Alex Danco’s article on debt from a few weeks ago made a lot of rounds. I’ve finally read it and I’m using this post as a way of summarizing some notes on the topic.
This post starts by exploring the relationship between financial capital, or FK (money used for investments like equity) and production capital, or PK (money used for producing real goods and services).
There’s a recurring dynamic of how FK and PK perceive each other and work with one another. Jerry Neumann’s explanation is good: “My long-ago operations research textbook had a cartoon showing one MBA talking to another: ‘Things? I didn’t come here to learn how to make things, I came here to learn how to make money.’ This is the view of financial capital. The view of production capital is exemplified by Peter Drucker: ‘Securities analysts believe that companies make money. Companies make shoes.’”
FK is deployed into companies that use it for PK. In early stage of any technology where potential is unknown, venture capital is the prevailing model to follow here. A small number of those deployed bets will produce outsized returns.
The new technology is exciting, and the market opportunities are large but unknown. Speculative investment, with ambitious but inexact expectations of financial return, is important fuel for founders who build the unknown future. However, investors and operators are often deeply misaligned: investors think in bets, while operators think in consequences. The relationship is tense, but can be explosively productive. The VC model is an institutional expression of this tension.
When technology is widely adopted and then becomes a part of everyday fabric of society, it becomes easier to predict how that technology will be adopted. Therefore, FK can be deployed with an more predictable outcome. VC is not the appropriate model here - but venture debt definitely is.
The overall bet may still be speculative, but the median VC dollar isn’t anymore. It’s buying customer acquisition and then financing service delivery.
This change will start to occur in areas where technology has entered the “deployment phase” - i.e. mobile. And for founders building those companies, they should consider more options for financing other than VC.
If you’re a tech founder raising capital today, there’s really one mainstream way to fund it: by selling equity. The VC model capital stack, which the Silicon Valley venture ecosystem has optimized itself around, is the one-size-fits-all funding model for startups of all shapes and sizes. We know it like muscle memory at this point. If your career began after the dot com crash, as mine and I’m sure many of yours did, you’ve probably never known any other way.