Capital Reigns Supreme.
That’s a unanimously held belief in the business world. Whether we’re discussing underdeveloped states, a developing economy, or a developed system – capital reigns supreme.
In the business world, the significance of capital is such that around 80% of a venture’s share goes to the investor while 20% goes to the active partner. That’s the norm of the industry.
But the startup world is where norms get challenged. In the startup world, it is the founders who get 80% while 20% goes to the investor.
But why? And most importantly, what does that mean?
In this post, we address the reason why there’s a difference between the two approaches. It’s an underlying philosophy that will change the perspective of founders who approach startups as yet another business opportunity.
The Role of Financial Capital & Founder Capital In A Startup
A startup needs two types of capital for its sustenance.
The first one is financial capital. It’s the fuel that is required to keep the startup going and pay the salaries, clear the bills, etc. It provides every person in the startup with just enough so that they can show up every day.
But what will it take to truly inspire them? What will motivate them to move in a specific direction and achieve well-defined milestones that lead to the ultimate goal?
In the startup world, all of these objectives are out of financial capital’s league. This is where Founder Capital comes into play.
A founder is someone who inspires people and motivates them, has enough technical skills to solve complications along the way, and helps the company expand its value by 1% each day.
That’s precisely why a startup founder is not just another businessman.
Instead, founders are a delicate, very well-balanced composition of domain and technology knowledge, leadership, recruitment skills, the ability to develop a product vision, and the ability to take it through to MVP and to product-market-fit.
All of those qualities (and beyond) combine to make founder capital. Without it, financial capital gets wasted and goes down the drain because it’s not wisely utilized.
Founder Capital ff Experienced VS First-Time Founders, Investors’ Expectations, & The Challenge
Think of a founder as someone steering a ship.
And as the one steering the ship, one automatically takes on responsibility for one’s own safety as well as for the safety of others. One takes on the responsibility of making it to the shore.
But if there’s any difference between this analogy and actually running a startup, it’s that the latter requires more sophistication, balance, and precision.
By utilizing their human capital, founders steer the ship with precision and reach the shore of financial success. And by the time it becomes successful, it has proven to be a functional one. Most of all, it has proven to be scalable and repeatable.
Moreover, it has also offered a learning and growth-oriented experience to every person on board. Some of them learned how to cruise a ship in the highs and the lows while others learned how to best do their part in other areas.
Finally, the ship has proven to be of greater use. It’s of use to the people on board and to the people on the shore – who are now willing to pay in order to cruise it. Thus, its value has increased, independently.
Its value has also increased in comparison to its counterparts – the ones that were supplied and supported with resources and were moving on the waters. Some stayed afloat but were directionless, while others started to sink midway. Perhaps that had something to do with the captain?
Now imagine a captain who perfectly steers a ship enough times and makes it to shore, not once, not twice, but most of the time – though it was hard enough to do it the first time alone. That means that the captain (the founder) had the right skillset. Simply put, they had Founder Capital.
But what about the other ships that sank or strayed away aimlessly?
They had enough financial capital to get built, but not enough Founder Capital to make it to the shore of financial success. That’s exactly what goes wrong with most startup founders who are starting out for the first time.
They manage to peacock their way in and arrange the funds. But they don’t have any Founder Capital.
Fresh founders, like experienced founders, need funding. But whether it’s an angel or a human investor, no one simply gives the money away without establishing some trust in the credibility of the founder – and that’s just the tip of the iceberg.
Now let’s look at where the bottom of the iceberg begins: experienced founders have a legit background and the right skills. On the other hand, fresh founders make up a legit-looking list of industry contributions that has little to do with reality. It’s a vain attempt.
Given that landscape, it’s only logical (and easy) to understand why founders and investors believe financial capital to be the only differentiator – even in the startup world.
Investors contribute to this fallacy when they expect first-time founders to drive the value expansion by 400X. But how is that possible if the founder has peacock-ed their way in? They are truly first-time founders with barely any Founder Capital at all.
The Optimum Strategy that Empowers First-Time Founders & Justifies the Financial Capital
So on the one hand, investors need a seasoned individual who has enough experience and skills to be trusted with the investment.
On the other hand, this creates a ‘chicken and an egg’ problem for founders: in order to become experienced founders and develop Founder Capital, they need investors to fund their startups. But to get the investment, they need experience.
This creates a dire need for an optimum solution.
Now let’s imagine if the fresh founder is accompanied by an experienced founder with the right skillset. That would achieve the following goals:
- Minimize the risk of wasting away the funds.
- Give investors the confidence needed to trust those founders with their financial capital.
- Actually improving the skills of the fresh, first-time founders, and helping them develop robust Founder Capital.
ScaleX believes in this optimum strategy, where first-time founders partner up with the missing piece of the puzzle, the potential source of the Founder Capital: a serial founder.
Serial founders are experts at starting, growing, and scaling startups, while first-time founders are motivated and bring over-the-top energy levels and learning potential to the table.
Serial founders complement the freshies in the strategic aspects and decision-making of the business, thus increasing their Founder Capital as well. When experience and expertise meet high energy levels, they give enough of a reason for investors to trust the founder and invest their money.
On the contrary, when an inexperienced founder, someone who lacks Founder Capital, manages to raise a $1M fund, what do you think happens next?
While this discussion can head in tens of different directions in hypothesis, what actually happens is 80% of that capital goes to waste.
80% of the financial capital goes to the gutter because the first-time founder uses the resources to learn from their mistakes. Couple that with 25-30 iterations, and $800,000 of the $1M are gone.
That’s a major capital efficiency problem because of the lack of Founder Capital.
To prevent that from happening, startup founders opt for general, cookie-cutter advisory programs and mentorship arrangements, which, to be honest, are not effective.
Instead, deep, tailor-made engagement by an experienced founder with the first-time founder will be effectively able to save 40% of that $1M.
In the startup world, the investor’s share is around 20% while the founder, the team, and the previous shareholders get 80% share.
While that might appear as yet another business opportunity, the reality is the complete opposite. If that reality and the underlying philosophy is properly understood, the frequency of startup failures will go down drastically.
The reason 80% goes to the founder and the team is because of the value that the founder brings to the table. Their immense effort is the main driver of the value expansion of the startup. Thus, a startup is just as good as its founder.