Incredibly Efficient Way to Build a Company

Posted: May 11, 2012 12:01 AM

Back in 2000, if you wanted to build an internet start up company, you had to raise a bunch of capital. There were servers to buy, and talent to procure. Fast forward twelve years and you will see why so much of the VC world is dislocated and why more people are turning to start ups as a way to work.

Today, if you want to start up a company, you need to rent servers for 30-50 bucks a month. Find a programmer. Between the equity you give up to them, and the pay for them, you burn very little cash. Most programmers are making between 50-80k/yr. Because there is a glut of commercial office space, rent for an office is relatively cheap. Social media tools to publicize your company are basically free, but the talent to maximize their use is not. Early stage companies are amazingly capital efficient.

Test your concept and see if it works. If it does, scale. If not, move on. It’s a simple thesis and in a short time frame you can prove if you have a market or not. If you don’t have a market for your initial idea, and discover it fits somewhere else, you don’t have a lot of sunk costs or fixed overhead, so pivoting to the better potential becomes easier than in past years.

Meanwhile, VCs have raised boatloads of capital from institutions. They aren’t risk takers, but act like bankers. Their goal is only to maximize return for their limited partners. Because of their fund size, they can’t afford to take risks at a lower valuation level-which is where the big ideas reside today. VCs are forced to wait until later rounds of funding.

The void is being filled by super angels, and to some extent angel groups. Super Angels are the 1970's version of VC. They are generally running their own money and can make the smaller bite sized investments that are required to get companies going. Because they have enough money, they can fill up succeeding rounds until the company really has to scale big. Then they knock on VCs doors and empty their coffers.

Viewed in market terms, prices for small firms have gone down over the past several years. Since the price has gone down, we are seeing more of them start up. Demand for them has remained constant, or even increased as corporate America retools. Because prices have gone down, there is a chance to earn a pretty decent return on firms if you invest properly. The problem is, investing in this area is not the expertise of mainstream America.

It is all interesting to watch. Classical Economics works on both a micro and macro scale in the start up world.