundant. So although many Profitable Entrepreneurs needed capital to invent new things, some of them figured out ways of building their businesses without capital, but even those who took money, wanted to take as little as possible, to retain as much ownership and control as possible; they preferred debt over equity, and when they took equity, initiated buybacks as soon as they were able. The ultimate case study in this is Henry Ford’s short and inspired autobiography My Life And Work, in which he goes to great lengths to caution entrepreneurs against the financiers of his day, detailing their misaligned incentives.

Capital had not yet flooded the world…

The Emergence Of National & Global Markets

Already, in the era of the industrialists, the flood-tide was rising: capital was compounding, overwhelming, and consolidating markets… Industrialists like Vanderbilt, Rockefeller and Carnegie, and capitalists like J.P. Morgan and Mellon, were not only the first proto-“venture capitalists,” they were pioneers of private equity, executing roll-up strategies… Not for nothing were they the so-called “Robber Barons…”

This capitalist activity is natural and legal, but was seen as predatory because it put so many SMBs out of work. Whereas 98% of the pre-modern workforce was agrarian, today only 2% is… and that transformation was already well under-way with Ford’s tractor, Edison’s lightbulb, and Carnegie’s steel and the skyscrapers they made possible.

Although Steinbeck’s Grapes of Wrath shows how much momentum these trends had in the first half of the century before World War II, during and after the war, they accelerated. The war was about SCALE. American industry needed to scale. And scale it did… American assembly lines dominated the economic war of attrition, pumping out fleets of air-craft carriers, divisions of tanks and jeeps, squadrons of fighters and bombers… By the war’s end, American GDP was half of global GDP: eclipsing all of the other combatants combined!

The modern “job” took form: with its monthly paycheck, benefits and so-on… Radio and then television consolidated national attention, creating cultural & commercial distribution in a way that newspapers had not… Techniques of mass-production pioneered at Ford were applied to every industry: washing-machines, dishwashers, consumer packaged goods (Procter & Gamble), telephones (AT&T)… swept the land, and mass-consumption demand met the supply with open arms.

By the 1950s, a strong national market had emerged. A new business could sell its products not just to a village, town, or city, or even to a county, state or region, but to the whole nation.

Furthermore, our triumph in the war, and our dominant international stabilizing presence in forming the new world-order and the peace afterwards resulted in access not just to national, but to global markets… all of which looked up to America aspirationally.

This was the golden age of modern capitalism, but oddly, modern venture capital was just being born.

The Disruptive Genius Of Modern Venture Capital

I have read embarrassingly little of the early history of venture capital, so it is as yet unclear to me who exactly was the first person or company to realize the potential of what became the modern venture capital industry, but here are a couple wikis. Iconic companies like IBM were not venture-backed... IBM traced its origins back to four companies in the 1880s that had been profitable from the beginning… American Research and Development Corporation (ARDC) was formed just after WWII and turned a $70K investment in Digital Equipment Corporation (DEC) into $35.5M… But my hunch is that capital-intensive industries like telecom and utilities, and companies like Edison’s Edison Illuminating Company, financed by J.P. Morgan, and Alexander Graham Bell’s Bell Telephone Company, later AT&T, which were both founded in the late 19th century, relied on Wall Street to finance their large infrastructure investments.

But to caricature the realization, it was like “The First Great Capital-Markets Enlightenment”! It gradually dawned on people that as capital accumulated in savings accounts at banks, it could be lent or invested in huge sums to companies with hugely UNPROFITABLE and/or DILUTIVE (capital-intensive) strategies to either A) invent new things, B) distribute new inventions, or C) consolidate existing industries, but that after short to medium-term losses, these strategies would result in STUNNING long-term profits, in the form of MONOPOLIES paying dividends on captured rents.

The dam of heaven broke-loose, and the flood was unleashed upon the world...

The Contrarian Counter-Enlightenment, The Sovereign Company & The Return To Capital-Efficiency…

Capitalism is always at war with itself, and that is its genius... Capitalists and socialists can agree that capitalism has failed to create a perfect world. The difference between them is that capitalists believe that the world will never be perfect, that capitalism is “the worst government, except for all the others” and that the only way to solve the problems of capitalism today is with the new, disruptive, contrarian, sovereign, mission-driven companies of tomorrow…

As the “unprofitable and dilutive first great capital-markets enlightenment” spread across industries and came into vogue, incentives shifted: nobody wanted to miss out on the “gold rush” of cheap capital, so CEOs levered up to the max, investors speculated aggressively, losses mounted, dilution piled on…

… and eventually the bubble burst.

It burst in the crashes of 1929 and 2000, and in the stagflation of the 1970s. When crashes are allowed to liquidate naturally, markets recover from the darwinian events better trained and stronger than ever. But when markets crash, the political will shifts strongly towards intervention on the Right, and outright socialism on the Left, and this creates Keynesian bubble economies, at best, or worse, stagflation economies, and worst of all, socialism or communism.

Without turning a business essay into an essay on political economy, avoiding the natural overlap is impossible, it must be confronted head-on: there is a very strange conceptual similarity and evolutionary correlation between the political emergence of Keynesian Progressive Socialism and the economic emergence of undisciplined speculation in private equity, venture capital and other capital markets. The undisciplined speculation had cultural implications: people saw funny money sloshing around, invested wildly, spent loosely, and they learned the wrong lesson: money is cheap, money can be printed, money falls from the sky... When the bubble burst, the speculation creates a political backlash that conceptually mimics the economic logic of private equity: stimulate printing, borrowing and spending, give money to people and see if that creates growth… As natural inequality sets in, so does natural resentment, and jealous demands for redistribution, and “equality” so that printing, borrowing, spending, and over-consuming can be practiced by “me, too!!…”

True wealth comes from manufacturing and trade: from making and selling goods and services. The wealth is not the money, the wealth is in the residual value of the goods and services — money is just a store of value and medium of exchange…

True growth comes from labor productivity gains. Although capital, invested with discipline, can accelerate labor-driven innovation, manufacturing, distribution and operational consolidation… When so much capital has accumulated over time, eventually there is more capital seeking returns than there are productive labor-teams with productive opportunities to deploy it…

This results in three tragedies, aside from the natural inflation which results from too much money chasing too few assets, but which is usually balanced, if not exceeded, by the natural deflation of progress:

First, large investments in bad teams with bad opportunities.

Second, too-large investments in good teams with good opportunities. At best, this results in unnecessary spending and dilution, reducing capital-efficiency and new wealth creation, as the equity value of labor-teams get diluted by old money... At worst, it corrupts these teams and projects entirely, ruining the ventures and ultimately destroying the capital too.

Third, too-large investments in too-many good teams competing for a single opportunity. This results in a game-theory of MUTUALLY ASSURED DESTRUCTION in a CAPITAL-DRIVEN ARMS RACE. When Lift raises $60M and spends it quickly, Uber must raise $100M and spend it faster, which, in turn, drives Lift to raise $250M and spend it even faster, driving Uber… off a cliff. Perhaps, in the case of ride-hailing apps, they have created enough underlying time-saving labor productivity through their service, and all of this capital has made their services sufficiently defensible, that enough value exists to salvage these investments… Only time will tell. But Uber is certainly less profitable than it would have been in a world flooded with less capital…

What, then, should be done?

The independent captain realizes that capital has become a commodity whereas labor is no longer a commodity when it is organized into a productive team exploring and exploiting unique opportunities with a difficult-to-replicate approach.

This is the contrarian capital-markets enlightenment (“Enlightenment 2”).

Having had this realization, the independent captain rallies his crew, promises them far greater spoils than their capital-bosses offering jobs-pay could ever provide, and they begin to act as a sovereign company. That is, they act as if they don’t need capital.

But although we live in a flooded world that has accumulated a practically infinite amount of capital relative to the good opportunities available, there are always more bad ideas available than money, so the only way to act as if you don’t need capital, but to get access to unlimited capital anyways, is to become profitable! In the same way that a nation cannot declare its independence without a military, a company cannot declare its independence without profits…

Easier said than done. In a competitive market flooded with capital, you cannot escape the destructive logic of mutually assured destruction in a capital-driven arms race.

So the only way to retain sovereignty and survive is to make money doing something that is difficult or impossible to replicate, and to accellerate a profitable development trajectory with efficient uses of capital…

Three modern CEOs illustrate the counter-enlightenment:

The profitable approach. Steve Jobs lost sovereignty of Apple in the 80s. Although it was profitable at the time, Jobs had given up too much ownership and control in early rounds, and the capital fired the labor of its CEO. By the late 90s, almost bankrupt, the capital realized it was a commodity but that the company’s founder was not, and, in desperation, brought him back... He didn’t live long enough to restructure the cap table, but his de facto power after the glorious return of the Phoenix was such that he had undisputed sovereignty, and his first priority was not just innovation, but profitable innovation. And indeed, he created the most profitable company in the world. I fancy that if he were still alive, he would have taken the company private and bought back all the stock…

The defensibility-through-difficulty approach. Elon Musk’s approach was to stay in a capital-intensive industries, some competitive, others not, but always attempting projects so incredibly unprofitable and difficult that no sane competitor would attempt them… Even so, it has been nothing short of miraculous that he has stayed in control through the massive dilution… Although his teams, which ultimately create the real value, suffer under venture socialism… In this model, Net Income plummets downward towards the depths of hell… In the hope that someday, it shoots up towards heaven like Jesus Christ in an Iron Man suit…

How is this not just Enlightenment 1; what makes this contrarian Enlightenment 2? Although the V-graph looks like any other venture-backed company, there are two big differences. First, it’s incomparably more intense, the scale makes an enterprise software venture investment look risk-averse by comparison. Secondly, these market and technology challenges are incomparably more daunting; again, making normal venture-backed companies look pathetically unambitious by comparison...

By the paradoxical logic of strategy, this works, and is contrarian. Si vis pacem, para bellum. If you want peace, prepare for war. When you realize how the unprofitable Enlightenment 1 game is played, if you play it to the absolute extreme, you can actually disincentivize the value-destroying competition that normally accompanies it…

The capital-efficient approach. Jeff Bezos’ approach is a hybrid. Amazon stayed unprofitable, or barely profitable, for a long time. Even last year, it only made $11B, whereas Apple, by comparison, made $260B. But Bezos heavily reinvested capital and profits in infrastructure, in new lines of business, in new technologies… Arguably this was a capital-intensive approach, but arguably it was capital-efficient because every bet had a payback period and expected ROI, and Amazon never lost track of the price-signal of profitability… In this model, Net Income zig-zags around zero: where every zig is an investment, and every zag is a validation of that investment with a raising of the trajectory…

Twitter, Facebook, Google and Netflix are classic First Enlightenment companies. Their business models required scale, monopoly pricing-power, and network effects (to varying degrees). The CEOs of these companies didn’t give a damn about profitability, they only cared about sustaining insane growth… This strategy is perfect for the First Enlightenment venture model and, when it works… it works brilliantly, in spite of the model’s inherent disadvantages, it has enabled new and never-before-possible businesses that have created extraordinary value…

But these ships aren’t free… And their crews aren’t owners

The Art Of Building Capital-Efficient Businesses In The Capital-Intensive Markets Of The 21st Century: A Tale Told In 7 Graphs

In the same way that the first captains who figured out the secret of venture capital unlocked its disruptive genius to create new, extraordinarily valuable and never-before-possible businesses… The first captains who figure out how to maximize their ownership and control, by minimizing dilution, dependence and distraction from capital, will also create new, extraordinarily valuable and never-before-possible businesses…

The 7 Graphs that follow illustrate the Counter-Enlightenment…

Graph 1: Three Modes Of Corporate Evolution

Imagine a company that can productively deploy $10M in 1 day. That is a capital-intensive company, and its evolution is determined by capital… By a paradoxical logic, the most capital-efficient strategy for that company is to be as capital-intensive as possible…

In contrast, imagine a company whose evolution isn’t responsive to capital at all, but extremely responsive to time. The longer it lasts and the team sticks together, the more it evolves… The most capital-efficient strategy for that company is zero capital.

The optimal mixture for most companies is somewhere in between, but if the mixture is mis-judged, then the result is failure. Michael Bloomberg’s recent Presidential campaign comes to mind as an example of failure: he joined the race at the very end, but even though he deployed a huge amount of money rapidly, the market proved to be relatively capital-insensitive, if not capital-allergic...

This graph implies more than it says… One of its implications is that necessity is the mother of invention… Large, over-capitalized teams rarely feel the same existential pressure that small, under-capitalized teams feel. Give a small, under-capitalized team enough time, and they might come up with a vastly-superior solution that a large, over-capitalized team would never have thought of…

Graph 2: Three Investment Strategies Compared…

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Capital-Intensive, V-Shaped, Standard Venture Playbook
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Capital-Intensive With Profit Discipline, W Shaped, Amazon Playbook
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Capital-Efficient With Profit Reinvestment, Bull Shaped, Berkshire Hathaway Playbook

All three graphs can work. But strategy depends on situation. Apply the wrong investment strategy to your situation and you will fail…

The first graph is the First Enlightenment. As discussed earlier, Elon Musk takes that strategy to its paradoxical extreme…

The second graph is a Second Enlightenment strategy. It is capital-intensive, but always maintains profit discipline, and combined with a strong balance sheet, results in capital independence and maintaining the “price signal” of Net Income…

The third graph is a Second Enlightenment strategy… Berkshire Hathaway, to my knowledge, has made no new stock issuances since its first issuance: the proceeds of which were used to acquire a small, failing New England mill at below book value... The profits from that mill were used to acquire an insurance company, and the float from that insurance company was used to buy and invest in other companies, and the rest is history and legend… The point is: the capital for all subsequent investments came from reinvesting profits and float from cash-cows and proceeds from capital-events…

Ceteris paribus, the third strategy is superior as it minimizes dilution, dependence and distraction, maximizing ownership and control…

Graph 3: The Relationship Between Team-Size & Metrics Signals

The insight here is that an entire company, if its team-size is small, can be managed against just four metrics, all of which come from the Income Statement: Revenue, Gross Margins, Contribution Margins, and Net Income… The “price signal” from these metrics allows for decentralized, self-organizing, fluid coordination of effort… There is a clear feedback loop between actions taken by the team and the resulting business performance… If incentives are tied to these price signals, their effect is maximized, but even without direct incentives, the simple clarity of defining a game in which success is defined by the upward movement of just four metrics will probably result in aligned behaviors… The culture that tends from this is unified, tightly-knit with high standards… Like Buffett’s investment strategy, the “unicorn” hiring strategy “makes its money” at the “moment of investment…” but every “hell yes” is rare and miraculous, following countless “no, no, no…” decisions.

But if the team-size is large, the company needs to be organized into a hierarchy with each team in its own silo, with its own OKRs and metrics… What results from this is a multiplication in the number of “price signals” in the company, many of which will naturally conflict, noise will be hard to filter out, and the effect of any given action on overall business performance will be hard to track… The culture that results from this is fragmented, mercenary and mediocre… as new hires are made to “fill roles” when a “job” needs to be done to “stay on track” with growth…

Don’t lose sight of the Net Income price signal!

Graph 4: Corporate Strategy: Capital-Efficient vs. Capital-Intensive Game Theory…

Without repeating the contrasts in the graph, the synthesis is that these corporate strategies could not be more different. One is a Pirate Ship, the other is The Imperial Navy.

Indeed, more contrasts are implied than are stated. For example, a capital-efficient company is more likely to be fully transparent; whereas a capital-intensive company is more likely to be low-visibility…

Also note the paradoxes: the time-horizon of a capital-efficient company is longer, but its offers liquidity faster… whereas liquidity for a capital-intensive company is in the mythical future…

To distill it all down to a single difference: the difference is that in the smaller company, where every shareholder owns a larger percentage of the company, the culture is more ownership-oriented, and it is harder to lose sight of the PRIZE… equity.

All great fortunes not made in war are made with equity. But as wealth begets wealth for the wealthy, broad-based progress in a society must come from the creation of new equity wealth in successful new ventures in which the team, as opposed to the investors, owns the majority…

Don’t lose sight of the Equity price signal!

Graph 5: Explore vs. Exploit

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How many explore bets can you have at a given time? In the beginning less. Later on more…

In the beginning, a capital-efficient company will feel FOMO: its capital-intensive peers will be spending huge amounts innovating on a single bet.

But capital-efficient companies exploit once, then explore forever…

Graph 6: Capital Allocation Strategy

Again, I will let the graph stand alone. The sections that follow will discuss the 4 investment types on the left-hand side of the graph: Type 1: Growth (i.e. reinvesting in growing the core business), Type 2: Buybacks (i.e. using capital to buy back previous investors), Type 3: Investments (i.e. using capital for R&D, starting new lines of business and new companies, investing in other companies and M&A), and Type 4: Dividends.

When venture investors advise you on capital-allocation, consider their misaligned incentives…

Firstly, the classic maxim that “equity is a pillow, and debt is a sword” is not necessarily true: equity is not necessarily a pillow, debt is not necessarily a sword. Equity dilutes ownership and threatens loss of control. Although truly game-changing strategic partners are possible in theory, they are rare in practice: equity is a sword in the hands of the wrong partner… In the beginning, equity might be the only way to finance the company, but the better your trailing business performance history, the more debt becomes available on better terms, although the best financing of all is profits… Debt is not necessarily a sword if you don’t raise too much, if your revenue is secure, and if you’re confident in the anti-fragility of your business…

Secondly, the hurdle rate for investors is not necessarily the same as your hurdle rate; that is, the company’s internal hurdle rate… Their incentive is very macro: to invest every marginal dollar that can clear a, say, 12% annual hurdle… Your bar for high-ROI should be higher, and the way you think about acceptable risk should be different, more micro… You want fast payback periods, say, within three months… You want to know that each individual bet on a hire, on a feature, on a strategy has actually worked out before you make the next bet…

Thirdly, their risk is diversified, yours isn’t. They’re optimizing for portfolio returns, you’re optimizing for the company… If you’ve been at this for five years, you don’t want to “risk it on one turn of pitch-and-toss, / And lose, and start again at your beginnings / And never breathe a word about your loss”… if you don’t have to. No, your first objective should be to ensure the company’s survival. The principle is: don’t destroy value. Protect value: it’s hard to build, easy to destroy… Once your downside is hedged, then yes, you want to optimize for upside and take risks

But even then, the way a VC wants you to take risks is by deploying huge amounts of capital, which increases their ownership, control and portfolio returns… But, again, from your perspective, deploying capital means taking dilution, losing control, and running huge losses… Huge losses mean increased existential risk, structural dependencies on more capital in the future (capital addiction), and consequences (usually terrible) for your organization’s culture and incentives

The way YOU want to take risks is by reinvesting profits, perhaps deploying small amounts of capital, maintaining a strong balance sheet as a bulwark against unforeseen downside, and iterating on ROI-analyses and payback periods until your investing confidence increases…

The owner following the PE playbook behaves like the company isn’t just one of a portfolio of diversified bets… the company IS the bet. Instead of maximizing risk around a single huge bet with a small chance of huge reward, the owner is inclined to minimize dilution, get to profitability, then make many small-then-increasingly-larger bets with ROI-optimized investment decisions…

Once more…

Whereas VCs want to turn each company in their portfolio into one huge unprofitable monolithic bet… YOU want to protect downside, THEN maximize upside, by taking MANY bets: first small ones, then medium ones, then large ones — as your confidence increases…

The Micro-Economics Of Making Type 1 Investment Decisions: How To Reinvest In Your Core Business…

How does the theory of Graph 6 translate into practice? For your core business, how do you know what to invest in, how much to invest, and when? How do YOU know you aren’t investing too MUCH or too LITTLE right now?…

If all four of your Income Statement price signals — Revenue, Gross Margins, Contribution Margins, and Net Income — are going UP, then invest a little more...

Encourage your team to come up with as many proposals as possible. Select the fastest-payback investment with the highest-ROI: optimizing for payback first, ROI second. Then see how it goes…

Once it pays back and all four price signals are now higher at T=2 than at T=1, invest a little more… Repeat: making the investments incrementally larger, as long as the Net Income baseline is also rising, becoming less conservative after profitability, and becoming very aggressive once profits are substantial

Notice that this approach for is time-intensive at first then gradually becomes more capital-intensive until diminishing returns are reached

Conflicts With The Round Structure & Fundraising Dynamics Of Venture Capital

The evolutionary-logic of making Type 1 internal investments (see above) is AT ODDS WITH the ROUND-STRUCTURE of Venture Capital: it is not NATURAL to deploy capital in 18 month cadences… The natural deployment cycle is incremental, experimental, and gradual

The political dynamics of fundraising further distorts strategic clarity. When pitching, the CEO presents a use of proceeds plan which persuasively demonstrates that he knows exactly what to do with the capital once it is raised to rapidly create value and accelerate the company on to the next round... So, after closing, the CEO feels pressured to deploy rapidly.

But, to follow the micro-economic strategy laid out above, which is more prudent, the CEO must SIT on the vast majority of the capital, and IGNORE the ARTIFICIAL 18 month timelines... Deploy a small initial amount, and see if it pays back. If it doesn’t, learn… then make another small bet. If that works, then make another one, etc., following the strategy above, deploying capital only gradually, most of it at the tail-end, rather than at the beginning…

The Micro-Economics Of Making Type 2 Investments: When To Do Buybacks… Why Now?!

Capital markets for private investments are far from rational, efficient or liquid. It takes the CEO a long time to create demand for his stock. Rounds come together alchemically as underlying business performance momentum combines with a techno-visionary monopoly strategy pitch, combines with the mimetic desire of competitive frenzy… Once that demand exists, it is foolish to waste it, so the CEO must maneuver around the reality that investment interest does not correspond to optimal capital allocation timing, and price does not correspond to value creation...

As long as the four Income Statement indicators are trending up…

As long as Type 1 capital allocations have already been maximized…

As long as the CEO has the discipline to sit on capital and maintain a strong balance sheet…

As long as capital is raised without yielding control, whether mechanically through the security itself, for example, via a SAFE, or through winning all control points in a negotiated priced round…

Then the CEO has everything he needs to keep raising money at progressively higher prices, “painting the curve,” while recycling as much capital as possible with buybacks…

Just as the Legislature yields the prosecution of war to the Chief Executive, so too, the delicate market judgements involved in pricing the sale, on the one hand, and the repurchase, on the other, of the company’s stock, should be left the CEO. But the principle is that the CEO should make as wide a spread as possible, without setting expectations too high with buyers or damaging relationships with sellers.

As a rule of thumb, in my opinion, as long as sellers are getting a 3X exit pre to post, the CEO should be able to sleep well at night. But this, of course, is not how all of those sellers will see it. In exchange for early loyalty and extended patience, they will feel that they deserve more. If the buyers’ market won’t bear a higher price, and all the sellers feel bitter about their exit price, then perhaps the spread will be too small and buybacks will have to wait. But if enough sellers are willing to sell, the CEO should provide liquidity at that price. Then, if the buyers’ market moves up as the business performs, the sellers unwilling to sell in the first round of buybacks, may be willing to accept a higher price later…

Although it may take many years, over time a CEO should be able to use this strategy to recover historical dilution. But to buy back all of your stock, you either have to accumulate substantial profits on your balance sheet, or do what Henry Ford did, and, in one fell swoop, use debt instead of equity…

The Micro-Economics Of Making Type 3 & Type 4 Investments: When To Make New Investments And Pay Dividends

In the graph I listed five types of Type 3 investments: innovation (R&D) in your existing business (a variant of a Type 1 investment, to differentiate between investments in growth and incremental investments in engineering, and truly disruptive and risk R&D), starting new lines of business, starting or spinning out entirely new companies, as in a holding company structure, investing in other companies, and buying other companies.

I won’t expand on these here, as they deserve an entire essay… I will merely say that once Type 1 and Type 2 investments are maximized to the point of diminishing returns, Type 3 investments should be as well, and then, and only then, assuming the maintenance of a very substantial balance sheet, should dividends (Type 4) be paid out...

As a rule of thumb, I assume that Type 3 investments will not be made until the business is generating a million or more of Net Income per year, has built tremendous demand for its equity in the capital markets, is fully capitalized, and is executing buybacks…

The hurdle rate of Type 3-A investments is even harder to computer than Type 1 investments, as there is more uncertainty involved and longer timelines. The hurdle rate of Type 3 B-E investments, however, are easier to compute, and can be approached through the same framework that your external investors approach your business through… “Does this investment return more than my capital could receive in the stock market?” The key difference, however, is that you are EMPIRE BUILDING, looking for ways to leverage your strategic advantages, ways to recycle your TALENT and not just your capital, etc.

Turning Competitive Risk On Its Head: “On Defensibility”…

19th century entrepreneurs that insisted on building businesses un-leveraged by capital or technology competed themselves to death, or were consolidated by the capital-driven markets of the 20th century… .

By a similar strategic irony, most of the 21st century CEOs that insist on the unreconstructed VC-playbook of the 20th century First Enlightenment will compete and dilute themselves to death… How do they escape mutually assured destruction in a capital-driven arms race? To escape MAD game-theory, they’ll have to out-Elon Elon: go after increasingly difficult problems while promising increasingly lucrative payoffs…

Because there are so few Second Enlightenment captains, the competitive risk they face is just inherently low, simply because they think so differently.

What is difficult about building a company like this is that it cannot be formulaic, for the same reason that it cannot be replicated. Venture Capital has turned into a full-blown industrial complex, accelerators like Y-Combinator, countless books, VC blog-posts, tech conferences and buzz-words are proof-of-formula

Thiel, Machiavelli of our age, is wise in advising that “competition is for losers.” But the true winners not only avoid competition in every way they can, only to squander that decisive advantage by getting lazy… they compete against themselves, driving themselves onwards to greatness, striving to be better in every way. Gradually, as their core advantages compound, they may grow bored of non-competition, and seek out competition in areas adjacent to their core advantage… Through striving with competitors, defeating them, and capturing these markets, they grow even stronger… Until, at last, they may seek out competition simply in order to lose… By a paradoxical logic, to be defeated, “decisively, by constantly greater beings…” is the surest path to greatness…

This is the Defensible Strategy of Simply Being The Best In The World.

First, consider the misaligned incentives of those asking the defensibility question…

Granted, I know that I am not yet defensible at all points… Granted, that I don’t really know what other companies are doing… Granted that I don’t have enough time to research my competitors or my customers and their markets… Granted, that I don’t know the secret counsels and hidden designs of my competitors… Granted, I could wake up tomorrow to news of an enemy product-launch, a direct competitor emerging from stealth after raising millions, a market collapse, a churned customer, a departed team member, a withdrawn investor, a lawsuit, and all manner of the calamities of war!

Granted.

Be WARY of all who use FEAR to their advantage… Competitive fear is INFINITE, and so justifies the raising of infinite capital!

Know myself, know my enemy. But first, know myself.

What do I know that I know?

I know that even at a $5M EOY run-rate, I don’t own even 0.01% of the market… The market is infinite… The only market comparable to the labor market is the capital market…

I know that I am breaking all the rules… With each rule broken, I have increased the risk of copying me, increased the distance between me and my competitors, and I know that they will not begin to copy me until it is too late, and I know that even when they do, it will be as difficult for them as it was for me, if not more, and I know that customers know the difference between an original and a copy, and I know that by the time they catch up to where I am now, I will be long gone…

I know that, because of the way I am approaching the market, although another CEO might beat me to a point solution, I have optimized for systematically attacking the whole…

I know what I and my battle-hardened team are capable of, and I know that we can and will adapt to all circumstances… and I know that, given the vastness of the market, there will always be room to maneuver and differentiate…

What do customers want?

Know the enemy… What do I know about the enemy? Well, I know that any potential enemy will be operating within this market, and I know something important about this market.

The main thing I understand about this market is what the customer wants. For the hundredth time, the customer does not give a FUCK about software (only investors care about that shit): the customer doesn’t want tools, the customer wants SOLUTIONS!!! And not just solutions to one little problem, but solutions in general: the customer will always naturally prefer horizontal over vertical (although she’ll never think in those terms), as long as the solutions work and are affordable, because one solution is easier than many. But the customer doesn’t want weak or partial solutions that require her or her team to do more work, the customer wants power, wants full end-to-end solutions, indeed, wants more than software-alone can ever provide, so we need to be the best at human-in-the-loop solutions on the back-end, so that we can handle increasingly complex work on the back-end, while keeping the customer’s reality on the front-end stupidly simple, as the message always boils down to two words: problem. solved.

Strategically this gives me the signal I need to keep optimizing my risk profile: if we double, triple and quadruple down on what buyers want, we will be increasingly defensible. This is similar to the insight that Steve Jobs had with Apple. All of the computer hardware and software companies were focused on the wrong things. They were optimizing for enterprise customers and power users, selling metrics like processor speed… Jobs focused on user experience… There’s no metric for user experience, which makes it hard, but once you’ve nailed it, that is precisely what makes it defensible…

User experience and quality are synonyms. That company will triumph that obsesses the most about quality… “Quality is the best business model.”

Focus on what buyers want.

What does your team want?

Know the enemy… Well, who is the enemy, in this case? Not necessarily our competitors. Indeed, translating the military metaphor to business requires creativity… “The enemy” is “the landscape” which means all market factors, everything external to you, including your buyers and your team. That’s right, if you know what customers want, then you “know your enemy.” In the same way, if you know what your team wants, then you “know your enemy,” in the Sun Tzu sense, so “you need not fear the result of a hundred battles…”

When deciding strategic questions, I ask myself questions like this… What do your team want: venture-backing or profitability? Then I make decisions on that basis. By designing a whole corporate strategy around what is best for my partners, not just my investors, I have made the company more defensible… Even TIME is my “enemy,” but it is now less likely that time will steal away my team… The more powerfully we align and incentivize the team, the less likely that a competitor will be able to attract or motivate talent as much as us…

Focus on internal incentives and alignment…

What does The Sovereign Will of the company want?

Know yourself… “Yourself” is not just “you” the captain of the ship, the general, the CEO… or “you,” your brave crew, your loyal team, your team… It is the “you” of the company itself, which has its own emergent identity, existence, and destiny.

Allow it to unfold its logos, ethos and mythos… Play to its Grand Strategic strengths

For example, a team incentivized by equity and profits might stick together longer, innovate more, take more and more intelligent risks, make better decisions, and build an empire instead of just one idea…

For example, a team of contrarians that maximizes alignment while minimizing agreement might, through debates, stumble upon breakthrough insights that more conformist teams missed…

For example, a smaller team of generalists might be more agile and adaptive than a much larger and better resourced team…

For example, an operations-as-a-service company could naturally evolve into an engineering-as-a-service company…

If you listen to the tao of your company, it will whisper the strategy that can’t be written…

The Sovereign Will wants a strong balance sheet and profitability, because TIME, above all, guarantees survival and survival, above all, guarantees long-term thriving... Buying profits buys time, over and over again, more and more time, more time to think, more time to plot, more time to scheme, more time to invent, more time to tinker, more time to experiment, more time to analyze, more time to research, more time to network, more time to code… Time is more precious than capital, time is undervalued…

Don’t lose sight of grand strategy…

Design inherent network effects into the product… For example, the more delegations we do, the more price data we have… The more a client uses it the better it gets… There are a dozen or more listed here

So much VC ink has been spilled on this topic I won’t focus on it. Granted, they are extraordinarily powerful and should be maximized. But what I don’t like about it is that network effects are a “mechanistic savior”: the fallacy is that if you just build this or that network effect into your product, you win, billions, now and forever, by definition. While that may be the case in some situations, it does not encompass the whole of strategy, and begs the question of how… Network effects can take so many unconventional forms. The network effect of the interoperability of Apple products is different than the network effect of Facebook users…

Read better books and generate more ideas than anyone else… By the logic of the Lindy Effect, dead people know more than living people… And by the logic of “effort over time… the most powerful formula known to man,” the more practice you give to creativity, the more systematically you go about it, the more you build and use technology to enhance it, the more creative you will become… The most creative team comes up with solutions to all of its problems faster than the other teams…

Be contrarian. It’s the ultimate competitive advantage.

Question dogmas. Build contrarian principles into your business model. Do not underestimate a series of subtle but subversive premises. Automation companies are unlikely to break these rules, until it’s too late, and even then…

Sell something nobody is selling, and that nobody can sell until everybody changes their mind… because markets are network-effect phenomena, once an opinion captures groupthink, confirmation bias takes over, and nobody can change their mind until everybody changes their mind, because even if you change your private opinion, you cannot advance your new contrarian position as a serious market proposal without suffering some economic and social penalty. Everybody won’t change their mind until you’ve proven them wrong, so you can safely innovate until it’s too late…

Sell to the contrarian in others… Groupthink exists because of majorities, and is not mutually exclusive with individualism. That is, it is possible for each individual in a group exhibiting groupthink to hate groupthink. Indeed, that is what we are witnessing now: most people are aware of political polarization and the tribal signaling and confirmation bias that results from that, and they don’t like it, but they are too busy pointing out the speck in their neighbor’s eye… Or, they are in a captured market, where even if they disagree with the group, they cannot do so publicly or materially, due to penalties… If you give people permission to disagree with the world in more ways, while turning it to their advantage… they will love you for it, because you are restoring their identity to them, and letting them rediscover and recover their individualism. This applies to marketing, selling, hiring, fundraising…

Stand for something that nobody else is standing for… For example, everybody thinks that AI is inevitable, dangerous and requires socialism to save us… But I think they’re wrong: we’re not automating fast enough, automation creates abundance, the Wand will never replace the Wizard, and we need more technology, individualism and liberty to express our full potential.

Do something really difficult… All the greats have this in common, although Musk perhaps takes the prize for having the greatest death-wish… “One must become insane and desperate to die… ten men cannot stand against such a man!”… For example, try to build an Invisible Assistant to be a single touch point for receiving and delivering unlimited delegations… powered by a Digital Assembly Line to source, interview, hire, train, manage, coordinate, manage and pay workers… and a Process Builder to measure, organize and automate work… With the end goals of employing 70% of the world, automating 41% of knowledge work, while spawning three revolutions: an entrepreneurial-capitalist revolution, a creativity-productivity-organization revolution, and a capitalist-worker’s revolution… This entire space, the whole business concept, was either so ambitious that people said it couldn’t be done, or so subtle that people questioned whether I was innovating at all…

Huge, undiscovered opportunities to build difficult and value companies exist all around us… And if you and your team have the minds of strategists, the hearts of warriors, and the smiles of children… nobody can stop you.

Fuck competition. Competition is fake news.

A New Land

Solvitur Ambulando. Words end. Theory limits. The test is actually doing it. I have used words to remove theoretical blockers… And I will keep using words when I find new ones… Now I make myself a prophet or a liar.

The bridge must be crossed, first in the mind, but then in the body… To do a backflip, you must first, do a backflip. The paradox is solved by walking.

America is “The New World,” “The Home of The Free” and “The Land of The Brave.” I confess that I struggle to look upon Her as new… That I have lost the Hope of her dawn and beginning… That I question whether she still has that spirit of daring adventure and enterprise, that spirit of fierce independence, with which she made her name upon the earth…

Return, let us return, to Homer and Virgil, the virility which birthed our striving civilization… Achilles, who triumphed over all the others before competition destroyed him, Aeneas who fled and overcame and out-manuevered to claim a new land…

Much have I travell’d in the realms of gold,
And many goodly states and kingdoms seen;
Round many western islands have I been
Which bards in fealty to Apollo hold.
Oft of one wide expanse had I been told
That deep-brow’d Homer ruled as his demesne;
Yet did I never breathe its pure serene
Till I heard Chapman speak out loud and bold:
Then felt I like some watcher of the skies
When a new planet swims into his ken;
Or like stout Cortez when with eagle eyes
He star’d at the Pacific — and all his men
Look’d at each other with a wild surmise —

Silent, upon a peak in Darien.

If any man obeys the gods, they listen to him also.

And all Olympus was shaken!!!

Now always be the BEST, my boy, the BRAVEST,
and hold your head up high above the others.

Life and death are balanced, as it were, on the edge of a razor.

Once a thing has been done, the fool sees it.

The great line of the centuries begins anew.

Your descendants shall gather your fruits.

Look with favor upon a bold beginning.

Practice and thought might gradually forge many an art.

Toil conquered the world, unrelenting toil, and want that pinches when life is hard.

Blessed is he who has been able to win knowledge of the causes of things.

Endure, and keep yourselves for days of happiness.

Yield not to misfortunes, but advance all the more boldly against them.

Long is the way
And hard, that out of Hell leads up to Light.

Ye realms, yet unrevealed to human sight…

I will teach you your destiny.

A greater history opens before my eyes,
A greater task awaits me.

Fate will find a way.

Fear is the proof of a degenerate mind.

They can, because they think they can.

Audentes fortuna iuvat.

Mind moves matter.

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