

Low Startup Capital Requirements: Blessing or a Curse? - apsec112

Most people in the startup world know that, compared to other industries, you need very little capital to start a startup. If you want to start a restaurant, you'll probably need hundreds of thousands of dollars to buy the building, buy the equipment, hire the staff, etc., before you're profitable. Starting a startup can often be done for no more than the cost of the founder's living expenses. This might seem to be great for a founder.<p>However, one of the fundamental laws of economics is: there ain't no such thing as a free lunch. In a competitive market, any advantage which is <i>freely available</i> to all of the participants doesn't benefit any of them, because it will simply cause new people to enter the market and make things more difficult for everyone. Suppose there are two cities, A and B, and people in both have a taste for ice cream. People in A are willing to pay $1 per scoop, but people in B are willing to pay $3 per scoop. This might seem to benefit ice cream sellers in city B. However, what will happen is that ice cream sellers will move from A to B until there is no more reason to move (ie, expected profits in both cities are equal). In other words, even though prices are higher in B, so many people are selling ice cream in B that any one ice cream store will have relatively few customers, canceling out the benefits.<p>The same goes for the world of entrepreneurship. There are lots and lots of people who have, or can get access to, $5,000. There are many fewer people who have, or can get access to, $500,000. Hence, many more people will try to start companies in fields where the capital requirements are only $5,000, and so the market in these fields will be flooded with new entrants. The flood will continue until the difficulty of competing with all the other entrants equals the difficulty of getting $500,000 (assuming the expected reward and risk are equal).<p>If we look at the Internet, this is, in fact, exactly what we see. The capital requirements for starting a website (whether for profit, for fame, for the heck of it, or whatever) are so low that millions of people have done it. Someone once quipped, "Type in, ‘Find people that have sex with goats that are on fire,’ and the computer will say, ‘Specify type of goat.’" This is great for Internet users, because they can find information on practically anything, and a huge variety of applications, at no cost to them.<p>However, the flip side of this is that there are so many people competing for Internet traffic that you either have to be really skilled, or really lucky, or spend a ton of money on advertising, or do deals with a bigger partner, or something else extraordinary to get a decent amount of traffic. For every YouTube, Facebook, and MySpace, there are a hundred applications out there which will never have enough users to pay the founder's living expenses.<p>So, to everyone who would say that the low capital costs of startups are a boon for founders: you are not avoiding pain through low capital costs, but merely switching from one kind of pain to another, like a person who chooses to work for a big company for twenty years and invest the money to get rich instead of starting a company at all.
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lsc
The expensive part of a web startup is Engineer salary. for nearly all web
startups, everything else is comparatively free until they get fairly big.

The thing is, Engineers are pretty expensive. around here, once you get
through benefits you are probably looking at $120-$200K+ per head, for upper
mid-range people (assuming you aren't paying for office space and have minimal
hr overhead; it's more otherwise)

So yeah, if you talk 3 or 4 friends into taking a year off to work on a
startup, guess what? You've just got your $500K in investment.

~~~
apsec112
Most startups pay early-stage people primarily in equity. You sound like
you're not from the US, but that's mostly how it works here. Startups are also
founded mostly by younger people, who have much lower salaries and cost of
living requirements. It might work differently elsewhere, in which case my
argument doesn't apply, but I was talking specifically about the US startup
industry.

~~~
lsc
I'm saying that you can look at the engineers working for equity as investors;
they are. Your Engineers getting tired of eating ramen and leaving for real
jobs is a lot like investors not giving you the next round of funding.

Also, even mediocre engineers in their mid 20s are going to be making $85K or
better plus benefits here in the sf bay area. add in benefits and you start
approaching the lower end of what I suggested; and all other things being
equal, you are going to have a hard time if all your Engineers are mediocre.

~~~
apsec112
"I'm saying that you can look at the engineers working for equity as
investors; they are."

Not in the barrier-to-entry sense, which is the one I was discussing. It's a
_lot_ harder to get a VC to invest in you than to get some guy you know from
college to help you write a piece of software.

"Your Engineers getting tired of eating ramen and leaving for real jobs is a
lot like investors not giving you the next round of funding."

Hence vesting.

"Also, even mediocre engineers in their mid 20s are going to be making $85K or
better plus benefits here in the sf bay area."

I know several full-time software engineers in the Bay Area who are 25 and
making that much, but they're all a). extremely smart and b). have degrees
from top universities, so I really don't think "mediocre" people make that
much. Still, you're right that top people are reasonably expensive if you pay
them in cash rather than equity.

~~~
lsc
"Hence vesting."

Your equity only acts as an incentive to stay as long as it looks like you
have a chance of winning. Just like investors will eventually stop throwing
good money after bad if you don't meet your numbers, your Engineers will start
looking for paying work.

Getting good people who have other options to work for free for any period of
time is no mean feat. Personally, I've gone the other direction; I hire
inexperienced people and train, but that only works because I am experienced
myself.

(of course, I've never seriously tried to get VC, so I have no clue how
difficult that is.)

My point is just that as long as you have your Engineers, you can cover
infrastructure with beer money (at least, until you get really huge.) which I
guess was your point, too, what with saying the barrier to entry is low.

I'm just saying; keeping a few really good engineers happy without money is
not as easy as it sounds. And, it's not as hard as you think for Engineers to
come up with money. I spent almost $60,000 on servers last year.

------
coryl
I get what your saying, but you're looking at it from a purely economic point
of view. Actually, when I started reading your post I thought to myself,
"seems like this guy just finished his chapter on Perfect Competition".

Even though there are benefits and differences to high capital vs low capital
requirement markets, you have to look at the human aspect of it. There are
failures on both sides, and probably a higher failure rate for web startups.
But the main difference is that regular people have the opportunity to
actually strike it rich. High capital requirements tend to mean you need
social connections to people with money. In society, this means political,
industry, venture capital, and business connections. If you're the wrong race,
sex, religion, or just don't fit the profile of someone who tends to be able
to have access to money, you won't get it.

Low capital requirement markets means anyone can play; everything is more
competitive, all products are higher quality. The discriminator is the market,
and thats fair for all. If you take these into consideration, than you see low
capital requirement markets are in fact a blessing, regardless of the economic
returns of high capital markets. They are two completely different beasts.

~~~
apsec112
"Actually, when I started reading your post I thought to myself, "seems like
this guy just finished his chapter on Perfect Competition"."

I will admit to being an economics student, but I've known about this
principle for years, I didn't just learn about it yesterday. I made this post
because five people on a forum I frequent were all talking about how great it
was for them that startups required very little capital.

"But the main difference is that regular people have the opportunity to
actually strike it rich."

Regular people have _always_ had the opportunity to strike it rich, and for
most of the US's history, it was _easier_ than it is today. The idea that
technology startups are some sort of fundamental shift in US social mobility
dynamics is a _harmful, dangerous lie_.

<http://en.wikipedia.org/wiki/Andrew_Carnegie>

[http://www.amazon.com/Millionaire-Next-Door-Thomas-
Stanley/d...](http://www.amazon.com/Millionaire-Next-Door-Thomas-
Stanley/dp/0671015206)

"High capital requirements tend to mean you need social connections to people
with money."

You need those connections _anyway_. Or, at least, you need to be part of the
upper third of society. It's not an accident that Bill Gates's father was a
name partner in the largest law firm in Seattle. Why do you think Y Combinator
has so many applicants? It's because they provide the connections people need,
and the applicants know that.

"than you see low capital requirement markets are in fact a blessing,"

Low capital requirements are good _for the customer_ , and I explicitly stated
that fact. What I was saying is: they aren't necessarily good for the
entrepreneur.

------
jsankey
I look at it like this: up front capital requirements are more of an
artificial barrier to your success. It doesn't matter how good you are: if you
don't have the money, you can't get started. Removing this artificial barrier
is a good thing: it makes the market closer to a meritocracy.

Although anyone can stick up a website, not anyone can make a good one. But if
you've got the skill, there's nothing standing in your way.

~~~
apsec112
"up front capital requirements are more of an artificial barrier to your
success"

This isn't necessarily true. In markets requiring a high degree of sales
skill, like enterprise software, ability to raise capital is highly correlated
to business success. However, I will agree that it is true in some cases.

"Removing this artificial barrier is a good thing: it makes the market closer
to a meritocracy."

It's a good thing for Internet users. The point is that it's not necessarily a
good thing for founders.

"But if you've got the skill, there's nothing standing in your way."

If you have _arbitrarily good_ skill, there's nothing standing in your way.
This is not a good argument for whether you should go into the startup
industry, anymore than "if you're Michael Jordan, there's nothing standing in
your way" in the sports industry or "if you're Harrison Ford, there's nothing
standing in your way" in the movie industry. Most people aren't Michael Jordan
or Harrison Ford.

~~~
jsankey
Well, I don't see why a person without the requisite skills should expect to
succeed. Sorry, if you're no good at basketball, don't expect to play in the
NBA.

So, by all means, if you're no good at creating websites, it's not a good idea
to start one. But I'm thankful that there aren't any arbitrary walls standing
in the way for those people that do have what it takes.

~~~
apsec112
False dichotomy. There is a linear continuum of skill, from "completely
unskilled" all the way up to "world-class rockstar". In some fields, eg.
medicine, if you have median skill for people in the field, you'll do pretty
well. In other fields, including programming, sports, movie acting, and math,
if you have median skill you'll never get anywhere. Your argument was, "If you
have world-class rockstar skill, you don't need to worry about succeeding".
This is, in fact, true. However, this does not apply to the 99.9999% of us who
do not have world-class rockstar skill. And it does not refute my argument
that, given lower capital requirements, there is going to be more competition,
making it more difficult for the 99.9999% of us without world-class rockstar
skill.

~~~
jsankey
You're putting words in my mouth. I'm not at all suggesting that you need
"world-class rockstar skill" to succeed. You do need some skill (I suspect
less than you think), and the more you have the more likely you are to
succeed. And that's the way it should be - success determined by skill rather
than your ability to raise capital.

That's why I think low capital requirements are an advantage. Not because they
make it easier to succeed in some theoretical sense, but because they make
things more fair. I'll take the level field with more competition, as it
rewards talent and effort.

------
_delirium
I agree that removing barriers to entry means more people can get in, but
isn't that the point? I can see that, from the perspective of someone who
would be in the market either way, more people is bad: you'd rather be one of
10 than one of 100. But what if I'm one of those 90? I'd rather be one of 100
than excluded from the market entirely. And it forces everyone to compete on
innovation, rather than using market incumbency and competitive moats to keep
up profits by keeping out competitors.

~~~
apsec112
"I'd rather be one of 100 than excluded from the market entirely."

No, you wouldn't; that's the whole point. Suppose that there are two options:
an open market and a closed market. If it's a closed market, there's a high
barrier to entry, and so only ten people are in the market. If it's an open
market, anyone can join who wants to, and so there are a hundred people.
However, you must not be able to _benefit_ from joining the open market, or
else more people would join and drive wages down. And, if you were one of the
ten people in the closed market, you _still_ wouldn't be any better off,
because the high wages of the closed market would be counteracted by the
difficulty of getting into the market (see: "medical doctor"). There ain't no
such thing as a free lunch.

EDIT: Your reply is potentially valid, but only if the market we're talking
about is so large that opening it up will raise salaries outside of it. The
startup market is only ~0.1% of the US economy, so I don't think this applies.

~~~
_delirium
Distribution of wealth isn't necessarily the same in both situations, though,
so things can really be materially better in one situation vs. the other for
different sets of people. The closed-market situation leads to more divergent
outcomes: you have wealthy people who are in profitable markets, and non-
wealthy people who are kept out due to high barriers. Reducing market barriers
makes that rigid in-v-out dichotomy harder to maintain, which is better for
the people who would have been out in the closed-market situation. They can
still only profit a little, but before they couldn't profit at all.

Markets where capital is a requirement also tend to result in rich-get-richer
effects, where you have to have money to enter profitable markets, which then
make you more money. Low-barrier markets make it harder to get a return out of
capital, and force people to get returns from other things, like their tech
skills. (Of course, tech skills are probably correlated with wealth too, but
not to the same extent that literally having piles of money is.)

------
tlack
Another aspect is that expensive startups require more planning and careful
attention to profit and business strategy. If you're investing $500k, you will
spend more time figuring out what you are going to be selling and how it's
going to work out. I think that is planning that a lot of dot com startups
could really use. "Minimal possible product" often winds up being quite
underwhelming these days.

------
medianama
In our business Intellectual capital is more valuable than real money. To me
that is the real barrier to building great businesses (and not money as in
traditional business context)

