The Real World Innovator
The primary exchange occurring in the incubation model is the trade of mentorship for company equity. Incubators are being compensated for their services with an asset other than traditional monetary currency. Clearly, their long term goal is to earn a monetary return, however these equity investments may persist in their portfolio for a significant period of time with only a rather arbitrary accounting value assigned to them. In other words, these assets are not easily converted into hard currency.
In what sense does this arrangement meaningfully differ from a typical investment? Regular readers of this blog will be familiar with my categorization of currencies into two distinct groups…a quick refresher:
- used in the exchange of scarce goods
- both sides of the exchange are defined explicitly and valued at the time of the transaction
- each side of the transaction is expected to be roughly equal in value (symmetric)
- used in exchange of abundant goods
- no point-in-time transaction takes place, therefore no formal delineation of the terms of trade or explicit valuation takes place a priori
- terms of trade may be highly unequal (asymmetric)
The transactional model is the one we generally associate with currency – a clearly defined exchange of money for goods or services. The reciprocal model is implicitly in use for most activities that influence anything under the umbrella of social capital. For example, a favor is done for a friend creating some intangible increase in reputation or the implicit expectation of future reciprocation.
Returning to the incubation model….while it appears at first glance that the incubator is making a straightforward investment, in some respects this exchange actually has more in common with social capital than it does with a typical transactional investment. The typical investment generally has an explicit market value that, though it may fluctuate, is acknowledged by other market participants at the time of the transaction. Social capital, by contrast, is intangible stuff that only acquires tangible value when we “redeem it”. An equity position in a start up is much more like the latter. While an explicit transaction does occur and the incubator does acquire a tangible equity share, the value of those shares are highly uncertain (intangible) until they become “redeemable”, once the start up either produces a profit or a market price exists for its shares.
So here we have two factors combining to push the incubator arrangement towards the asymmetric zone:
- the exchange of one abundant asset for another (mentorship and company equity are both abundant to their respective owners, see this post)
- intangible value with no assurance of return
The first point distinguishes this model from other speculative investments, for which the returns may be uncertain but the exchange itself is clearly of one scarce asset for another (money now[investment] for money later[return]). The second point distinguishes this situation from simple barter, trading one asset or service for another. The incubation model avoids drifting fully into the social capital zone however, because the terms of trade are explicitly defined at the time of the transaction.
The Idealized Model
[note: the post discussed below is from 2009, see the comments for current thoughts from Venkat]
This is where we return to Venkat’s piece The Crucible Effect and the Scarcity of Collective Attention, in which Venkat attacks the notion that the average “long-tail” content creator should aim to attract 1000 raving fans.
This basic model of creative capital is just not believable for two reasons. First, it reduces a prosumer/co-creation economic-cultural environment to a godawful unthinking bleating-sheep model of community.
The second problem is the tacit assumption that creation is prototypically organized in units of 1. The argument is seductive. The bad old corporations will die, along with its committees of groupthink. The brave new solo free agent, wandering in the woods of cultural anarchy, finds a way to lead his tribe to the promised land of whatever his niche is about.
He proceeds to argue for creators to organize themselves into groups of about twelve people – small enough to foster collaboration while at the same time large enough to motivate competition. In this model creation is still an individual act but is perpetually spurred by the pressures and opportunities created within the group dynamic. Venkat also asks that we consider a more intimate market for our creative output:
Your actual goal as a creative today is to find and keep your 150, to whom you pay individual attention. Pass-through crowds don’t deserve much attention. In fact, the monetary value of your transaction with them is exactly $0.00. Anderson hammered home the point that to the masses, the right price for your work is $0.00, but he didn’t address the flip side. They are also worth only $0.00 to you on average. Which means you should put no marginal effort into pleasing them. If one of them finds something you did for your 150 useful, let them have it. You get paid in word-of-mouth, they get free stuff. Small serendipitous barter transaction. Aggregate over 100,000 and net hard-dollar value is still 100,000x$0=$0. The barter is non-zero sum, but doesn’t pay your rent.
As the closing comments make clear, Venkat is concerned with how the creative earns the “hard-dollars” that enable him to satisfy material needs. While your group of twelve provides motivation and co-creation opportunities, it would be your 150 devoted customers who pay real money for highly personalized, high value service.
You have probably recognized by now that Venkat’s model describes the approach taken by Y Combinator quite accurately. Y Combinator lists six partners on their website. Adding in an equal number of non-partner contributors you would arrive at the magic number twelve. Y Combinator also notes on their about page that they have “funded a total of 208 so far”…very much in the ballpark of Dunbar’s 150 and probably even closer if you were exclude those start ups that have already failed, been acquired, or are otherwise no longer within the relevant purview.
Do all these similarities indicate a nearly exact match? The significant point on which they differ is the compensation strategy. The idealized version calls for 150 uber-loyal customers who pay hard currency for the personalized service that the creative delivers. The incubator model, by contrast, calls for compensation in the form of an equity position in each of the “customers” (funded/mentored start ups). In so doing, the incubator formalizes the deep relationship between the two parties. The creator/mentor still achieves real hard-dollar compensation in the long run, but those hard dollars are funneled through a conduit that aligns his incentives with the interests of the 150.
So what was the point, at the outset of this piece, of analyzing the degree to which start up equity shares resemble alternative currency? If we were only concerned with the behavior of a small number of venture capitalists then that analysis would have little relevance to most readers here. However, Venkat’s ideal business model for the creative knowledge worker suggests that a diverse array of individuals might benefit from adopting practices similar to those that Y Combinator has established…including potentially taking compensation in the form of stock in their best customers – either in their success as individuals or their relevant projects.
The initial analysis was pertinent because it points out how such markets might take on a decidedly social capital-esque character. These would be markets in which producers share in the successes (or failures) of their customers…markets in which financial transactions create an expectation of long term mentorship and collaboration. An baby step towards this potential future occurred just last week when the SEC acknowledged the possibility of relaxing restrictions on investments in private companies…a move that would significantly blur the distinction between public and private companies, and thereby set the stage for a much more granular and subtle multitude of economic relationships.
How might our social and economic relationships look different if the legal environment empowered us to invest in each other, both formally and informally, as we might deem appropriate for any given situation? What other types of innovative hybrid economic/social arrangements might we see? Please leave your thoughts in the comments…
photo courtesy of jurvetson