The important business skill in life

Published on May 12, 2013 in Entrepreneurship, with 0 Comments. Tags: , , , .

I believe there is one true lesson that matters for anyone running a business in whatever space you find yourself in. A skill that if you learn the manage techniques in executing them, are transferrable to any business. Thee core concept is called “working capital”, and although they teach this as a basic accounting concept — the meaning of it is not something you can learn, but simply feel have to feel as a CEO founder.

Have you ever had to worry about not being able to pay payroll next month? Have you ever had to raise financing to *continue* (not start) the operations of your business? That’s what I call the working capital burn. And while the tech press is littered with “acquisitions”, the truth of the matter is that the majority of businesses that get acquired knew their future was limited and/or their working capital was running out. An acquisition is a failure in the ability (which may also mean fatigue, not just lack of skill) for an entrepreneur to expand their working capital.

Working capital is a deep concept that incorporates a lot of skills in order for it to successful function. It means fundraising and revenue; it means cost control and hiring. Working capital management is one of the three core functions any CEO — big or small business — that s/he needs to be responsible for outside of setting the strategy and building the team. But the truth is, it’s something everyone in the businesses needs to be responsible for — it’s just the CEO is the only person who has a true picture of the operations.

One of the sad things about the recent financial crisis that has had many economies go into deep recession, is that thousands of businesses went bankrupt despite existing for many decades in some cases. And the reason, was because the banks stopped lending when even $20k may have been enough to boost the working capital of an existing business to continue its operations. Because you see, working capital is not something you solve once you graduate from being a startup — it’s the thing you need to think about from the first day of starting the business and the last day of ending the business.

When I hear of a CEO who is hiring staff faster than the revenue growth of the business, I shake my head. When I hear of a person giving me advice on how to run my business about investing the businesses’s cash in a certain direction despite more short-term challenges being apparent — I dismiss them because they clearly have never had to *feel* the stress of the working capital burn. When I have people claim “profit” is bad even in non-profit organisations, I can only put my hands up in despair because they don’t understand that business has costs — many of them indirect — which you need to always be thinking about and building up the cash reserves on seemingly unrelated activities.

The working capital burn is a thing that all entrepreneurs that have experienced can relate to, and why they can connect despite decades between them in age and a world of difference in terms of what business they work on. And I have to admit, despite my six years of tertiary education and three years work experience to become a chartered accountant where working capital was just one of many accounting concepts I had to learn; it wasn’t until I started my own business that I *felt* the working capital burn and really understood it. Which is why before I can trust anyone in a position of authority for a business I run or a business I invest in, I look to see if they not only get working capital, but if they’ve felt the working capital burn before.

Why entrepreneurs need to say “fuck you”

Published on May 12, 2013 in Entrepreneurship, with 0 Comments. Tags: , , , , , .

One of the StartupBus teams this year was interviewed by Y-combinator. They were turned down. Why? According to the team, it was because they were not a billion dollar company. This is something I’ve warned StartupBus teams before when they pitch investors so it doesn’t surprise me. But there’s a lesson here that I hope all entrepreneurs understand.

Professional investors are in the game to make money. Their motivation is to generate a multiple on the fund they have raised.

Why is that a problem you may ask?

Well, who cares if a company makes a billion dollars? Apparently from sounding cool that you built something like that up, as a founder, you will be so diluted through multiple rounds of funding that you will probably have a 5- 30% equity stake in the business, depending on how capital intensive the business is and how many co-founders you have.

A VC however, not only makes money on a billion dollar exit, but they get to brag about it to limited partners and to attract new entrepreneurs, which helps them raise new funds and get new deals. The way it works in venture capital is that it is all about the brand and communicating your successes. Any investor that doesn’t admit to not knowing what they are doing are full of shit. Because billion dollar exits come in two forms: entrepreneurs who successfully played a game to  take advantage of the current market (ie, an acquisition today that had it not happened may not have become a sustainable business) or fundamentally disruptive businesses that no one saw coming. I can think of many examples of the above, but I’ll hold back as my knowledge of various companies are not mean to be public  – however, all that matters is the point that billion dollar exits are either due to a confluence of market factors or a fundamentally disruptive business model. You can’t predict for that. Which is why the safest strategy, as an investor, is to back a proven entrepreneur who knows how to make opportunities like that happen.

While investors look for the 15 deals that generates 96% of the returns in a year, let’s bring this back to the entrepreneur only making $300m. Put another way, a billion dollar business is more like a $300m business for you financially speaking (assuming you have 30% of the entity, a best case scenario). But if you are a $300m business pitching a VC, you probably won’t meet the investors cost of capital (ie, their fund is $300m+) and so therefore they don’t get the returns to justify their capital. Putting that into context, a billion dollar startup that a founder has a 30% equity stake in and a $333m startup that a founder has a 90% equity stake in — is, financially speaking, the same. And what I mean by that, is the people who will make that “billion” dollars (the founders) will need to work three times harder for the same return…meaning by raising financing, the market problem that needs to be serviced needs to be three timeS bigger so that people sitting in the backseat (the investors) make just as much money out of it.

Which means absolutely nothing about the problem you are solving in the world. The fact the entire silicon valley ecosystem is influenced by the investor industry, at a time when the costs of doing a startup have dropped dramatically – is a misalignment that will change one day.

If an investor says your business isn’t biggest enough, it means 20% of your hard work isn’t high enough to meet their capital hurdle of providing a certain return to their limited partners which will impact the investors future fundraising. And sadly, this fact is lost on a lot of entrepreneurs who feel they need a sense of validation despite having identified a real market problem. Which ironically, I think is what separates the true disruptive entrepreneurs from the rest. They are the ones that say “fuck you, I’m going to make this work”. And they end up disapproving the assumptions the investors falsely asserted when rejecting the teams’ vision because fundamentally disruptive businesses are never obvious from the outset.

Bitcoin makes sense for the future

Published on April 14, 2013 in payments, with 2 Comments. Tags: , , , .

Bitcoin fascinates me. Whether it’s the future of currency itself I don’t know, but it will pave the way for the future so it’s worth studying.

There are two reasons that people claim make Bitcoin flawed.

The first is that it’s based on ECDSA (Elliptic Curve Digital Signature Algorithm) which consists of a private key (a secret number known only to the person that generated it), a public key (a number that corresponds to a private key which is calculated from the private key but that is very difficult with current computing to reverse engineer to predict a private key), and a signature (a number that proves an operation took place that  used a hash and the private key). Values can be determined without the private key ever being disclosed, so that a bitcoin can correspond to a public ledger to prove the authenticited of ownership — for example, an algorithm can determine with the public key on a signature to determine it was produced by a hash and the private key, without needing to know the private key.

And so the critique goes, if someone can build a sufficiently powerful quantum computer, Shor’s algorithm will enable someone to steal bitcoin’s at will as they can crack the secret of someone’s private key. But basically, it’s practically impossible for this to happen. I’m not crypto expert, but I’ll leave this for others to digest further.

The second critique is due to the known limitation that bitcoin will one day cap at 21 million units. If bitcoins go missing, we will never be able to replace them — such is the case with physical currency today which goes out of circulation (but a central authority issuing it can reprint them). And inherently, Bitcoin is considered to be deflationary — the problem with deflation is the decreased price level of goods and services. Meaning, because it’s got a future guaranteed scarcity it will get scarcer and lead to deflation so therefore it’s doomed.

This is what I want to explore further because it’s worth clarifying some fundamental assumptions about the world.

What is value?
Let’s start with a functional definition of value. “Value is energy applied to resources where the perceived utility of the output is more than the inputs.” That definition implies there are three sources of value in the world: energy, resources, and outputs that have used the application of energy on resources and becomes a transformation. And the utility of a transformation, is different from say energy and the resources that went into it, simply due to perception of it. Basically, value is at core about utility.

Resources are finite: we only have a limited amount on earth that we can use. And most of it is not usable, as we don’t have the capacity to extract the resources in a usable way. Energy on the other hand, by the human definition, is unlimited — the sun sends 1.KW for every square metre of the earth surface for free. But what limits energy is the ability to capture it, store it and transport it — so therefore energy has value. We need energy to function: animal and plant life need it to function, and we need it to extract resources as well as apply it to transform resource into new products.

Is energy in itself valuable? Well, only if we use it: if a plant sits in the sun, it’s free — as does a human who will get Vitamin D that helps it function. Just because it’s free though doesn’t mean it doesn’t have value: it’s just the price is low. Humans also need other vitamins to survive, and it requires the expenditure of energy to acquire future sources of energy — that energy could be valued as time to hunt down animals for example.

Do resources have value? If it’s utilised, it has value — and the more it’s used, the scarcer it becomes for other uses which is why it gets regulated by price when there are competing seekers of the resource. Like energy, the question isn’t if there is value: the issue is what is the price of that value. It’s how to price that utility to regulate its usage.

Theoretically, you could say the current available energy in the world that can be used and the current available resources are what is value in the world, as well as the products created through the transformation of resources with energy. Value is what the total utility in the world is. And if there are no competing uses of those pieces of value, then prices are practically nil: but once there is competing needs for limited pieces of value like resources, that’s when we see the price increase.

And that is, why fundamentally, all value is tied to scarcity: the scarcer the value (supply) and the higher the demand, the higher the price.  This is fundamental economic theory which is the study of how to best allocate limited resources in an world that is based on the assumption of unlimited wants — which theoretically, makes sense. What breaks down is that interpretation of the theory.

For example, it’s fine to say there are unlimited wants in the world — but that’s a assumption that says there will always be competing demands for resources so therefore everything needs a price. Which again, is fine: it’s just this assumption of an assumption needs to assume a more fundamental assumption: a price of zero doesn’t make something less valuable than the same resource which has a price of more than zero. If you can buy a diamond for $1 but it normally would be valued $1000, that doesn’t mean it’s less valuable fundamentally: it just has less competition and so therefore less cost to acquire.

What is currency?
Arguably, you could say the sum of value in the world is all the stored energy, available resources, and transformations in the world which has utility. The world’s currency system should be tied to that: if you could exchange all the value in the world, it should be equal that.

Currency should be a way to store value and transport it. The energy I applied with my time which created more perceived value than the energy itself in the form of knowledge,  I want to store for a future use where I can exchange that for something of similar value. Therefore, a currency needs to have a consistent form of pricing (to make value comparable) and it ideally has a stable means of being valued (ie, storing it a year ago should theoretically be valued as the same as storing it today).

But the hard thing about utility  is that it’s hard to measure at the one point in time –even though we know there is a fundamental fixed amount that can be used in the world. But that’s why the assumption that a currency should have a fixed supply makes perfect sense: the price mechanism of currency adjusts for changes in utility (assuming the supply of currency doesn’t degrade, which is another factor why modern day currency can adjust in value).

Bitcoin’s fixed supply
Which brings us to the question: does Bitcoin having a fixed supply make sense? Yes.

But what about the risk of “deflation” in the world due to a fixed supply? Well, it’s not that value in the world goes does — it’s just the pricing of that value might go down.

The above discussion I hope answers those questions.

And what about if there are missing bitcoin’s in the world, which creates a supply constraint on this new currency? Bitcoin’s are divisible up to 8 decimal places which means one bitcoin has 100 million components (yes, they have a name: called a “Satoshi”). Ignoring the clear economic incentive to not lose Bitcoin’s, lost coins get lost in the noise and this divisibility allows it to adapt. With 21 million final bitcoin’s divisible by 100 million, that means 2.1 quadrillion units of currency or Satoshi’s. To put that in comparison, in 2009 there was approximately 8.3 trillion US dollars in the world or 0.0083 quadrillion cents. If one cent was one Satoshi, that would be 2100 trillion US cents or 21 trillion US dollars.

Some say the value of the US economy to be 188 trillion dollars (different from GDP, which simply accounts for   spending in one year). Assuming the US economy in 2009 accounted for one quarter fo the world economy (based on GDP), we can assume the world has a price on the value in the world of about 750 trillion US dollars or 0.8 quandrillion.

If the total *value* of available Satoshi’s in the world one day equals that amount (One Satoshi equals 0.35714285714 US cents  or 750 trillion divided by 2.1 quadrillion) — then who cares if a few bitcoin’s get lost along the way. What we have now is a currency that does what currency is meant to do: store value for the exchange of value in society.