I am seeing a lot of companies building “InvestorTech” startups to help solve the plethora of problems that the private sector sector is dealing with. From the function of investing in startups, to managing the paperwork, and everything in between, there is a startup for every use case in 2022. Although there are hundreds, if not thousands of solutions at this point, there are really only three types of companies in this space:
- Tooling companies
- Social capital driven companies
- Companies somewhere in the middle
What are InvestorTech Tooling Companies?
A tooling InvestorTech startup pretty much handles everything once one an investor has decided to invest into a startup. They build they pipes to make investing in companies as simple as clicking a button, like AngelList, Party Round or Stonks. They make investor communications much more seamless, like Cabal or Paperstreet. Every week, I see a new tooling startup aiming to make the process of investing easier, tackling one more part of the stack.
What are social capital driven companies?
Social capital driven companies are ones that have developed a sense of social capital around their offering, that gives the company some element of signal, which then gives any company that is associated with it some sense of signal as well. Two examples are On Deck and Launch House. Getting into these programs makes investors heads turn, and can instantly make you investable, even if you previously weren’t. These companies have power. Older examples include illustrious accelerators like Y Combinator or programs such as the Thiel Fellowship. Being a part of these social capital driven ecosystems simply makes the startups that are apart of them more valuable.
The Challenge With The Middle
There are also companies trying to ride the middle, having elements of both tooling and social capital. They want to have the signal that a social capital driven startup has and the scalability and qualities that a tooling startups has. The issue is that those two elements are at odds with eachother. The wider the network, the lower its social capital command is. The tighter the network, the higher the social capital command is. These implicit laws govern what problems these types of companies are able to solve.
What Problems Are We Solving Here?
Now in my (incredibly biased) opinion, the tooling problems being solved are a first world problem for a small % of people. For the founders that have been able to convince rich people to give them money, there is a suite of tools that one can use to send that money over. In fact, a majority of tools in VCtech serve this 1%.
With that said, I think we are fooling ourselves here if we think the most important problem to be solved in the venture capital world are tooling problems. Nope. The real answer lies above. If 1% of founders are able to get access to capital, will building better tools increase this number? No. An investment decision is an emotional one. It’s one that is decided inside of the brain. An investor builds conviction with a startup until one day, they decide to make the investment and write a check. AT THIS POINT, the tooling startups play their role.
I think the problem that needs to be solved is answering the question of why are only 1% of capable founders getting funded out of the entire pool. And of that 1%, why are an extreme minority of these startups are women led and even fewer being black led? The fact that venture capital is supposed to fund solutions to the world’s hardest problems, but only one perspective is considered when getting that capital, is the problem here. We need to be building tools for BEFORE the investment decision, not after. Due to this, I don’t believe tooling startups are nearly as impactful in this realm as social capital driven startups.
Early Stage Investing is a Social Capital Game
One implicit truth in the game of early stage investing is that it has little to do with the potential of the businesses being invested in and everything to do with social capital of the players involved. This is a social capital driven game. Investing in a seed deal that Sequoia led could make you rich in a decade, but leading up to that, you get to say you invest with Sequoia at parties. Want to get an in with the Harvard Board? Invest in one of the decision maker’s kids. Want to be seen as cool by techies? Invest in startups, not to make money, but to fit in, socially. Making money is secondary to many early stage investors’ goals, where the fruits of the social capital benefits are so much sweeter.
If early stage investing is a social capital driven game, then it means we need a social capital driven solution to solve this insider:outsider funding gap. Enter the second type of company mentioned in this post. The social capital driven company. These are the ones that have the potential to change things, if they choose to. Once enough social capital is built around an entity, anyone they let in gets to use some of that social capital for their own benefit. Some examples:
- Got into YC? Say you’re a YC founder and nearly anyone will take you more seriously. Got into Angelpad? People will ask what that is and treat you the same.
- Got into Stanford? Anyone will take you more sersiouly. Got into GCU? They’ll treat you the same.
Worked at Stripe? Anyone will take you more seriously. Worked at Juicero? They will probably treat you the same.
The reason these dynamics exist are not random. YC, Stanford, and Stripe did the things necessary to build up enough social capital to become valuable, and enabled their ability to lend it out. Sure, did Angelpad, GCU, and Juicero want to build the type of institutions that had the same result? Yes. But in order to build up social status, it takes tradeoffs, skill, and luck. The primary tradeoff that YC, Stanford, and Juicero used was that it was exclusive. Only “the best” got in. And this created networks that only attracted “the best”. But unfortunately, the definition of “the best” has changed in 15 years.
Modern Social Capital Driven Companies are Seeking “The Best”
New companies (as mentioned) have been built in the last few years to try to build the future of InvestorTech, and have borrowed the social capital model from their predecessors. And they are running the playbook beautifully. They started off exclusive. Surrounded themselves with high signal (high social capital) investors, all in an effort to find the best. They want to attract the BEST companies so they can build similar copies of YC or Stanford, and have a kingdom of social capital to lend out to who they choose. With social capital comes power.
The issue with this is that “the best” is an extremely quickly moving target. Over the last decade, the internet has democratized access to startup knowledge, and there are people building all across the world with viable companies. The best used to be 2-3 CIS majors from Stanford or ex Googlers tackling a hot market. Now, I don’t even think the tech world knows what the best is anymore, but we know that it’s changed.
Companies building a treasure trove of social capital don’t have the risk tolerance to take a guess on what the “new best” is. So they look for what has worked to lend their social capital to. And everything looks the part. They attract similar types of people with impressive backgrounds. Silicon Valley rewards them with capital, they get validation that their model is working, they get more capital, and all of a sudden, these future of Silicon Valley companies claiming to build something better fell into the social capital paradox.
The social capital paradox is that the larger a network gets, the less valuable its social capital pull is. Sure, Stanford has social capital, but someone might leave Stanford for a org that has an even higher social capital value ascribed to it. This is almost a law. On Deck and Launch House think that they can break the paradox but scaling up a venture backed style company and maintain the level of social capital required so that lending it out still means something. Unfortunately, it means that the types of founders that get accepted into these programs all come from a similar monoculture. which doesn’t solve problems in VC that I mentioned above.
If you’re in tech, you know what i’m talking about when I say monoculture. It’s people that think similarly, act similarly, and have somewhat similar backgrounds and ambitions. And it’s pretty obvious to tell when someone is a part of this monoculture and whens someone isn’t. Hint - most of the world isn’t.
These companies aren’t able to stomach the rick of letting a ton of unproven outsiders into their program that don’t fit into the monoculture. Their perceived social capital would go down so they only let in people that “deserve” the benefits of their social capital, or who are the “best”, or who are the “coolest”. Ones that fit into the monoculture.
The Best Are Rarely the Coolest
If we look back in history, this isn’t really how earlier orgs got started though or built their status up. YC and the Thiel Fellowship (+1517 down the line) attracted a ton of misfits when they first got started. Outcasts. Weirdos. And then those founders built such powerful companies that signal was thrusted onto the organizations by the world. They didn’t try to fabricate their own status with branding and funding announcements. They did it by attracting outsiders who could ship, sell, and eventual lead. I have to guess that the types of founders that YC and Thiel Fellowship attracted are not the type of founders that would be attracted to a On Deck or a Launch House today, and vice versa. But if this is true, it means there is a moat…and an opportunity.
The Monoculture Has a Moat
On Deck and Launch House pigeonholed themselves to only working with a certain type of founder. A founder that “looks the part”, or fits into the monoculture. And there’s millions of people out there that fit the bill. But there will be a point where the land runs out and they can’t find any more people fit the ideal persona they are looking for. They run into a dead end. I like to call this the monoculture moat. Only SO MANY PEOPLE want to do the same thing and think in the same way to get the same result. Yes, the tech monoculture has transcended the physical barriers of the Bay and is spreading across the world, but I bet it won’t spread very far. I personally have a hunch that most of the world doesn’t care about social status like the Bay Area monoculture does. I know that Launch House and On Deck is hoping that it will spread though. Their survival depends on the fact that there are enough people in this world that will join a monoculture that their own company cultures are based on. But, there is indeed a moat that they can’t cross.
On the other side of this moat, you have the people that On Deck/Launch House wouldn’t touch with a 10 foot pole. Outsiders. Weirdos. Builders. For what they lack in coolness, they make up in interestingness. Humility. A builders mindset. If 1% of the world fits in with the monoculture, that means 99% of the world is still looking for a home. And this is the exact same 99% who have been locked of the private markets to begin with. And since there have been companies/firms built that serve this demographic (YC, TF), and has made everyone involved fabulously wealthy, there is an opportunity for a new company to leverage social capital arbitrage, and solve the private market problems that lock billions out of life changing wealth by building on the other side of the monoculture moat. Where On Deck’s and Launch House’s standards drop off, someone else needs to pick them up at that very point and get to everyone else.
Leveraging Social Capital Arbitrage
This whole essay has been written on the premise that social capital can be used to lend out and help its participants. And the assumption is that this can only be done in an exclusive way, to make sure the social capital is kept up. And due to this, this limits the amount of people who can benefit from this social capital, reinforcing the insider:outsider problems we have in startups. But in venture, everyone deep down knows that the real 10x and 100x returns come from outliers and/or outsiders. YC didn’t start out as a magnet for cool people, it started off as a magnet for outsiders. And these outsiders created the signal that now surrounds YC.
I believe there is an opportunity to build an equivalent model to “Stanford for outsiders”. Although that wouldn’t work in higher education, it could work in venture because 1. It already has and 2. If you put 100 VC in separate rooms and ask them where “alpha” is, they would say it’s on the fringes. Only when you get them all together do you get the group think answers that we have in 2022.
By building a Stanford for outsiders model, you effectively open the door to anyone in the world that wants to enter startups, because the next Mark Zuckerberg can come from anywhere. And as long as this Stanford for outsiders produces 10-100 wins for VCs every year and billions in exit value over time, everyone will have their eyes on it. The social capital can be lent to a complete outsider and it forces people to think “why did THIS person get in. What’s special about them?”
Of course for years, the public will overlook the magic that happens in this place, thinking outsiders can’t build billion dollar companies. But builders are going to build. At some point, the truth will be undeniable. As the successes pile up, the signal will get stronger. The social capital will increase. And within a decade, this model will eclipse any model that thrives on attracting the “cool” 1%, but ignores the outlier 99%. By flipping the model on its head, you can use social capital to get rich, and help private markets spread the wealth they create beyond the monoculture.
Social Capital Can Be Bought With Time
I’ve been working on InvestorTech for over two years now, and everything I say in this post will go over the head of the monoculture. They will write me off like the outsider I am, and keep doing their thing. They won’t recognize the problem exists, because to them, it doesn’t. This is why tooling startups can’t solve social capital problems. They have an upper limit on the influence they have. And it’s why VCs like funding them. No VC can stomach the idea of funding the changing of the guard of their own industry, even when most of them know it’s necessary. Luckily, social capital can be bought with money and also can be bought with time. And in time, there will be a company that uses its social capital to let others in, not keep them out. That’s a world I am working to build.