The Three Types of Capital Every Startup Needs

Today I am going to write about the three types of capital every entrepreneur needs. Financial capital, human capital, and social capital.

Its helpful to define what capital actually does, regardless of what type it is.

Simply put, capital yields income and other useful outputs over long periods of time.

Financial capital is pretty straightforward – It’s just money. I’ve talked about this in the past – you can read about money and the Funding Escalator here.

Today I want to discuss the two other forms of capital, because they are hugely important and sometimes we forget just how much we need them.

First, let's look at Human Capital

The Nobel prize wining economist, Gary Becker said that investments in things such as health care, education, and training are investments in capital. They improve health, raise earnings, and add to a person of his or her lifetime.

I think about human capital as learning (there are some ‘lifestyle’ aspects too). The reason I call it learning is because things like education and training make us immediately think of Universities and schools. This is dangerous because we then think ‘I’ve done school’ or ‘I’ve already been to university’, and we fall into the trap of thinking we know all we need to know. 

Universities are great places to learn, but there are other ways to add to what we've learnt

The reality is, we can get human capital from lots of places. From the perspective of a start-up, it is most commonly associated with angel investors. 

Experts describe human capital as the set of productive knowledge and skills that belong to angel investors. This knowledge and set of skills is a possible source of innovation and idea generation. So while we can get human capital in a formal sense, the real value for entrepreneurs is actually in the informal context. 

What I mean by that is that innovation and idea generation are things that come from discussing and thinking about a problem and not from sitting in a lecture theatre listening to someone talk about Porter’s Five Forces.

Its just brainstorming.

In my entrepreneurship courses I get students to think of a problem and I give them a really poor solution (and look like a twit!). They usually say something like ‘that won’t work’, but they start talking about what might work. Eventually they come up with something that’s pretty innovative. 

This is human capital at work!

The other type of capital, which I think is equally as important, is social capital. 

Social relationships are important for angel investors and entrepreneurs.

Sociologist Ronald Burt says that social capital is “friends, colleagues, and more general contacts through who you receive opportunities to use your financial and human capital.”

The important part of social capital is the connections between actors. Angel investors, through their work experience, have lots of different contacts that they can leverage. These are the relations that have been built up over their careers. 

Its important to recognise that this is more than just a LinkedIn profile with thousands of connections (though LinkedIn is obviously valuable). The relationships are usually deep, trusting, and well-established. Angel investors can use these connections to add value to a firm. This might be something like a potential supplier or customer, or even a distribution channel. 

To give you a practical example of social capital in use, I had a client (many years ago) who had a product that he wanted to export to China. Unfortunately, he didn’t have any contacts that he could use, but managed to find an angel investor who had pretty good experience working in China. 

The angel worked in a related industry and had developed a network of friends and colleagues in China. A couple of those people happened to own a company that sold products to the same customers that my client was trying to sell to. And that lead to a distribution channel, which led to sales etc. 

An angel investor’s human and social capital is all about adding value to the firm (after all, they invest in the firm to help in grow). But how does it add value? Glad you asked, there are four ways.

An angel’s human and social capital adds value through four roles – strategic, monitoring, resource acquisition, and mentoring. These are actually really well established in the research. 

I’m not going to define each of these, but I the lead image for this post provides examples of an angel investor’s roles.