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Financing Businesses in the 21st Century
European Straits #42
My cofounder and CEO of The Family, Alice Zagury, was asked by the French government to draft a report on financing businesses in today’s economy—along with Jean-Noël Barrot, a member of Parliament (and a professor at the MIT Sloan School of Management!).
Financing businesses is a topic on which people like Alice, who work with entrepreneurs on a day-to-day basis, have a lot to contribute. Indeed a cornerstone of The Family’s strategy has always been our view of how entrepreneurial ventures should be funded in the digital age. I’d sum it up in four short theses:
Launching a startup has undergone a radical commoditization, mostly due to cheaper technology. As startup capital costs fall at the earlier stages, there are more entrepreneurs willing to launch startups—and less need for angel investors.
Just as startups multiply, we’re transitioning from the predictable (Newtonian mechanics) to the unpredictable (quantum mechanics). And the best weapon to survive as an investor in an unpredictable world is not to crunch more data; rather it is to look for singularity.
Investing cash early invites selection based on signal: it leads to tense discussions, a premature elimination process, and overlooking singularity. Conversely, providing an infrastructure like ours triggers a different dynamics: it enables emergence and, over time, reveals value.
Once value is accounted for with hard data, capital turns into a commodity. Thus to participate in the best deals, financiers have to make a difference by providing additional value. This is where we’re better positioned: at this point, future winners are already part of The Family :-)
In line with this vision, here are a few ideas that I think policymakers should bear in mind when it comes to financing businesses in the 21st century:
‘Small Businesses’ is not a homogeneous category anymore. There are the service businesses that don’t grow, like mom-and-pop restaurants, barbershops, and plumbers. There are the industrial businesses that grow, albeit with diminishing returns, like car parts manufacturers. And then there are the startups, which as put by Paul Graham are “designed to grow fast”—with increasing returns to scale. Obviously the financing needs of these three categories of small businesses are not the same. Yet governments have a hard time telling the difference, as reminded in this article: Why Washington has it wrong about small business.
Financing is an industry like any other—ripe for radical change. And like in every industry undergoing its own transition, dominant players are subject to the consecutive stages of denial. First they think they’re not concerned. Then they think they're innovating, too. Then they lobby the government to make it more difficult for startups to enter their realm. And then they start to consolidate so as to reach critical mass and supposedly regain the power to preserve the status quo. As those of you familiar with our framework know, being in denial doesn’t mean that change has been stopped. It means that you’re probably not a part of it.
The digital transition impacts industries more than individual companies. That doesn’t mean incumbents don’t have to change. What it means is that reacting to the transition is more about strategic positioning (strategy) than transforming one’s organization (operations). Based on industries where the transition has already advanced, the best strategic positions in the digital economy are at the extremities of the new value chain. Those who win are way down the value chain, serving the end users, or way up, where it’s about extracting and providing essential resources. This is why future winners in the financing industry are (i) those working directly with entrepreneurs from the earlier stage (yes, like The Family) and (ii) large institutional investors—which, by the way, are already taking the initiative in repositioning.
All in all redesigning financing is about the digital transition. Shifting to a new techno-economic paradigm is making the ‘small businesses’ category more diverse. It is confronting the financing industry with its own repositioning challenges. And it will lead to the emergence of a new breed of dominant players: not today’s asset managers, which are (badly) positioned in the middle of the value chain, but rather large, global ‘super funds’ that are already working at repositioning further down the value chain, as well as early stage players that own a trusted relationship with entrepreneurs.
In the meantime, we’re stuck in a frustrating situation, where the new categories don’t fit in the box. No wonder why there’s this major misallocation problem known as the “global savings glut”!
If you want to read more about all this, here are two sources:
An article by Stanford’s Dr. Ashby Monk, who advises the CIO of the University of California $103B fund: Where Is the "Funders Fund" for Venture Capital?
The Family’s (very long) secret master plan, by my cofounder Oussama Ammar and me: The New Berkshire Hathaway You Haven’t Noticed (Yet)
Above all, if you have ideas on business regulations and financing, please contribute to Alice and Jean-Noël's work here: On a Mission: Financing French Businesses
Warm regards (from Paris, France),