Builders and extractors

Tim O’Reilly poses a question every entrepreneur and investor should consider: are you creating more value for others than you capture for yourself? Google makes billions of dollars in annual profits, but generates many times that in productivity gains for other people. Having a positive social contribution isn’t limited to non-profit organizations – non-profits just happen to have a zero in the “value capture” column of the ledger. Wall Street stands at the other extreme: boatloads of value capture and very little value creation.

I think of people who aim to create more value than they capture as “builders” and people who don’t as “extractors.” Most entrepreneurs are natural-born builders. They want to create something from nothing and are happy to see the benefits of their labor spill over to others. Sadly, the builder mindset isn’t as widespread among investors. I recently heard a well-known Boston VC say: “There are 15 good deals a year and our job is to try to win those deals” – a statement that epitomizes the passive, extractor mindset. The problem with VC seed programs is they not only fail to enlarge the pie, they actually shrink it by making otherwise fundable companies unfundable through negative signaling.

The good news is there is a large – and growing – class of investors with the builder mindset. Y Combinator and similar mentorship programs are true builders: their startups probably wouldn’t have existed without them (and the founders might have ended up at big companies). There are also lots of angel and seed investors who are builders. A few that come to mind: Ron Conway, Chris Sacca, Mike Maples (Floodgate), Roger Ehrenberg, Keith Rabois, Ken Lehrer, Jeff Clavier, Betaworks, Steve Anderson, and Aydin Senkut. There are also VCs who are builders. Ones that I’ve worked with directly recently include Union Square, True, Bessemer, Khosla, Index, and First Round.

Given that there is a surplus of venture money, entrepreneurs and seed investors now have the luxury of choosing to work with builders and avoid extractors. Hopefully over time this will weed out the extractors.

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http://twitter.com/knowledgenotebk Knowledge NoteBook

I like the way you put things into perspective. Thanks.
http://www.adrianscott.org/ Adrian Scott

Nice way of categorizing certain aspects of things. One small point: Are you sure all of your assumptions in the assertion that VC seed programs fail to enlarge the pie are correct. Is there any possible way for a VC to set up a seed program that enlarges the pie under your model (not saying that there is a good example of that yet)? It would seem there ought to be. And perhaps the reasoning behind the negative signaling argument is more focused on the past / status quo, than need be, if we get creative.

http://www.cdixon.org chris dixon

I guess in theory VCs could do this, but the fundamental problem is they have ~$300M+ and the seed investments themselves can't “move the needle” so it just has to end up being leadgen for their real business ($10m+ investments). I think a better structure is what seems to be emerging – a separate class of true seed funds that operate independently of big VCs.
http://www.ronen82.com Ronen Mendezitsky

Actually Adrian, We have a VC in Israel that has a seed/early-stage program along side with the chief scientist of the state of Israel.
http://www.jvpvc.com/investments/studio_comps.s…

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http://kickpost.com/ calebelston

The other great thing about partnering with builder angels and investors is they also tend to understand you need to create value for your customers before you try to extract it away from them as well. There's a reason Paul Graham's saying is “Build something people want” and not “Build something you can get people to pay you for”. The first leads to the second, but the reverse is not always true.
NicolasVDB

Chris, we all like to see the world Hollywood style: good guys on one side (here the builders), bad guys on the other (the extractors), but as always reality is a bit more nuanced.

For example I'd be very inclined to join you in chastising these bastards on Wall Street who just move money around and create no value. Yet if they happen to be the money managers of my 401K, I'll feel differently about their role in “value creation” – the value they create for me becomes very real.

Even within the people you mention, I see many nuances. For example Mike Maples is very focused on early value extraction in the form of revenues (I remember his advice “think of how the first $100K will come, and then how the first $1M will come”). On the other end, Fred Wilson seems to be willing to take more risks on the absence of obvious value extraction – see delicious or more recently twitter in his portfolio.

In all fairness, when that Boston VC talked about catching the right deals, the same comment could have been made by Y Combinator or Union Square: the job of investors is first and foremost to pick the right team and right market opportunity at the right price – in other words, “win the right deal”.

http://www.cdixon.org chris dixon

I agree the world is nuanced and I am describing to poles.

I think Maples and Wilson can have very different attitudes toward how quickly you get to revenue but still be focused on helping to build companies. It's just different styles of building.

Totally disagree re Boston VC vs Y Combinator. Y Combinator sees the world as a talent pool of raw clay that they help mold into new things. Boston VC sees the world as fixed and he tries to grab is piece. Sure, builders also compete for deals, but they also look for fixer uppers, half baked stuff etc.

BTW, they guy managing your 401K is a waste of money. If you want public market exposure, put it all in an S&P ETF.

Josereyes

You can say the same thing about Venture Capital exposure, if you want it just by the micro cap or small cap index….. I will be willing to guess if you take into account survivorship bias, VC returns on average are no better if not worse than the returns generated by these indexes which one can trade in and out of all day long…… I'm not defending wall street, just pointing out beauty is in the eye of the beholder and value is a very subjective thing…. for example, many people say RE brokers provide no value, I agree in general, but if a broker can find me a house thats worth 500k and lock it up for me at 400k they have created value…. I don't think u can paint with such a broad stroke……

http://www.victusspiritus.com/ Mark Essel

We're both builder and extractor depending on the time and need. I want very few things other than to help build a self sustaining web tech business. I realize the pattern has to give and take to become part of the infrastructure for future business and not just another social bubble of attention.

I agree that there are extreme archetypes for these traits, and herald the winning of builders. But business building is a type of art based on shared value, and reaping what is sown.

Farmville has taught me that.

I couldn't resist that last line, j/k

ps: Chris did your write this as a self reminder or just as a message to folks that follow your writing? I do the former with posts regularly.
http://donaldryan.net DonRyan

You mentioned these two types in your interview with Om and it really clicked in my brain- Am I providing real value to the companies I work with? I'm very new at angel investing and have a recent investment in a company well within my knowledge base. After seeing your interview, I've made it a point to bust my hump for these guys using whatever connections and knowledge I have to make them a success. I realize that if they are successful I will benefit as well but, as you mention, the drive is to build the company rather than just eyeball whatever value I can extract. Great point.

http://www.cdixon.org chris dixon

Yeah, one of the great things about the startup world is – because it is so small and reputation so important – being a helpful, decent person often contributes to your own success. Doing good and doing well are highly correlated.

http://twitter.com/aortenzi Anthony Ortenzi

The beauty of it is the self-fulfilling nature of it.

A builder treats help with respect — “help me, don't do for me” — and pays it forward even when he's not paying it back. He gives help in return for grace.

A builder necessarily believes in a purpose larger than himself which he must fulfill, and in pursuit of that larger purpose pays all around him in hope, inspiration, and motivation. With regard to value, while those rewards don't always fully replace cash, they do more than their fair share supplementing it.

http://sheynkman.tumblr.com Kirill Sheynkman

There are two ways of getting a seed to bear fruit. Sow a seed, tend to the plant, care for it, watch it grow big. Result = food. The other — sow many seeds, let a reasonable percentage sprout and grow, and mow the field down. Result = food.

The agricultural analogy is similar to seed fund investment, not only in name. But, a skilled farmer must understand that different plants need different seeding, caring and reaping.

Today, social network and peer review sites (for example) are like stalks of corn — there are many of them, they are only slightly differentiated (despite what the founders think), many will fail to grow, and the rest will be mowed down by the ag-farmers and made into corn syrup — a big business.

Occasionally, a different kind of seed pops up. Call it an “oak” or a “sequoia” . Small seed, lots of care, lots of time, lots of money. But, the result is impressive.
While there are few sequoias, there are even fewer farmers/foresters that have ever seen a sequoia — they grow in restricted parts of California. So, not knowing what really big trees are like, they spread their seeds into the soil, sometimes barren, sometimes depleted soil, and wait for stuff to sprout.

Any fund that doesn’t know what a big tree looks like, be it a seed fund or a big VC will not succeed no matter how much they nurture a dud. Whether you have 30x$500K to invest or 30x$10MM, your approach and focus will be the same — deal flow and active betting. It is knowing which ones are going to be winners AFTER you have invested in what turns out to be the right sector and switching from a mass farming to a nurturing strategy. That’s the pivot good VCs know how to make.

I have seen the attitudes of good VCs change dramatically when they smell success. Dramatically. All of a sudden, they start caring, get active on the BOD, want to suggest candidates and hires you've been begging for, start eagerly discussing the next round and giving you a list of funds that are calling them about you.

So, both seed funds AND VCs are ultimately extractors. BUT, the good ones know how to switch into the “build” mode once there is something worth building.

http://www.cdixon.org chris dixon

Great comment-thanks. The point at which I'd disagree is that's it's
ok to get actively involved only when you smell success. Y combinator
takes an active role after only sensing raw talent, and as a result
more good (great?) companies are creates.

http://twitter.com/josephcohen Joseph Cohen

Excellent post. I try to live by this philosophy. One question though: is every builder necessarily creating a social net positive?

http://www.cdixon.org chris dixon

I don't think builder implies social net positive. A guy who creates a cigarette company or value extracting hedge fund could be a builder in some sense but not creating net positive social value.

http://twitter.com/josephcohen Joseph Cohen

Agreed, just not sure the distinction was clear in the post.
http://lmframework.com/blog/about David Semeria

The good side of the dark side of the Force…

http://en.wikipedia.org/wiki/The_Children's_Inv…

vishigondi

I describe below a primary difference between builders and extractors:

Builders embrace change and modify their product to benefit from the rising tide.

Extractors stifle innovation and build walls around the rising tide to keep it from engulfing their product.

The ability to change fast is the primary difference.
http://hdemott.wordpress.com Harry DeMott

A few thoughts here.

I've seen a video of a Boston/Valley based VC and his partner – a well known angel talking about the 15 investments per year. Perhaps you are alluding to the same thing. In their case – I believe they are doing what is correct for their partnership and thier LP's. They have a number of large funds, and so are focused on making much bigger investments in companies that have already shown themselves to be successful. Of course, if you have a $500M fund, and need to generate returns, you probably need the companies you invest in to return something like $7.5B – so good luck there – you need some massive winners.

Are they builders or extractors? Hard to say really. I guess you would view them as extracting some of the value that builders had worked for. Same as public market investors.

What I've never understood in this whole debate – is why, as an investor, you would ever not attempt to build the company, being as involved as you can, and as helpful as you can to management?

One thing I do agree completely with is that the vast majority of Wall Street belongs in the extractor category. There are investors and bankers working with small companies to provide growth capital – and strategic help – but these are increasingly rare for a lot of reasons – but that's a longer story.

I can see in the start-up phase where being a builder makes a lot of sense – but I would ask you – once you are beyond the real start-up phase – and the company is doing well – and looking at a B or C round – when does the building end – and the extraction begin? Because as you go beyond the basic job of the angel investors and get into the later stage VC's how do you avoid dealing with the extractors and the board directions they steer the company in? (Again, I can think of a few ways – but would love to understand how you think about it)

http://www.cdixon.org chris dixon

I think in later stage investing the distinction between building and extracting still holds, but the execution is very different. In a late stage company, building might mean helping recruit a management team that is focused on long term value creation as opposed to, say, quickly IPOing and collecting large fees (as was increasingly common the last few years in the LBO world).

Mike P

As an idealist, I think the posit is an excellent one. I do, however, think O’Reilly is wrong about Microsoft and Google though, because MS has boosted productivity more than Google by factors of ten or hundreds if taken over time, and particularly if measured in bytes or usage time. Aside from his bias against MS, O’Reilly is too quick to sip the ‘Google is not evil’ kool-aid before it has proven to add social value. But hey, it’s cool when you get stuff for free even if it is much less feature complete.

Despite a numerical surplus, VCs show little desire to alter their investment strategies and succumb to finicky entrepreneur demands. They don’t need to – they can hold out, do fewer, larger deals and back their pet entrepreneurs. At least the Boston VC scene has proven immune in this regard and held to their approach. Maybe West Coast VCs have to play nicer?

Fund sources like Y Combinator are certainly welcomed respites for entrepreneurs over VCs, but they too have a fatal flaw: they utilize the same screening approaches for admitting start-ups into the program as VCs do for funding (and hence garner similar results). Once in, though, ventures certainly experience a greater attention then their VC funded peers.

Perhaps the true definition of ‘builder’ is when that person or entity’s actions to grow a company are better recognized and successful to the point that few realize that the ‘builder’ also injected the proper amount of capital into a venture to make it viable. As a result, they are virtually unknown as an investor when in reality they have served that role equally as well.
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Nicholas Turner

How does the Dixon Framework apply to acquisitions? Perhaps “extraction” might better be named “vultures ripping flesh from carcass”. Should mgmt teams even attempt to qualify the mindset of the acquiring company, or just take the money and run?

http://www.cdixon.org chris dixon

I think mgmt should try to do what's fair for the acquirer so they get the value for their money. And of course smart acquirers should build incentives for this into the acquisition structure.

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http://startupcfo.ca startupcfo

With the exception of Index, Khosla and Bessemer, the investors you list as “builders” are all seed investors. First money in.

Is it fair to say that the work of 'building' for an investor as a complement to the core team is all front-end loaded? Or do you think 'building' as an investor is ongoing even when there is complete team in place?

http://www.cdixon.org chris dixon

I think you can build in all sorts of ways – making intros, helping with financings etc.

http://twitter.com/mediainvestors Ted Carroll

Loathe extractors – never want to be one in any deal I’m in. Just steered a founder we both know away from taking seed capital from an investment bank who initiates “relationships” with seed but then circles in for the mammoth extract later. Hurts everyone – and I’ve seen it done repeatedly. John Doerr has a somewhat similar analogy to yours Chris – missionaries and mercenaries.
http://nextgencrm.blogspot.com/ Ami Assayag

I think your post represents reality very well.

I think the coaching you get with the pre-seed funds (Y-Combinator, DreamIt, etc.) creates success for both the fund and the portfolio companies. At SeventySix Capital, we look at our Rolodex when evaluating companies because companies that may not be that attractive in general, could be with some help.

On the other hand, entrepreneurs usually don't have the flexibility of choosing an investor because they need the cash, so you have to be very disciplined and refuse money from extractors.
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Radfasde

Khosla is a builder? Have you ever talked with V.K. or tried to negotiate a deal with him. Do a deal with V.K., and guarantee that 1).You will be removed 2).ASAP they will sell it at a profit.
Vincent van der Lubbe

Completely agree: but doesn't it apply to work and life in general? I quit my last job, because I felt I was extracting more value from my clients than adding. And offering added value “features” did not prove commercially viable, since I did not find a way to charge customers for them (I worked commission based).
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http://squallco.tumblr.com/ Kevin

One of the things I like about reading your and Fred’s posts is a sense that you are in this game to help build things. Yes, when done correctly this means making money, as it should. However that money isn’t made passively it seems (I don’t know either of you), and your goal seems to be much like the old sports metaphor – if you concentrate on playing well winning will be a byproduct. Same type of thinking, I think, applies to the VC and angel businesses. If you concentrate on helping good people build good businesses the money will come and you will be able to keep doing so. In my own business I wish two things (well, more, but 2 that apply). One, I wish there were more investors out there who were builders … people like you guys that aren’t just negotiating their piece of the pie and calculating their IRR, but also sharing the vision and helping to build it. Second, I wish there were a community like the online (and offline, it seems, I am not a part of it) that surrounds the VC/angel world with blogs, Twitter, and the like. You guys share ideas and expose yourselves in ways that very few leaders in other industries do, and you do it publicly. Try as I may to engage people in similar dialogue about the real estate development world and sustainability and to find more people willing to build, rather than take, it is hard to do. Builders need help. Nothing is built in isolation. That you and the community you’re apart of do this both on blogs like this and in private is a great thing.
http://www.weiksner.com Michael Weiksner

Isn’t a version of “smelling success” providing resources (financial, advice) to people pre-selected to have “raw talent”? To me, YC differs from a VC not in strategy but in how it sniffs for likely success at the earliest stage.
http://twitter.com/getgingerd gingerd

hi chris– I really like this post.

For first time entrepreneurs, it applies even more so to so-called ‘business cofounders’. You want a co-founder who obsesses over the product / market, and not one looking for a token ‘brilliant engineer with lots of ideas’

http://thenewcareersblog.com career ideas

well said gingerd,

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Chris Dixon