Automation has served us for thousands of years. It comes with the good, the bad, and the destructive. But as AI and robotics propel humanity into a future with more powerful automation, is it possible to steer it towards greater good for all?

Our belief at Ada Ventures is a resounding yes. However, the risk of harm can’t be ignored. At Ada we acknowledge that we have the privilege of optimism — we are optimistic that technology and automation have the potential to improve global living standards. We don’t believe that automation should inevitably exacerbate inequality, but this could be the eventual outcome if, as a society, we are not thoughtful about how new technologies are developed and deployed, and who is at the table when those decisions are made.

Technological progress that accelerates inequality rather than inclusivity can destabilise societies and cause harm at scale. So, there is no doubt that governments will have a significant role in setting policies that prevent rising inequality and excessive concentration of wealth. This is both an opportunity and a threat, making our mission at Ada more important than ever.

With the resurgence of AI-first startups, the capacity to automate tasks — whether that’s knowledge work, frontline duties, learning and training, or delivery of products and services — has never been greater. This makes today an exciting time to back founders who are using technology to not only automate what we’ve historically done manually, but are doing so in a way that unlocks access to economic opportunities, better work, and wellbeing for people and the planet. In this article we will share some of our thinking on this and the areas we are actively exploring.

If you’re a founder building a company with the potential to equitably accelerate human progress through automation in health, climate, or the economy, please get in touch!

Lessons from History

History is repeatedly punctuated with automations that unlocked better living standards for everyone, with the largest leaps in improvements among the underserved.

For example, the printing press eliminated the painstaking work of copying books by hand. Scribes were replaced with an automated book production process that drove the rapid advancement of global literacy rates. It democratised access to knowledge and education and made them more inclusive.

Similarly, everyday household items like the washing machine generated significant impact. This innovation turned hours of work into minutes, thereby contributing to the success of more women joining the (paid!) labour market and granting people more leisure time.

In agriculture, the introduction of tractors and combine harvesters transformed farming. These machines ended the gruelling, manual, and labour-intensive work of farmers. Automation in the field accelerated food production to feed a growing global population and freed up labour resources for other high-value activities.

Another example is the connectivity we have today. People used to manually move cords around on a switchboard to connect each phone call. But as demand for communications soared, so did the complexity of managing connections. Automation resolved this bottleneck, and although automated switchboards eventually replaced humans, the telecoms industry grew and employed millions of people. We have a more connected world with greater communication, collaboration, and shared understanding thanks to automation.

The Path Ahead

Today, advancements in software and hardware continue to make great strides in automation. We have the potential to improve outcomes more inclusively across our economies, climate, and health, as well as freeing up people to do more of what brings them joy.

For example, imagine a world where doctors can help more patients because large swaths of their administrative work have been automated. Or consider a plumber, electrician, or therapist who can serve more customers thanks to automation in their work, training, or finances.

Imagine a future where our planet is cleaner and more sustainable thanks to AI and automation in scientific and industrial endeavours. Our investment in Materials Nexus is one such example. It’s a deep-tech company that uses AI and machine learning to automate the discovery of high-performing industrial materials that are cheaper and greener. Their technology accelerates a decades-long process to months.

While automation today might conjure up images of mass job displacement, it shouldn’t bias our view against the positive case. There are many problems we can’t solve and opportunities we can’t seize without automation. Additionally, although AI will replace some jobs, researchers from the London School of Economics have highlighted evidence that automation “doesn’t just destroy jobs, it can also raise demand for other workers, and create the space for entirely new jobs.”

Additionally, the Pissarides Review into the Future of Work and Wellbeing finds that the new jobs that emerge with AI and automation may be of a higher quality. In other words, fair pay, reasonable hours, work that is meaningful, challenging, and which offers opportunities for growth and development.

Opportunities to build

At Ada, we are actively investing in AI-First companies at pre-seed (we have invested in three in the last three months already) and are especially interested in companies that address the following opportunities:

• Accelerating skills acquisition. An increasingly automated world will require significant agility from employees and the ability to learn new skills effectively. One example is our portfolio company Gizmo. It uses Generative AI, along with proven techniques like spaced repetition, to accelerate learning and education.
• Increasing access and affordability — We’ve also seen entrepreneurs build products for large segments of society that were previously priced out of a service or product. By using automation to reduce the costs of serving a product, businesses can offer more affordable pricing and grow their customer base. Do Not Pay and Valla are great examples of this. They democratise access to legal support and advice.
• Promoting economic prosperity — As jobs are created and destroyed, society will need new tools and platforms that alleviate income inequality. We are not yet sure what this looks like, but one area that’s interesting today includes products that eliminate the complexity of being economically productive. For instance, the Ada Ventures portfolio company OpenFormat enables creators to build a no-code web3 application in hours rather than weeks.

Our Faith in Founders

Even though every innovation comes with risks and challenges, we believe that the best founders want to build things that positively matter.

And just look at the recent flows of talent to more purpose-led companies. Over 80% of under-25s think that social impact is important when choosing a job. More than half of consumers buy from brands based on positive values — a figure that rises to nearly 90% for Gen Z consumers.

It’s hard to deny the world’s growing interest in products that do more good than harm. For these reasons, we are optimistic about the future of automation. We believe that when it is implemented with ethical structures and governance, it can be a social good, and there should be more of it.

What do some of these guardrails look like? Here’s a sample of ideas that we’re actively working on with founders:

• Examine bias in training data and models.
• Engage customers, employees, and policymakers on how to develop and deploy technology more equitably.
• Consider how technology can augment existing jobs, skills, and work satisfaction.
• Conduct ‘pre-mortems’ on how technology might cause harm at scale and consider mitigations against that.
• Explore an ethics framework early on (in the first six months of incorporation) and consider iterations along the way.

What have we missed here? Who are the most thoughtful people writing about this? Please let us know in the comments.

If you’re a founder building a company with the potential to accelerate human progress through automation in health, climate, or the economy, please get in touch!

The Social Good of Automation was originally published in Ada Ventures on Medium, where people are continuing the conversation by highlighting and responding to this story.

Hi friends,

I’ve now moved all my venture capital blogging to a new substack called VC Mastery. We are three issues in already!

Join 200+ other industry insiders on a journey of learning and mastery in venture by signing up here.

I’ll be sharing my learnings in VC as I research best practices from other investors, alongside the angel and venture investments I’m making.

See below a sample of the posts so far.

• How the Cost of Code is Disrupting the Venture Industry
• The Upside of Liquidation Preferences
• Venture Capital on a Sugar High: The Interest Rate Effect

Thank you for reading and supporting my Medium posts. I hope to see you all at VC Mastery!

I’ve moved to Substack! New Posts Now at VCMastery Subtack. was originally published in Venture Capital Research on Medium, where people are continuing the conversation by highlighting and responding to this story.

If you enjoy this post, be sure to sign up to my VC Mastery newsletter.

I’ve been reading Fred Wilson’s blog for almost a decade and his writing inspired my move into venture capital some years back. He’s a seasoned early-stage investor and a co-founder of Union Square Ventures, one of the best venture capital firms of all time. (They invested in the likes of Stripe, Twitter, and Coinbase).

I’m still reading through each and every one of Fred’s blog posts because there’s a ton of early-stage investing knowledge in it, and his writing is such a delight to read. But as a fan of his blog I also wanted to create an interactive way of traversing his knowledge base.

Enter GPT, Langchain, and Chromadb. These tools helped me quickly build a prototype chatbot that I could ask questions about early-stage investing. Below are some gif examples of the answers I can get from the bot. I also tweeted about it here. How did I build it?

How did I build it?

There were broadly three steps. First I used an open source Python library called BeautifulSoup to extract all the text from https://avc.com/. Second, I created an AI-native database of that text using Chroma. This part is really cool because Chroma stores the text in a highly multi-dimensional space where related concepts can be found easily. Finally, I used Langchain to connect to OpenAI’s GPT model for chat and language capabilities. (The user interface is powered by Gradio.)

All this sounds super technical for non-coders, but I’m not a software engineer by the way. I’ve completed online coding classes before and I know a few basic programming principles, but it’s not my area of expertise. I built this VC AI by using open source tools and asking ChatGPT for a lot of help!

Implications for Entrepreneurs

If I can build something like this over a few evenings, and the technology that enables people to do it is getting simpler and more accessible, we’re going to see a massive rise in the number of people who can create software tools and apps. And one of the things I’m excited about here is that entrepreneurs who previously weren’t technical enough to start a tech company can do so without the hurdle of having to find a technical co-founder. That partner could be an AI.

Implications for Investors

I’ve built a prototype investor chatbot for personal use and learning but I don’t believe it can displace any seasoned investors, yet. Coincidentally, just as I was finishing the prototype, Fred Wilson wrote about this same topic yesterday and he makes a number of points that I agree with.

The thing is, there are facts, there’s knowledge, and then there’s wisdom. Everyone has cheap access to facts. Wikipedia does a wonderful job of that. Many people also accumulate knowledge with time and some expense — i.e. the know-how and nuance of applying different facts and ideas in a specialist area. AI is now getting really good at this.

The final element is wisdom, and that’s hard-won. It’s very human. It involves living through an experience and internalising the whys and counterfactuals of what happened and what could have happened. I can’t just read a blog post from Fred Wilson or ask an AI about how to deal with a situation and all of a sudden become a wise person. That takes significant time, reflection, and tangible practical experience.

AI might become wise some day, but from what I’ve built and learnt about large language models so far, it will be exceptionally difficult to replicate that. I remain open to the idea that this could change quickly if some new innovation in AI emerges. For now though, I don’t think investor jobs are going to be displaced by bots. Investing will, however, be augmented by AI.

Originally published at https://michaeltefula.com on May 5, 2023.

How I Built a Venture Capitalist A.I. Bot and What I’ve Learned From It. was originally published in Venture Capital Research on Medium, where people are continuing the conversation by highlighting and responding to this story.

Most VCs have never worked at a startup. In the UK just 8% of venture investors have startup operational experience, according to data from a 2019 Diversity VC report. In the USA the fraction is higher, ranging from 20% to 30% across a random sample of funds. (It’s double that rate at top-tier firms.)

At first sight of this data one might think that we need more ex-operators working as venture investors, especially in the UK & EU where this element of diversity lags behind the more developed US ecosystem. However, it’s worth recognizing that operational experience doesn’t necessarily make a better VC, as a few notable investors have pointed out before, and as one preliminary analysis on the topic highlighted.

No doubt, operational chops have the potential to translate into more successful venture investing. A recent paper by economists Paul Gompers and Vladimir Mukharlyamov provides some evidence of this. In their research they found that founders who became VCs after a successful exit of their company do about 28% better than professional VCs at investing in successful companies. (Success was defined as a portfolio business listing on the stock market or being sold at a value higher than the total funding it received.)

The paper also attempted to untangle what contributed the most to this difference in performance. The researchers found that the outperformance wasn’t just down to successful founders having better deal flow or joining better VC firms when they became investors. The key factor, perhaps unsurprisingly so, was that these founders somehow added more value to their portfolio companies.

The paper doesn’t identify the mechanics of the value-add of successful founders, but it suggests that it may include a mix of halo effects (where people take interest in a company because a successful ex-entrepreneur name is associated with it), network value (where a successful founder helps recruit top talent or customers), and operational know-how (where a successful founder uses their experience to guide new startups through critical challenges.)

Tellingly, the analysis of Gompers and Mukharlyamov also found that VCs who did not exit successfully as founders actually did worse on their investments by 17% compared to VCs who had never worked at a startup (the “career VCs”).

Just because an investor was a founder or startup executive doesn’t mean that they’ll become better VCs. They not only have to be a good fit for an investing career, but the underlying quality of their experience, as well as how they leverage their credentials and networks to support portfolio companies matters more than the outward appearance of previous success or failure.

What are we to make of these mixed findings? In my experience as a VC-turned-operator, and work over the last two years as an angel investor, I’ve come to the conclusion that VCs don’t always need strong operational chops to do well by their portfolio companies. Instead, what they always need is strong operational empathy. What exactly does this mean?

Frank Slootman (currently the CEO of Snowflake) is a revered operator and had an IPO under his belt before he tried his hand at investing. He later on recognised that being a VC required something else. Here’s how he recounts his investing experience:

“…I joined some of my VC friends in investing in early-stage companies, and I served on a few boards. I admit that I’m not the best board member: I get impatient and struggle with the hands-off relationship boards are supposed to have with management. As I had learned at Greylock, I have the temperament of an operator, not an investor/advisor.”

This idea also surfaced in a conversation I had with VC recruiter Hazel Mulhare. For over a decade she has helped startups recruit top executive talent and she also helps venture funds identity talent across ex-operator and career VC groups. Mulhare’s observation is that there’s a mindset shift required for effective investors. Once they back a founder with an idea, they shouldn’t rock up trying to “fix things”. They should respect that the startup will work through its problems and proactively empower the company in a different capacity, one that involves asking the question: “How can I best support from the sidelines?”

This approach is a key part of operational empathy. It involves trusting and empowering operators to be operators, while seeking out the opportunity to support them in a capacity that considers the complexity and challenges of building a company.

Naturally, it’s easier for ex-operators to have operational empathy. It’s perhaps why tech ecosystems will always benefit from having some investors who have operating experience. Working in a company gives you more context than any investor could ever have looking from the outside-in. Teia Negoita, who worked as Series A investor before joining Meta as a Product Marketing Manager, put it to me this way:

“An investor thinks they are involved because they receive company updates but actually, they’re quite a few steps removed. They only see outputs. They’re not seeing how everything works…Everyone in a startup is an expert in their respective fields while investors tend to be generalists.”

This puts a cap on how effective an investor can be in providing direct operational support. A startup would rather hire an expert operator in product, sales, marketing, or some other function than rely on a time-starved VC to help them figure out an operational problem.

That said, there are some areas where a VC can be supportive by getting more involved in a company. “Even with so much written on the topic,” ex-VC Meri Beckwith and now the founder of Lindus Health told me, “there are still unwritten rules that a VC background helps you navigate.”

These rules mostly relate to raising capital, an area where VCs have more expert knowledge than a startup. In such instances a VC can get more hands-on to help close an investment round but again, operational empathy requires the acknowledgement that it’s the startup that closes an investment round, not the investor.

​​Ultimately, operational empathy is about putting yourself in the operator’s shoes. If you were a founder or startup executive, you wouldn’t want a generalist investor mindlessly espousing the latest startup advice they had consumed from a twitter thread. Nor would you want them to dominate function-specific decisions in a startup when they only see a fraction of what goes on in your business. Yet, you would welcome an investor’s support in areas where they have seen more than you have, or areas where they have access to knowledge and networks that you lack.

Investors with operational empathy respect the boundaries of operating versus investing, and tactfully contribute to a startup from the sidelines without interfering excessively. Rather than opine without due regard for what it really takes to build a company, investors with operational empathy know when and how to add value where it counts. That’s what operational empathy is about, and all investors — whether they worked in a startup or not — can cultivate it.

Not All VCs Need Operational Experience. But They All Need Operational Empathy. was originally published in Venture Capital Research on Medium, where people are continuing the conversation by highlighting and responding to this story.

If you enjoy this post, be sure to sign up to my VC Mastery newsletter.

The venture industry has matured to thousands of firms globally and a multitude of investment strategies. Some firms choose to specialise as a way of being more efficient at finding and winning the best deals, while others choose to be generalists so that they can maximise the number of winning investments they can make.

Both strategies can be successful, but what does the data tell us about the relative performance of a generalist versus a specialist VC? In this post I’ll share a summary of findings from three research papers on the topic and what they mean for VC firms as well as individual investors building a career in the industry.

Some background on this blog post: About four years ago when I was an associate at a generalist investment firm (I now work at a fintech startup and angel invest on the side), I wondered whether it was better to be a specialist or a generalist investor. I wanted to figure out the answer to this question at an individual level and a firm level so that I could shape my investing career more effectively.

After three years of investing across a diversity of areas in venture, I concluded that I was probably a better fit for the generalist approach. This was before I firmed up research on the topic, so it means that my views of the data likely have some bias in favour of generalists.

However, as you’ll see in the remainder of this post, the data so far shows that it’s possible to make either strategy work to your advantage. You just have to be mindful of the costs that come with each approach and find ways to limit their impact. The following table is a handy reminder of the pros and cons of each strategy.

With the above table in mind, here are the key findings across thousands of VC firms, investors, and investments.

1. There is no significant difference in performance between generalist funds and specialist funds after you control for wider market and industry conditions. (PitchBook, 2021)

PitchBook analysed the performance of 451 VC funds in the US with vintages between 1995 and 2015. After controlling for general market and industry performance, they concluded that LPs “should be skeptical of any claims that industry specialisation leads to superior performance.” PitchBook’s analysis found no significant differences in performance between generalist and specialist funds.

On the surface, this data goes against what would logically follow from being specialised. The advantages of a specialist firm being more efficient at reviewing deals in its area of expertise, selecting better opportunities in those spaces, and the higher likelihood of the best founders choosing a VC because that investor understands their market, all point to some form of specialism doing better, right? There’s more to the story.

2. Specialist funds tend to outperform generalist funds but the difference in performance is virtually eliminated if the generalist fund has a team of specialists. Generalist funds with a team of generalists fare the worst in these comparisons. (Gompers et al., 2009)

Economists Paul Gompers, Anna Kovner and Josh Lerner reviewed the performance of 800+ VC firms and 3,500+ individual VCs by looking at the IPO or acquisition success rates of 11,000+ portfolio companies from 1975 to 2003. They found that specialist VC firms outperformed generalist firms and that the difference was statistically significant. However, if a generalist firm was composed of individual VCs who had a variety of industry specialisms, that firm did just as well as specialist firms.

The VC firms with the lowest performance in the data were generalist firms that also had a team of generalist investors. The authors of the paper suggested that this could be the result of generalists failing to identify and win access to promising new opportunities in unfamiliar markets.

It’s worth remembering at this point that although differences in strategic focus appear to play a role in performance in this data set, VC firms with the most investment experience usually outperform those that are inexperienced. Experienced investors have stronger reputations, networks, and are better at identifying and timing great investments in attractive markets. This ultimately translates to better performance across both specialist and generalist firms.

The data from this paper also highlighted that VC firms tend to become more generalist in later years. I think this is because firms that do well usually go on to raise more capital in subsequent funds. To deploy larger amounts of capital meaningfully, a VC fund has to also expand its investable universe. This is achieved by widening the investment remit to cover more industries, as well as investment stages, and geography.

3. Performance has a U-shaped (non-linear) relationship with portfolio diversification. VC firms do best when they are highly generalist (strong portfolio diversification) or highly specialist (strong portfolio concentration). Firms in the middle fare the worst. (Matusik and Fitza, 2012)

The final data to consider comes from the work of corporate strategy researchers Sharon Matusik and Markus Fitza. They looked at 4,500+ VC firms that made investments between 1960 and 2000 and from this, they reviewed some 7,500 data points. This allowed the researchers to explore the links between a VC firm’s portfolio diversification and its IPO success rate. Here’s what they found.

High levels of diversification (in other words being a highly generalist VC firm) generated the highest IPO rates in this dataset while high levels of portfolio concentration (in other words being a highly specialist VC firm) also generated strong returns. Firms with moderate levels of portfolio diversification did worse than those with very high or very low levels of portfolio diversification.

According to the researchers, this U-shaped relationship comes from the fact that there are levels of diversification where the benefits of a particular strategy outweigh the costs and vice versa.

For example, a highly specialist firm is more advantaged by its depth of knowledge than it is disadvantaged by being slightly more rigid in dynamic markets. Meanwhile, a generalist firm with a highly diversified portfolio is more advantaged by its exceptionally broad stock of knowledge and experiences than it is disadvantaged by having shallower knowledge in each area of investment. Firms in the middle fare the worst, since they don’t have knowledge that’s broad or deep enough to offset the costs of being a generalist or a specialist.

There are some more nuances to note in this data. It appears that VC firms that invest at the earliest stages benefit the most from high levels of diversification (see chart below). One possible reason for this is that operating in areas of high uncertainty requires a broader and more diverse stock of knowledge. Such diversity facilitates better problem solving relative to the proverbial person with a hammer who sees every problem as a nail.

Also notice in the chart above that late-stage investors have a flatter curve, which suggests that diversification is less critical for firms with a more mature portfolio. Moreover, late-stage investors with average levels of diversification appear to outperform early-stage investors who are also at the mean level of diversification.

Finally, the authors of this analysis found that the link between performance and levels of diversification was weaker when a firm had a good number of co-investors. Presumably generalist VC firms that co-invest with specialists do better than those that don’t.

What does all this mean for VC firms and individual investors?

Implications for Venture Funds

Overall, it seems to me that the best approach is to be a highly generalist firm (particularly at pre-seed/seed investing) with access to a team of specialists (whether that’s in-house, external, or through specialist co-investors). This gives a VC firm flexibility to invest in the most promising areas and to allocate capital efficiently in those areas with input from specialists. There are many firms that take this approach but one example I particularly like is that of Village Global. Here’s how they articulate their strategy.

I also think that VC firms that employ a thesis or a thematically-driven approach are also essentially generalists but with in-house domain expertise. These firms identify a few “themes” or “theses” that they can specialise in, yet, they can still be highly generalist and broad enough to cover investments in a variety of sectors, verticals, and business models. One prominent firm that takes this approach is Union Square Ventures. Here’s a quote from one of the partners at the firm (Fred Wilson) on why this works for them.

The key takeaway here is that a strong and clear direction of investment strategy is critical and that some kind of focus matters, even for generalists. In contrast, the worst approach is to be unclear about where a firm stands and why. This lack of clarity dilutes efforts, makes deal sourcing reactive and ineffective, and probably won’t resonate with any founder or LP.

Implications for Individual Venture Capitalists

My conclusions here are slightly different. If you’re early in your investing career, you benefit from initially broadening your stocks of investment knowledge by seeing and doing lots of deals across sectors (and perhaps even across investment stages). This will help you figure out what areas have the potential to be a good fit for you. The alternative approach is to specialise early in your career. However, that comes with the risk of never getting exposure to areas of investing that could have been a better match for you.

In later years, if you discover a preference for a specific industry or vertical, you could take that up as an area of focus at your fund. You may also choose to join a generalist fund elsewhere but as a specialist. In fact your chances of being hired are stronger if you bring new specialisms to an investment team compared to if you simply try to join as another generalist. Alternatively, if you enjoy being a generalist, you could join an early-stage fund since that’s where high levels of diversification are most advantageous.

If you enjoyed this article and would like to add to the discussion, feel free to comment directly on this post or on this tweet.

Ps. What do LPs prefer? Here’s a survey finding from a report by Atomico.

Generalist vs. Specialist VCs: Data from 4,000+ firms and 10,000+ investments. was originally published in Venture Capital Research on Medium, where people are continuing the conversation by highlighting and responding to this story.

The world emits about 50 billion tonnes of greenhouse gases annually. In contrast, the average UK citizen contributes roughly 10 tonnes each year to the grand total. This represents one part in every five billion parts of global emissions. It’s one fifty-millionth of a percent (0.00000002%). In other words, it’s a rounding error and practically negligible, according to some people.

Given how tiny our personal carbon footprints are, it’s easy to dismiss individual efforts. It’s also common to feel despair about how much influence you can really have on climate change — after all, what meaningful difference can a ‘one fifty-millionth percenter’ make in the grand scheme of things?

In recent months I’ve come to appreciate that our personal action matters more than we realise. In fact if you combine a lower personal carbon footprint with climate activism, the impact you can have is hugely meaningful. Here’s how I see it.

Every tonne of CO2 matters

First, let’s bring to life what 1 tonne of CO2 really looks like. This is roughly the amount someone in the UK emits every 5 weeks. Below you’ll see how much volume you can fill up with just 1 tonne of CO2.

Now imagine dumping one of these cubes or balls outside your home every five weeks for 60+ years. Would it be something you’d ignore? Is it really that negligible? Or, does this volume of CO2 actually count and would you be compelled to do something about?

What you do is magnified negatively or positively

Our collective impact on the planet is unquestionable. We already have irreversible climate damage and events such as the recent 1-in-a-1,000-year heatwave in Canada — which was 150 times less likely to happen without human influence — are a testament to this. But surely our individual action is so tiny that there’s no point trying, right? This statement is wrong on two accounts.

1. Negative Knock-on Effects

In the Jenga example, small changes appear harmless until they aren’t. This is also the case with climate. Someone’s pollution seems harmless but in the background, it’s linked to a collective instability that each one of us — to varying degrees of course — is responsible for. So although one person’s footprint will always appear negligible in isolation, its systematic influence — which accumulates as time goes on — isn’t. Tiny changes can drive harmful butterfly effects.

2. Positive Knock-on Effects

The things you do about climate can also have wider positive knock-on effects. For example if you decide to live an eco-friendly life, your friends will take notice and ask about it. This won’t necessarily turn them into climate activists, but in learning about your choices, your friends (and their friends, too) might consider doing something good for the planet.

You can also multiply your impact through activism. And when I say activism, I don’t just mean just going out on the streets and campaigning — although this is certainly a proven means of enacting change. You can be a climate activist in other ways.

For instance, you can amplify your impact when you vote for and support politicians who are serious about climate change; you can influence sustainable investments with your wallet when you spend money with climate-positive businesses; and finally, you may also choose to put your talents and time to work at an employer that’s aligned with a greener future, just like I did when I joined tickr.

The challenges of climate change are undeniably epic. Governments and corporations will have to work hard together at a global level to avert disaster. However, what’s clear to me now is that there’s no reason to feel despair about how much you can do on personal level.

All our carbon footprints count. Who we vote for and where we spend our money and time all matters. And although our individual actions might not count for much in isolation, the reality is that they often go further than we realise — certainly much further than our ‘one fifty-millionth of a percent’ would suggest.

Originally published at https://michaeltefula.com on April 25, 2021.

‘How to Avoid a Climate Disaster’ is a fantastic read for people who are new to climate change. To my surprise, Bill Gates is also relatively new to the space (although he’s ahead by over a decade compared to most people!) He changed his mind on the topic in 2006 and I believe his newness to the topic led to a more accessible climate book. In the introduction he writes:

“Things changed for me in late 2006 when I met with two former Microsoft colleagues who were starting nonprofits focused on energy and climate. They brought along two climate scientists who were well versed in the issues, and the four of them showed me the data connecting greenhouse gas emissions to climate change.

I knew that greenhouse gases were making the temperature rise, but I had assumed that there were cyclical variations or other factors that would naturally prevent a true climate disaster. And it was hard to accept that as long as humans kept emitting any amount of greenhouse gases, temperatures would keep going up.

I went back to the group several times with follow-up questions. Eventually it sank in. The world needs to provide more energy so the poorest can thrive, but we need to provide that energy without releasing any more greenhouse gases.”

— How to Avoid a Climate Disaster (Hardback version, Page 7)

Bill Gates does well to avoid technical jargon in the book, and balances pessimistic realism with reasons to be optimistic. This makes the book an easy and encouraging read.

Below are some of the highlights I made in the book but the full title is worth reading if you’d like to learn more about climate change and what we can do about it.

• We add 51 billion tonnes of greenhouse gases to the atmosphere annually. That’s about 1 billion a week. The warming impact is equivalent to detonating 1 Hiroshima-sized nuke every second of every day, all year round.
• Greenhouse gases are roughly composed of CO2 (76%), methane (16%) and nitrous oxide (6%). But even though methane and nitrous oxide are a smaller portion of the total, their warming impact is significantly larger. Methane causes 28 times more warming per molecule in 100 years compared to CO2. Meanwhile nitrous oxide causes 265 times more warming per molecule over a century. (See Box 3.2, Table 1 here.)
• The fossil fuel energy industry is huge and will be resistant to change. It generates $2–3 trillion of revenues a year. That’s like the GDP of a rich country. For example it’s more than the GDP of Canada or Italy, and close to that of the UK.
• The energy sector needs to urgently invest in the research and development of clean energy technologies given the climate emergency we face. However, it only invests around 0.3% to 0.4% of its revenue in R&D. The electronics and pharmaceutical industries do over 30 times that amount, with 10% or more of revenues invested.
• A small rise in global warming seems harmless but it isn’t. The Paris Agreement aims to keep it below 2.0°C relative to pre-industrial levels and ideally below 1.5°C. But if we go from 1.5 to 2.0 it won’t just be 33% worse. The damage could be 100% worse or more since climate is a non-linear system. (On a related note, researchers estimate that based “on current trends, the probability of staying below 2°C of warming is only 5%.” The temperature scale below from a book called ‘The Madhouse Effect’ shows what the impact of this could be.)

• Oil is so cheap that it’s cheaper than a soft drink. In 2020 a barrel of oil cost around $40 — that’s just 25 cents per litre. In pound sterling today that’s 18 pence, while a litre of coke at Tesco costs £1.45. (Notice that even though oil is cheap today, the price doesn’t reflect the potentially irreversible costs of climate change.)

• Around 50% of global CO2 emissions come from just 15% of the world’s countries. These are China (27%), USA (15%), EU and the UK (10%). (Bill Gates framed this slightly differently in his book, noting that “nearly 40% of the world’s emissions are produced by the richest 16% of the population.”)
• The major sources of greenhouse gases are listed below (from page 55 of the hardback version of the book).

• Cement is especially worth highlighting. The following statistic isn’t from Bill Gates’ book but it’s telling nonetheless: “If the cement industry were a country, it would be the third largest emitter in the word,” according to Carbon Brief.
• If we transition to clean energy for all our electricity, we’d have to pay a bit more in the short term. For Americans this would be around 15% (a Green Premium of $18/month for the average home) and around 20% for Europeans.
• Transmission and distribution make up a considerable portion of the cost of electricity. Bill Gates cites that this is more than a third of the final cost. The number I found for the UK is around a fifth.
• Although solar cells are almost 10 times cheaper since 2010 (which is fantastic progress), they are starting to reach their efficiency limits. The best solar panels convert less than 25% of sunlight into electricity and the theoretical limit for current technology is around 33%.
• Lithium-ion batteries might also be reaching their peak in terms of how long they can last and the number of charge-discharge-cycles they can go through. Bill Gates believes that we can probably make batteries 3 times better but we’re unlikely to get a 50x improvement.
• Nuclear energy sounds scary. People often cite accidents like Fukushima (2011) and Chernobyl (1986) as reasons for why we shouldn’t use it for electricity. However deaths per terawatt hour (“TWh”) are far less for nuclear (0.07 people) compared to coal (25 people) or oil (18 people). (Ps. The UK uses around 1 TWh in a day.)

• The UK is currently the biggest user of offshore wind energy but China will likely take that position within a decade. (Ps. Offshore wind powers around 10% of the UK’s electricity and could be cheaper than gas by 2023.)

• Carbon capture is an exciting new technology that can remove CO2 from the air directly. However, it’s technically challenging and expensive. This is because CO2 makes up just 1 molecule for every 2,500 molecules in the atmosphere (or 3.8 per 10,000).
• Americans waste 30–40% of their food while in the UK it’s about 16–18%. (For Europe it’s 20%.)
• Since 1990 the world has lost an area of forest that’s almost 4 times the size of Germany. That’s around 1.3 million square kilometres of forest cover.

• The poorest countries will suffer the most from climate change yet they are the least responsible. For example, Africa accounts for just 2–3% of global emissions but it will be the hardest hit by climate change. This BBC article covers why this is the case.

Originally published at https://michaeltefula.com on March 23, 2021.

Most people believe that only the Bank of England can create money. Many people also believe that high street banks can only lend money if they have enough savers’ deposits to lend from. But as I’ll explain shortly, both views are mistaken.

It’s true that once upon a time that’s how things worked. A central bank like the Bank of England had a monopoly on money creation and prior to 1931, this money was pegged to gold reserves.

Meanwhile, high street banks could only hold bank deposits in the form of savings from customers. And since savers rarely need all their money at once, banks would profit by lending out a portion (or multiple) of customer deposits at a higher interest rate than that offered to savers.

This isn’t how money works in the UK economy today. The reality is stranger than intuition would suggest. I certainly wouldn’t have believed the mechanics either had I not read a full account of the process in a 2014 bulletin published by the Bank of England itself.

It turns out, the Bank of England hasn’t got a monopoly on money creation. Commercial banks such as HSBC, Barclays, and Lloyds all create new money every time they issue a loan. They create this money as a digital entry that represents a new bank deposit for the borrower. So if I take out a loan of £1,000 from a bank, here’s what roughly happens:

1. The bank creates a new digital bank balance of +£1,000 in my account. It doesn’t need to draw from customer savings to create this balance. It just makes a digital entry.
2. The bank recognises a new ‘asset’ in its accounts because it now expects a future repayment from me that’s worth £1,000.
3. The bank also recognises a new matching obligation (or liability) of £1,000. This is because it has made me a promise—an I owe you (“IOU”)—that I can go to a cash machine and withdraw £1,000 in hard cash if I wanted. I can also send some or all of this digital IOU to others as payment for goods or services. This would transfer the IOU made by the bank to me, to an IOU the bank makes to another individual or business.
4. When I repay the loan, the new money that was created by the bank is cancelled out and destroyed. Any extra bits I repay as interest are kept by the bank as profit. Such earnings are usually held by the bank as ‘capital’—amounts which ultimately benefit the shareholders and other funders of the bank.

When I learnt about this process I expected these digital bank deposits to be a small fraction of money in the UK. But this expectation is wrong. Digital bank deposits make up the majority of money in the economy.

According to the Bank of England, around 80% of all money in circulation is created digitally by commercial banks. The remainder takes the form of currency (banknotes and coins) and central bank reserves (electronic money that commercial banks hold with the Bank of England). These make up around 3% and 18% of money in the UK economy respectively and only the Bank of England can create them.

If we focus on just the money that people and businesses use (so if we exclude central bank reserves), digital bank deposits make up 96% of money while just 4% is physical currency.

The curious among you will now have more questions about how all this works.

• Do banks create money from thin air?
• Is your personal income in the bank ‘real money’?
• What stops high street banks from creating too much money if issuing loans isn’t restricted by lending from customer deposits?
• Where does the Bank of England fit in? Does it also create money from nothing given it doesn’t hold gold reserves for every pound sterling?
• How do banks fail?

These are all good questions. I got sucked into a rabbit hole of inquiry trying to answer them and the next 3,000 words reveal what I found.

The following section will condense a lot of complexity but if you can get through it, you’ll know more about how money works than 85% of politicians in the UK and probably over 90% of the general public.

We start with some key definitions before moving onto the questions of how money works in practice.

Key Definitions

Money

Money is just an “I owe you” (IOU) that’s easy to move around. It’s a recorded promise to deliver value in the future but critically, if everyone trusts the issuer of that promise, you can exchange that IOU directly with other people for other goods and services.

Early versions of this system can be traced back to English goldsmiths in the 1600s. You could store gold or silver with them and they would issue a “promissory note”. This piece of paper promised that you could withdraw your precious metals from a secure vault at some point in the future. Since other people also trusted goldsmiths, you could trade your promissory note with other people directly for other goods, rather than go back to the goldsmith to fetch your gold or silver for trade. Promissory notes were IOUs that were easy to move around, just like today’s money.

The best IOU object—whether it’s digital or in paper form—does three things well. First, it reliably stores value over the long term. Second, it’s accepted by everyone as medium of exchange. And finally, it’s used everywhere as a unit to measure the value of goods and services.

Modern money achieves all these functions wonderfully. It’s a trusted store of value (so I trust that the Bank of England will protect it from losing its worth); it’s accepted as a medium of exchange by everyone (and more importantly, it will always be accepted by the UK government when I pay my taxes); and finally, everything I buy or sell is valued and denominated in pound sterling, not some other unit of account.

Bank Deposits

A bank deposit is a digital form of money. It’s an electronic IOU that you hold in your bank account. It’s created by high street banks every time they issue a loan and it’s distinct from currency (which we’ll cover shortly.) As I shared earlier, bank deposits make up over 90% of all the money that people and companies hold in the UK.

‘But if this money is created when banks issue a loan, what are my savings then?’ you might ask. We’ll answer that in the questions section later. For now, just know that bank deposits are digital IOUs created by the likes of HSBC, Barclays, and other banks.

When you take out a loan, a bank just makes a digital entry that represents an IOU to you. It’s a promise of value from a bank that you can cash in (literally) when you decide to withdraw that loan as physical money.

These digital IOUs are easier to move around than physical money. So instead of withdrawing cash and paying for goods, you can just wire a portion of your digital IOU to someone else’s bank account. In that instance, what the bank owed you becomes something the bank owes to the recipient of your payment. And since everyone trusts that these digital IOUs can be converted to cash, they are widely accepted as money. The Bank of England also provides further security: If a bank fails, up to £85,000 of your bank deposits are guaranteed by the government.

Currency

This is basically cash. It’s a physical record of an IOU from a central bank. It comes in the form of banknotes and coins that are manufactured and backed by the Bank of England. Only central banks can create this type of money and it represents just 4% of all the money that households and businesses have.

High street banks always have some currency to meet daily customer cash withdrawals. They buy it from the Bank of England using central reserves, which I’ll define next.

However, banks don’t need large holdings of currency because it’s unlikely that all customers would ever want to withdraw their full bank deposits at the same time. In addition, most people and businesses prefer the convenience of digital bank deposits. Currency is falling out of favour as you can see from the BBC chart below.

Central bank reserves

This is digital money created by the Bank of England for use by commercial banks only. Since a Barclays can’t create money to pay a Halifax or vice versa, central bank reserves are used as the ultimate settlement medium between banks. These reserves can also be exchanged for currency so that banks can meet customer cash demand.

How is central bank money created? Here’s a quote from a Bank of England handbook that explains the process:

“Unlike banknotes there is no physical cost to producing reserves, the central bank can create reserves simply by pressing a key on a keyboard to credit a commercial bank account.”

In other words, central bank reserves are created digitally, just like the money you have in your bank account. The main difference is that only banks can use this money. We’ll look at an example of this use later on.

Central bank

Each country has a “central” bank that manages its currency. In the UK we have the Bank of England (sometimes known as “the Bank”—with a capital “B”).

One of the Bank’s primary objectives is to help keep the value of money stable and to make sure there isn’t too much or too little of it. Without this stability, few people in the UK would adopt the pound as a medium of exchange or as a store of value.

The Bank can influence the stability of money by adjusting interest rates or creating more money (some people refer to this as “printing money” but the Bank does it digitally). You can read about how interest rates impact the economy here and how creating more money can stimulate spending in the economy here.

Although the Bank of England is owned by the UK government—and it returns most of its profits (around £400m per year) to HM Treasury—it’s independent from it. What does that mean in practice? Here’s a quote from the Bank’s website:

“Independence means that we can promote the good of the people of the UK by maintaining monetary and financial stability, free from political influence.”

Commercial (or high street) banks

This is all the banks you know, such as Monzo, RBS, Lloyds, Barclays and others. They are formally designated as ‘credit institutions’ and have permission from regulators to take deposits, make loans, and create new money.

Now that we know the different types of money and the distinction between central banks and high street banks, we can look more closely at how money works in practice. We’ll do that by addressing six key questions on the process.

FAQ on How Money Works in the UK

Do banks really create money from thin air?

No. This is because money is always linked to an IOU—a promise to deliver value at some point in the future. A brief historical detour on money makes this point clear.

Hunter gatherers didn’t need money (or IOUs) because they provided everything for themselves. But as life got more sophisticated, barter trade emerged. People would now trade various commodities for items they couldn’t get themselves, such as salt in exchange for clothes or spices for weapons.

This method of exchange only worked up to a certain point though. For example, if I needed to trade my ripe tomatoes today but I wasn’t sure what else I needed and when I needed it, my produce would go bad or I’d have to get spices or salt that I didn’t need.

This is where money as an IOU comes in. Rather than barter trade my tomatoes for a random commodity I didn’t need, I could go to a trusted party and get an IOU in exchange for my tomatoes. The issuer of the IOU would then promise to deliver some equivalent value to me in the future. Meanwhile, I could hold onto the IOU or trade it for other goods as long as other people trusted the IOU issuer as well.

This is what modern money enables. It transforms value into an easily exchangeable object that can move across time and space.

So when a bank issues a loan and creates a bank deposit, it isn’t really creating money from thin air. Instead, it’s transforming a borrower’s future ability to repay into an object that can be used today. Repayment is crucial and it’s why banks run credit checks to make sure borrowers can pay back their loans. Banks also charge a high enough interest on loans so that profits from lending can cover losses on the few debts that go bad.

Put in simpler terms, money used to be created by linking it to gold or some other precious object. Today, it can also be linked to someone’s ability to generate value in the future. Therefore money isn’t made from nothing. It’s always linked to value somewhere.

What stops banks from creating as much money as they want?

Commercial banks can’t issue loans and make new money without limit because doing so would put them out of business. There’s a variety of ways this can happen but let’s look at three factors that protect against this.

1. Regulation (by the Prudential Regulation Authority) — Commercial banks are highly regulated and there are rules on how financially sound they need to be. More specifically, if a bank lends too much money, it exposes itself to more risk of losses from loans that go bad. Such a bank would therefore need larger buffers of its own funding (i.e. ‘capital’) that could absorb potential losses. If the bank failed to secure enough of a buffer—as is required by regulators—it could lose its permission to operate. Here’s a recent example where regulators asked Monzo to increase its ‘capital’ to guard against potential losses.
2. Market forces (from other banks, businesses, and households) — A bank can only lend money if it has borrowers to lend to. And not just that, but the pool of credit-worthy borrowers is limited. So even if a bank finds enough good borrowers, it has to compete for them against other banks. One way it can do this is to offer loans at low interest rates. Yet, if the rates are too low the bank would risk making losses that could put it out of business. Lending (and money creation) is therefore limited by the opportunities a bank can find to lend money at a profit.
3. Interest rates (set by the Bank of England) — Another factor that influences the amount of money creation is the interest rate the Bank of England pays on central reserves held by commercial banks (i.e. the “Bank Rate”). You can read more about this here but the basic principle of this factor is this: If there’s too much money and lending in the economy, the Bank of England can raise the Bank Rate. This change usually flows through to the wider economy such that banks now have to pay more interest on savings and in turn, they have to charge a higher interest rate on loans. If loans are more expensive, less people will borrow money and that ultimately limits the creation of new bank deposits.

Are the savings and wages in my bank account real money?

Yes. They are real money to the extent that whatever deposit you have in your bank account, other people and businesses can accept it as payment.

You might now wonder: “My employer pays a salary into my bank account without taking out a loan. They have accumulated their own deposits by selling products or services. So if my salary isn’t linked to a loan, where do the bank deposits from my employer come from?”

I couldn’t find a definitive answer to this in my research but here’s what I believe is happening. If it were possible to go back in time and fully trace the family tree of where a bank deposit in your account came from, you’d probably find that a loan sparked its creation.

Consider the following facts. At the time of writing this blog, the private sector (excluding banks) in the UK held around £3 trillion of money. Guess how much debt the private sector has? Put another way, how much money do people and businesses owe to banks? When I wrote this it was around £3 trillion also. The chart below shows what these figures looked like historically.

Remember, money is an IOU and the majority of bank deposits in the UK are naturally linked to debt. That debt is then transformed into digital deposits that spread throughout the economy. This includes the money sitting in your account today.

How do payments between banks work?

Since each bank creates money when it issues loans, there has to be a way to use the sums created at one bank as payment to another bank account. This happens in two ways.

First, banks can offset payments against each other. For example if I send £100 from my Monzo account to a Barclays customer, there will also be payments flowing in the other direction that can offset what’s owed.

In our example, let’s assume a different Barclays customer has sent £150 from their account to another Monzo user. We now have a situation where the IOU Monzo had with me (it owed me my £100 of savings) has been transferred to an IOU it has with Barclays.

Conversely, the IOU Barclays had to its customer of £150 has now been transferred to an IOU Barclays has to Monzo. Still with me? Here’s a visual representation of this.

Given these exchanges, the two banks can just net off the two amounts to arrive at a net obligation. In this case, Barclays has a net IOU of £50 to Monzo (and in turn, Monzo has that IOU to the customer who was sent the £150).

Notice that Barclays can’t just create new money to settle the obligation it has to Monzo. It has to use another resource. This is where the second settlement method between banks comes in.

All commercial banks have an account with the Bank of England that holds their respective central bank reserves. Remember we defined central bank reserves as money that the Bank of England creates specifically for other banks to pay each other. We’ll come to how this money is created shortly, but for now, just know that all commercial banks have a portion of their ‘worth and savings’ (in other words assets) in the form of central bank reserves. They can draw from this balance to settle obligations with other banks when the offsetting method isn’t sufficient.

In our example, all Barclays would now have to do is ask the Bank of England to send £50 worth of central reserves from its account to Monzo in order to settle its obligation.

I wanted to write more about this process because there’s more to it. But given the 4,000 word limit I set myself we’ll have to stop here. For those who are super curious though, here are some quick facts about bank settlement systems in the UK and the relevant links where you can learn more.

• High value transactions (on average £1m+ or for things like buying a house) don’t happen with the offsetting system I described earlier. Instead, they go directly through a Bank of England accounting system called ‘real-time gross settlement’. These payments are dealt with one-by-one but through a ‘clearing house automated payment system’ called CHAPS, which draws from central bank reserves.
• In 2019 CHAPS payments were just 0.5% of the volume of payments in the UK (around 192,000 transactions a day) but they represented 92% of all the sterling value (£83 trillion for the year or £330bn every working day.)
• You might have heard of payment technologies like Faster Payments or Bacs. These systems are not operated by the Bank of England and deal with smaller value transactions. They allow banks to offset amounts with each other first, and then the final net obligation is sent to the Bank of England for settlement with central bank reserves through its real-time gross settlement system.

How do commercial banks get central bank reserves?

High street banks accumulate central bank reserves in three ways.

First, they can receive payment from other banks in the form of reserves—we covered this in the previous section.

Second, and more commonly, banks can borrow reserves from the Bank of England for a six-month period. This lending doesn’t come for free though. Commercial banks must offer the Bank of England a high-quality asset that it will hold until the loan is fully repaid. This ‘collateral’ is typically a high quality financial asset such as a gilt (i.e. a government bond — this is an IOU of future payments from a government to the bond holder). The diagram below from the Bank of England visualises this process.

Finally, commercial banks can get more central bank reserves by selling high quality financial assets to the Bank of England. Again, these are usually government bonds or other low-risk assets.

How do banks fail?

There are two main ways a bank can fail.

First, if we all decide to go to a bank and withdraw all our deposits as cash today, the bank would face a ‘liquidity crisis’ and go under. This is because no bank actually keeps everything it owns in the form of central bank reserves or currency. The majority of bank assets are in a less liquid form (e.g. its loan book and other investments) but so long as people have confidence that the bank’s finances are sound, this liquidity crisis—or ‘ a run on the bank, ‘ as it’s better known—is unlikely to happen.

The second way a bank can fail is if it ends up in a situation where the value of everything it owns (its assets) falls below the value of everything it owes (its liabilities.) This can happen if a bank issues loans recklessly to lots of borrowers who fail to pay back what they owe. In that instance, the following would happen:

1. The bank would have more liabilities than assets.
2. It would be considered ‘insolvent’.
3. Investors who originally funded the bank (by buying its shares or lending it money) could force it to shut down and sell everything it owns so that they could recover their capital.

That’s all for now on how money works in the UK. I left out a lot of detail to keep the blog readable but I look forward to discussing this with readers and friends.

Bonus question 1: Why isn’t currency linked to gold anymore?

The ‘the gold standard’ was abandoned because it was too rigid. Fiat currency — so currency that isn’t pegged to an underlying asset — gave governments more flexibility in managing their money supply and ultimately, their economies.

In fact some economists argue that the gold standard made the great depression in the 1930s worse. Meanwhile the UK fared better because it was able to control its money supply without being tied to how much gold was available.

All told, pegging currency to gold risks more economic volatility and many governments prefer to have more control of their money supply than what’s possible with a commodity-linked currency.

Bonus question 2: If currency isn’t linked to gold, how can it be worth anything?

It all comes down to trust. And currency and central bank reserves are currently the most trusted IOUs you can get. They are a promise of value from the central bank and ultimately the government.

Moreover if I have £10 today, I trust that the Bank of England will always honour that value in whatever type of money they create in the future. I also know that the government will do what it can to help maintain its value over time and that it will always accept currency as payment for tax.

This — along with wide public acceptance of its worth — is what makes fiat currency valuable, even if it isn’t linked to gold or some other commodity.

Ps. Other interesting things I discovered during my research.

• How does one interview for the job of Governor of the Bank England? Here are the answers Mark Carney had to give to a selection panel when he applied for and the job.
• What’s the most common banknote in the UK? The £20 note accounts for almost half of all banknotes in circulation in the UK economy both by volume and value.
• Will the Bank of England ever make central reserves available to the public and non-bank private sector? Possibly. Here’s a discussion paper from the Bank that considers the opportunities and challenges of a widely used central bank digital currency.

Originally published at https://michaeltefula.com on March 14, 2021.

This month I’m excited to join the consumer fintech startup tickr, and since a few friends have been curious about the move, I thought it would be good to share a brief note on what got me here.

Technology Innovation and the Gains of the Future

My fascination with technology led me to venture capital. Here I got to see up close just how beneficial and disruptive technology can be, and how that trend is accelerating.

For instance, just this summer, I trained an AI model on legal text and almost immediately it could turn legalese into plain English. Moreover, despite being a mostly non-technical person I could wield this technology to do something no one thought was possible a few years ago.

Many advances are happening in other areas but somewhat worryingly, the capital gains of progress are more concentrated than ever. So much so that it isn’t hard to imagine a world where the wealth generated by innovation always accrues to a few, while the livelihoods of many become increasingly fragile.

Since that’s a world I don’t want to live in I wondered: what are the various ways you can help people become more invested in the gains of the future?

Climate Action and Planetary Wellbeing

I have to admit, I’ve been shamefully ignorant about the planetary risk future generations face because of our doing.

As a VC, I was tasked with finding companies that had hockey-stick growth potential. Yet as a citizen of the world, I’d paid little attention to the surest hockey stick of all: the dramatic rise in CO2 emissions and subsequent risk of extinction-level events.

To turn things around we’ll need massive policy and coordinated global action. However, I’m also confident that as individuals we can all do a little bit more to drive positive change, however small that may be.

The question for me here then became: given my skill set, what can I do?

Financial Innovation and Why I Joined tickr

Technology is inseparable from the financing that drives it. Meanwhile climate action cannot be effective without innovation across technology and finance. It is with these three interests in mind (tech, climate, and finance) that I decided to join tickr — a startup (and B-corp) that has developed an impact investment platform that’s accessible via a mobile app.

tickr is an impact-first company that makes it easy for first-time investors to save for their future while doing good. Through its app, consumers can benefit from the growth of businesses that positively impact the well-being of people and the planet.

I’ve joined as a Finance Developer, which is akin to a Finance Manager, but with scope to support the team in developing their financial infrastructure, product range, as well as international expansion.

Although my transition from VC will take some getting used to (and I plan to return to VC someday), I’m more than thrilled to join an exceptional team that’s helping bend the arc of finance to a more impactful future.

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After four years in venture capital I was taken aback when I realised I’d never heard any one ask, ‘what’s the purpose of venture capital?’

The reason for this probably has a lot to do with the question being as fluffy as the answer seems obvious. The purpose of venture capital is clear: to generate financial returns by funding innovation.

But this statement — at least to me — felt just as two-dimensional (and as much of a cop-out from wider responsibilities) as the Friedman doctrine of profit maximisation. In his words,

“…there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game…”

We’ve seen this single-minded pursuit of profits fail many times over. From the Volkswagen emissions scandal to the largest bankruptcy of all time when Lehman brothers failed in 2008, thanks to its involvement in dodgy mortgage loans.

Harm of a similar magnitude is possible (and frequent) in other areas where purpose takes a less mindful and less systematic approach. Examples in venture capital are plenty enough that both insiders and outsiders are starting to call out issues that have long been ignored.

A scathing New Yorker article on the industry sums up the issue in a quote from the serial entrepreneur Steve Blank, who’s been in the technology business since the late 70s and helped pioneer the lean startup movement:

“I’ve watched the industry become a money-hungry mob. V.C.s today aren’t interested in the public good. They’re not interested in anything except optimizing their own profits and chasing the herd, and so they waste billions of dollars that could have gone to innovation that actually helps people.”

And so in thinking about the nature of venture capital — and this is mostly to help me operate more purposefully in the investment world— I’ve drafted a personal model of purpose in venture.

This is what it looks like visually.

The model can also be summed up in one sentence:

The purpose of venture capital is to responsibly generate returns for limited partners by funding innovation and serving entrepreneurs.

Inherent in this statement is a trinity of sorts, which we can explore further by looking at the role of a venture capitalist (“VC”) in the context of: (1) a duty to limited partners (“LPs”), (2) service to entrepreneurs, and (3) a responsibility to society.

LPs: they are a VC’s shareholder

The first role of a VC is a fiduciary duty to LPs — the providers of capital which VCs invest.

LPs trust that VCs will be as dutiful a custodian of funds as they would with their own money (this is also why LPs often ask VCs to personally invest in the fund — aka ‘skin in the game’) and that they’ll generate worthwhile returns.

In this way, LPs are a VC’s shareholder.

Entrepreneurs: they are a VC’s customer

Despite the power dynamic that has entrepreneurs pitching VCs more often than VCs pitch founders, the entrepreneur has always been, and always will be, at the heart of venture capital.

VCs exist to serve founders much like businesses exist to serve customers. VCs sell a product (mostly capital, with some value-add) in exchange for equity. And in this way, entrepreneurs are a VC’s customer.

Fred Wilson has a fantastic blog post on this topic here.

Society: they are a VC’s village

I left this one till last not because it’s the least important but because it’s the glue that holds everything together.

Entrepreneurs and investors thrive precisely because of a functioning society and a favourable environment within which to operate.

Democracy, public infrastructure, appropriate business regulation, and robust healthcare and education systems are a few examples of societal assets that make it possible for innovation and talent to thrive.

And since VCs (and everyone else for that matter) gain handsomely from a healthy society, there’s a duty to pay it forward by doing things that make society better.

So in this way, society is a VC’s village.

Managing the Venture Capital Trinity of Service

Working for LPs and entrepreneurs while being a responsible citizen comes with competing tensions.

Just as a company can serve shareholder interests at the expense of its customers and vice versa, so too is the case when it comes to VCs balancing their relationship with entrepreneurs and LPs.

We see this tension play out in overly aggressive term sheets at the expense of long term cap table health and founder motivation, or in excessive founder friendliness at the expenses of corporate governance.

And just as a business can generate financial returns at the expense of positive societal outcomes and vice versa, so too is the case when it comes to VCs balancing profit and responsibility.

We see this tension play out when VCs chase returns by investing in companies with questionable practices and products, or when a positive impact approach does some good but leads to unsustainable ventures.

Thankfully these tensions are not insurmountable. Venture capital has still managed to help generate high societal returns so far and it will continue to do so, as evidenced by the technology and services we all benefit from today.

And one of the joys of being an investor is having the opportunity to profitably take part in that process, all the while leaving society a little bit better off — or so I hope!

Special thanks my startup and VC friends, Adit, Anu, Audrey, and Matt, who shared their thoughts on this post.

What’s the Purpose of Venture Capital? was originally published in Venture Capital Research on Medium, where people are continuing the conversation by highlighting and responding to this story.