25 Nov Capital Formation: A necessary skillset for innovators by Dr. Neeraj Sonalkar
Capital is not money. Capital is energy. And much like energy, capital exists in multiple forms such as human capital, intellectual capital, cultural capital and financial capital. Capital formation is the process of mobilizing different forms of capital and converting it from one form into another to create an exponential value increase. Startup founders who launch unicorns, corporate founders who create new market-leading business initiatives, and entrepreneurs who create significant social impact – all rely on capital formation for their success.
Here is another way of looking at it from the perspective of venture returns.
Innovation returns are highly skewed. A study done by correlation ventures on twenty-one thousand venture deals found that 65% of deals lost money, the next 25% made a return of 1-5X, the next 6% returned 5-10X and the top 4% returned 10X or more. A similar study done by the Kauffman Fellows Program found that the top percentile returned not just >10X but >100X. The difference between the 70th percentile (1-5X) and the 99th percentile (>100X) is staggering.
This 99th percentile ventures do not have a product-market fit or a Go-To-Market strategy that is a 100X better than the ventures at 70th percentile. What they invariably have is a far better capital formation practice.
There exist multiple programs for helping founders find the right product-market fit and develop an effective Go-To-Market strategy. However, rarely if ever do organizations focus on capital formation as a systematic practice. Great accelerators like YC build a 99th percentile network that provides capital formation support leaving founders free to focus on product-market fit. However, even then a lack of appreciation and practice of capital formation can be disastrous for a founder. Simply put…
Innovation Performance = Entrepreneurial Performance X Capital Formation Performance
Our team of venture investors, innovation ecosystem developers and innovation performance researchers at Stanford has begun developing a systematic discipline of capital formation. We model it on energy sciences and incorporate principles based on pragmatic experiences of 99th percentile founders and investors. Learning capital formation is like training to be an elite athlete. It follows a fitness model and not a knowledge acquisition model.
We are using the capital formation power cycle as an organizing framework. Power cycles are thermodynamic process models for converting energy into work. The power cycle shown below converts intent into a network of trusted relationships through which capital can be mobilized.
Intent: The founders and investors who are masters of capital formation show up as highly intentional individuals. Clarity and sharpness of intent enable them to develop a focus that attracts the right form of capital to support their progress. We use several practice frameworks such as Conscious Leadership, SCARF model, psychological flow states, purpose statement and self-assessments such as Enneagram to help founders create an energy map for themselves that highlights what energizes them and what takes away energy. This serves to clarify their intent.
Design: Design involves the act of framing and building an organization that will serve as the container for capital formation. We highlight key organizational design practices that serve to translate intent into an effective organizational culture. We also introduce tools for developing an ecosystem level awareness that enables founders to find a fit with their regional ecosystem’s strengths and tap into the relevant networks. The third piece of design is the business model. This includes the key drivers of growth that founders needs to focus on week to week. This creates the operational discipline within the organization that aligns with intent and organizational culture.
Capital: The next stage is developing an awareness of the different forms of capital that need to be mobilized and the process for mobilizing 99th percentile capital. I have talked about capital as energy. Another way of looking at it is capital as organizational nourishment. Organizations are biological entities and just as a parent might provide different forms of nourishment such as food, discipline, love, independence etc. during different stages of their child’s development into an adult, founders need to provide different forms of capital as their venture scales up. Understanding which form of nourishment to provide when makes all the difference between realizing or missing the organization’s inherent growth potential.
Relationships: Trusted relationships are the pathway for mobilizing 99th percentile capital. High quality talent, intellectual capital or financial capital cannot be simply called upon. It is in high demand and to mobilize it, a founder needs to develop trusted relationships that will enable such capital to be activated. There is no secret framework or a method to develop such a network. It takes showing up with intent, excellence, authenticity, and integrity in your activities and existing relationships. The best we can do is to provide examples of others who have developed such trusted networks so that you can derive the insights that are most meaningful to you. Practicing clear intent, effective design, and capital as nourishment definitely helps in the relationship building.
Ultimately, this is a cycle since it brings us back to clarifying intent and proceeding with the next iteration of intent-design-capital-relationship.
This discipline of capital formation is being developed and codified within the Human Innovation Design group at the Center for Design Research at Stanford. A big thank you to my team members Phil Wickham, Greg Horowitt and Ade Mabogunje from whom I have learnt all that I have written here!
This article was originally published by Dr.Neeraj Sonalkar