Capital Efficiency Heroes
Scaling any startup is exceedingly difficult.
For most, there is glory in raising large sums to go after huge market opportunities. A visionary founder looking to “blitzscale” needs a sizable amount of VC capital to accelerate growth. Such a founder and business plan cannot rely on internally generated cash flows, self-funding, or even modest sums from 3rd-party investors.
That said, the stories and courage of founders who took on zero or modest amounts of outside capital usually get lost in the headlines. My goal with this piece is to call more attention to what I call Capital Efficiency Heroes.
How do Capital Efficiency Heroes differ from other startups?
Each year, ~2 million new businesses are formed that have indicated an intent to make hires.1 I classify these 2 million businesses in the following 4 buckets:
Bucket #1: Business models with traditional / proven products or services in traditional industries that are self-funded by their founders and potentially SBA loans / other debt. Examples are:
real estate brokers
general contractors
restaurants
trucking
legal / accounting / tax advice
Bucket #2a: Business models with novel products or services in traditional industries that require a **modest** amount of funding by 3rd-party equity investors. Capital Efficiency Heroes often emerge from this bucket. Examples are:
online furniture stores like Wayfair
healthcare services like eClinicalWorks
online used auto businesses like CarGurus
customer data analytics companies like Qualtrics
Bucket #2b: Business models with novel products or services in traditional industries that require a **sizable** amount of funding by 3rd-party investors. Examples are:
mental health platforms like Lyra Health
healthcare services like One Medical
online used auto businesses like Carvana
Bucket #3: Business models with novel products or services in novel industries (at the time of launch) that require a large amount of funding by 3rd-party investors. Examples are:
online services like Facebook or Google
AI builders like OpenAI
electric / self-driving car companies like Tesla
biotech compound developers like Moderna
Headline Grabbers versus Capital Efficiency Heroes
On a unit basis, Bucket 1 is the vast majority of the 2 million new businesses created each year. These businesses are not trying to build a highly differentiated or novel product and typically don’t need much outside capital before earning a profit. I call this bucket the Traditionalists.
On a dollar basis, Buckets 2b and 3 represent the vast majority of the invested capital in new businesses. These companies typically are the ones that make the headlines given the large amounts of capital raised. I call successful companies in these 2 buckets the Headline Grabbers.
Bucket 2a is overlooked by most people who are not professional investors. In this bucket, founders and management teams have opted to do more with less (i.e. even less than the average startup with limited resources). This is where Capital Efficiency Heroes are born.
A tale of two online used auto businesses
Carvana (founded 2012; in bucket #2b) has raised many multiples more than its competitor CarGurus (founded 2006; in bucket #2a). This dynamic was particularly true in their first 5 years post founding, when Carvana raised $300M in equity2 while CarGurus primarily relied on $5M funded by its founder3. Both companies target the similar problem of a highly inefficient used car buying and selling marketplace. The dramatic difference in initial capital raised largely reflects the different business models and ambitions out of the gate.
CarGurus was founded by Langley Steinert, who previously was a Co-Founder of TripAdvisor which sold to IAC/Expedia in 2004. In the early years of CarGurus, Langley iterated on the ideal business model and settled on an asset-light marketplace that matches existing used car dealers with potential buyers or sellers, a model common in the travel industry.
Carvana was founded by Ernie Garcia III, who wanted to more boldly disrupt the used car market by building a vertically integrated online-only dealer. Even in the early days, Carvana actually bought and held used cars on its balance sheet to sell to potential customers, who often never test drove the vehicle before purchasing. This business model required a lot more capital.
Interestingly, both companies went public in 2017 with market capitalizations in the $1.5-2.0 billion range, resulting in fantastic outcomes for their founders and early employees / investors. Since its IPO, Carvana’s highly leveraged model has resulted in tremendous stock volatility — at one point in late 2022, it was down 99% from its peak. CarGurus has been much steadier since its IPO but, as of today (Nov ‘24), it is a fraction of Carvana’s market cap.
Both founders are heroes but I deem Langley Steinert a Capital Efficiency Hero. Relative to a Headline Grabber competitor, Steinert had a much slower start and as of today, a much less valuable company. However, Steinert built an enduring business with a small team, that today has a public market cap of ~$4 billion. CarGurus has generated phenomenal returns on capital for its management team and early investors.
Choose your adventure wisely
Headline Grabbers may also generate exceptional returns for their stakeholders too. There is no single way to build a company and VCs can do better at embracing different growth models.
Part of the reason I like investing at the early-stage (pre-Seed through Series B) in business models with lower loss rates is that I don’t have to underwrite a unicorn or anywhere close to that to “succeed”.
Today, the VC world is appropriately focused on the transformative power of AI (a novel product & industry). Not making major headlines are Capital Efficiency Heroes building a novel consumer product or service (though, perhaps using AI to lower costs even further). That is fine by me. Leave those steady, near-profitable growth models with exceptionally compelling customer value propositions (driving high repeat purchase rates and strong margins) to the dwindling pool of VCs who focus there.
To all those Capital Efficiency Heroes out there building a product or service for the US consumer, please reach out to me to share your story.
In other words, not single-person businesses. Source: US Census Bureau.