Paths to $5M for a startup founder | Hacker News Reader

Paths to $5M for a startup founder

gabrielweinberg.com

108 pointsicey43 comments

Two co-founders that give up a total of 15% - 25% to raise $500k - $1M (ideally from well known investors) and never take another dime of investment. That seems like the best balance all things considered.

Your odds of success are much higher, and your opportunity to exit (if you want to) at a low price is still there.

1) You can still accept a relatively low acquisition price.

2) Your share is still 37% - 43%, which is a huge chunk.

3) You have investors that will help with acquisition offers/hiring/partnerships, etc.

4) You can afford to pay for things that significantly accelerate your growth, that you would otherwise shy away from.

5) You're instantly full time (compared with a day job, or consulting work on the side).

6) Other companies/people will take you more seriously because you have investors.

Yeah that sounds good. However I think there are a lot of ideas where a solo engineer could hack out a prototype over 6-12 months and significantly increase the pre-investment value of the company. I guess it depends on the type of product and the hacker's skillset.

As much as it's fun to think about how much you personally stand to gain in an exit, it's all just pie in the sky silliness. Your number one goal should be to maximize your odds of success without constraining yourself to any arbitrary parameter like "no more than 2 cofounders."

Building a profitable company is such a difficult and volatile process that if you try and focus on anything other than just success (e.g. your personal take) you're going to end up shooting yourself in the foot and end up with nothing.

Well put. Would be entertaining to see the same basic maths with an adjustment for probability of success. E.g. "if you feel the extra confounder increases your odds of success 40% ..."

At the end of the day though, I don't think this kind of percentage calculation is useful (entertaining, sure). The human mind doesn't work that way. Similarly I think it's a mistake to bring on a cofounder purely for the fundraising benefits.

The decision to bring on a cofounder should be based on whether they bring critical skills, connections, and if you really want to work with them. IMHO, going with your gut is going to be a much safer bet than putting a number on it and using that to influence your decision.

Agreed, not useful, but entertaining. (Similarly, how about a webapp for simulation of various founder /funding scenarios?)

On the contrary, there are many concrete decision points where this logic should come into play--dispelling your logic was exactly the point of the post. In particular:

--whether to go it alone for a while at the beginning and see if you can make something happen

--whether to bring on more than one co-founder; this may seem like a no-brainier, but I've seen plenty of startups with 3, 4 and even 5 initial founders.

--how much to raise in the first round of financing, which directly correlates to dilution

--what to do with the first round of financing, which directly correlates into whether you will need a second round and how much

--how much control to give up in terms of whether small exits are still on or off the table

I wasn't saying you should constrain yourself at all costs. I was saying you should really look hard at the potential personal financial outcomes that flow from these decisions.

Just so it's clear what I'm trying to say: when you're trying to decide whether to do x or to do y, you should always chose the one that maximizes the odds your company will succeed (whether that means exiting or becoming profitable...) So for example if you're thinking of bringing on another cofounder, quite frankly worrying about dilution is absurd - about 10x more important is whether this person is the right fit, and whether they will increase the chance that your company ends up on the right side of the 1/10 success ratio for startups.

Let me put it another way: startup success is largely a black swan event, so what you should be worrying about over and above everything else is your exposure to that highly improbably event, rather than the particular kind of black swan event you're hoping to get.

startup success is largely a black swan event

I don't think that is true at all, which is probably the core of our differences. Black swan implies a very low probability like 1% or less. On the contrary, I think that when approached well, the probability for startup success is much higher, like 10-40% depending on what you mean by success. I wrote up some of these thoughts at http://ye.gg/failure & http://ye.gg/success

More practically, consider the co-founder example. Worrying about dilution is not absurd because you have so many choices that may have equal outcomes for the success of your startup. For example, you can do a 50/50 split or you could hire a consultant for a specific aspect you need help with or you could do an 80/20 split like I mentioned in the post. All of those scenarios can be with the same person you have in mind, i.e. with all other things held constant. That's the point. People, especially first time entrepreneurs, reflexively pick up co-founders or reflexively go seek financing before they consider their other options.

Scenario 1: You work for six months and then take on Bob and give him 20%.

Scenario 2: You and Bob start working together from day one and it's a 50/50 split.

The same person in an even slightly different situation can behave wildly differently.

It's quite possible that Bob will feel awkward and detached. Never really able to commit, and always feeling that deep down it's really your company. The last thing you want is a co-founder with a morale problem, especially one lurking beneath the surface.

This is the kind of problem that happens when you're trying to have your cake and eat it too.

You are absolutely right. It won't work in every situation, and I've offered advice many times for 50/50 splits. I don't think it's one size fits all. All I'm trying to say is that one should really consider all the options. If there is a real possibility you can get some traction on your own in that first 6 months, I think in many cases you should go for it.

Just to share some industry perspective here, I heard that fewer than 15% of venture backed startups are still operating after 3 years (source: http://twitter.com/dharmesh/status/14067731416 <-- HBR hearsay). Presumably a significant majority of the survivors will never see a founder-meaningful exit and are in the "walking dead" category (as VCs call it).

Even if 1 in 3 see a meaningful exit, that puts us at a 5% win rate (I'm guessing it's more like 1 in 5).

I don't know if you'd disagree, but I'd say that venture-backed startups have a better shot at meaningful liquidity than their bootstrapped kin (given how many people have a vested interest in it and given that VC is a quality filter to SOME degree).

Anyhoo, all that tells me that 1% is a heckuva lot more correct than 10-40% (running the numbers).

I'm with the parent of your comment-- whenever you have the chance to nudge that 1% northward, you should take it.

The difference here is my when approached well language. When good angel investors report their #s, e.g. Brad Feld, Fred Wilson, etc. they say roughly 1/3 return nothing, 1/3 return something and 1/3 are successful to some degree. That's the 10-40% I'm talking about.

If you take the universe of all entrepreneurs, then yeah, it's super small, and looks like a black swan event from the outside. But that's sort of the point of the black swan theory--in the right context the black swan isn't nearly as rare. The context I'm talking about is entrepreneurs who are approaching it well. I know that is nebulous and I'm not defining it well, but roughly the type of people those really early stage angel investors would invest in.

I think he brings up important points that are useful to keep in mind. You don't want to put the cart in front of the horse, but you can't ignore this type of stuff either.

Interesting article, and I think part of the underlying point is that you might be better off building a smaller, less complex company if your primary goal is just to get to some (relatively small) exit.

It doesn't address the Equity Equation though. In theory you should be assigning shares based on some roughly calculated guess as to how much additional value those other employees (or founders) will bring.

Sure, if you can do it all yourself there is no need or reason for massive dilution by handing out shares to other people. But the reality is that you often have the "technical" founder and the "business" founder. In the majority of cases they are both worthless without their combined talents and contributions.

Interesting that all the paths involve selling the company. What about generating $5M for yourself through sales of the company's products instead of a sale of the company itself?

The 37 Signals approach is a good one, but one thing they ignore is that there are opportunities to make money in fast moving/growing areas that may not be the founder's true passion, in a short time period. 37S decries this as lottery thinking, but the odds are better, the process is repeatable, and methods are trainable. Gabriel happens to be in that part of the ecosystem and it is where his expertise lies.

The odds of making a $17-50MM exit is higher than what? Turning a $1M/yr profit over 5 years? I think not. If the process was so "repeatable and the methods so trainable", the world would be flush with quick flip, sell-out millionaires. It is not. It is however full of people who became comfortably rich building up a profitable business.

I was trying to articulate the odds of "flipping" a startup are greater than those of winning the lottery which is your oft stated comparison.

You guys are all about boot strapping and you provide an awesome contra view to the conventional wisdom. That said, I know a great many more people who have sold web businesses and never have to work again than those who are reaping millions in profits via the same. Honestly, I'm amazed at how many people I meet who are financially set based on some obscure web business they sold to a non-traditional acquirer. I'm not even that plugged into the startup community and I've met a couple dozen folks easily. Heck, among YC alums alone I bet you would find a bunch, even the under publicized ones.

Are the odds long? sure. Are you more likely to become wealthy spending a few post college years doing a funded startup rather than working at Google? Hell yes.

I really liked Rework, and like the "Profitable and Proud" series, but there are opportunities for people to fill small product niches and "sell out" quickly. Especially in unsexy categories like analytics and other B2B applications.

You might find it distasteful, but I'm sure a moderately well connected VC or angel could match every company in your P&P series with a series called "This company sold for XX millions and you never heard of them once."

Love the post, though the dilution #s seem whacky to me (my experience is somewhat limited).

First, it seems like an odd assumption that you'll be doing 3-4 rounds of financing before you exit. I've no idea to what degree that's the norm, but the founders I've known who've seen exits, very few had done a B round, much less a C or D. Certainly, companies who do C and D rounds tend to exit for MUCH higher sums than $30-50m.

Gabriel, you saw an exit. At the time, did YOU own 30% of the company? I assume not. do you think 30% is the a normal number for founders to share at an exit? I don't-- but again, my experience is limited.

In my case, the founders owned 100% of the company--we never had any external investment or employees.

Just to clarify, I was only suggesting further rounds (beyond A) for when you're really swinging for the fences, i.e. gunning for an IPO or a really really big exit.

As for the dilution numbers, 30% is accurate if you raise a series A. For some data check out http://www.wsgr.com/publications/PDFSearch/entreport/Winter2... and scroll down to the graphs.

To quote a friend, "In an A round, VCs typically do an 'n on n' investment, e.g. $3M on a $3M pre-money, or $4M on $4M, or 5 on 5." That means they're taking 50%. Then you add in the option pool. You could get less if you have a lot of traction, but to get there you probably raised an angel round that had dilution, so you're about at the same place.

Play around with http://www.ownyourventure.com/equitySim.html to see the possibilities.

I don't think those charts support your numbers (they show a median of $3m raised on $6m pre... $9m post-money, 33% sold). The idea that founders collectively own 30% of the company after a Series A is pretty wrong in my experience (I've raised a Series A and have lots of friends who have as well-- inside and outside of the "YC Mafia").

If I ever had a friend tell me they had a term sheet for $3m on a $3m pre-money valuation, I'd tell them they were either lacking leverage or that someone was trying to take advantage of them.

I'll see if I can dig up some better #s. But a few comments...

--to get that leverage you usually have to meet some milestones (get some traction), and that is usually done from a seed round where you already gave up some dilution. I think it can be increasingly done via YC (6%) or even by one-self, but there are still certainly a lot of seed -> series A

--the eventual dilution # also includes the option pool (another 20%). Like I said in the post, not all of this may be allocated at the time of acquisition, but it may be and it does sit out there on the cap table.

--I assume you and your friends have raised from relatively well-known top tier VCs. There are tons of VC firms we've never heard of, so when you look across everything I think the #s may look different. WSGR is of course seeing top-tier deals.

--This is mainly for first time entrepreneurs, who for many reasons are often in a position of less leverage. Of course, as I said traction trumps everything, so I think you should go for that first. It's the quickest path to exit and the least dilution.

I'm curious as to why you chose $5M and not another number like $3M or $2M? Is that the (gross) magic number to change your life financially?

Edit: fixed typo.

Yeah, with $5M in the bank you can live off the interest "forever" - ideally you'd spread the risk and stuff but with anything less than that amount it's hard to call yourself financially independent...

Of course, a $5 million exit is not $5 million in the bank. Depending on where you live, and a lot of other factors about the sale, it could mean as little as <$3 million after taxes (avg. case probably being around $4 million).

I'm curious whether stock-swap acquisitions get taxed as income or capital gains. If it's capital gains, can you hold the acquiring company's stock until you're fully vested, then quit and sell while unemployed to take advantage of the long-term capital gains rates in a really low bracket? (Which, last time I checked, were something like 5%.) What's your cost basis then? Is it the initial par value when you formed the original company?

I'd assume all founders would know about 83b election (us founders anyway.) to cap the tax rate at 15% (long term capital gain)

By 15% you actually now (as of next year) mean 20% + 3.8% + (state tax, such as California's 10.3%)

That's nonsense. If you have 5M in the bank, you can take out 200K (4%) every year and still never run out of money. Surely you can get by with a little bit less than that and still be financially independent? Honestly you can probably get by with just 1M if you're single, but 2M would be more realistic.

That ignores inflation, which is 3%-ish annually in the US. The number is less than $5m, but it's not $1m assuming you're reasonably young.

That does not ignore inflation. You need just 7% returns on your investments (stock market has historically returned around 10%, but some of your money will be in lower return assets) to be able to take out 4% per year (pre-tax). 1M would be theoretically possible, the problem is that a decade of bad returns could cause you to run out of money.

Banks generally don't pay 4%. Stock market returns and capital isn't protected. Though I am sure 4% can be achieved for little risk...

I was just repeating aditya's phrase. It's a common expression and does not literally mean that you have deposited the money in a bank.

What I don't like in discussions like this is that people are looking for a binary answer to a problem that clearly has no this type of solution (it actually may be sensible to start up alone but it depends on personal situation of the person with the initial idea...).

The issue is made even worse by those who 'have already done it'. We hear this all the time: you have to do A, C and F but never M to achieve Z.

Finally, I've always thought that delicious.com was started by one guy working part-time and only when there was some traction there was another guy taken on board. Am I correct?

As soon as you start doing calculations like this to determine how many co-founders you should have it's almost a guaranteed you're not going to be successful.

Build something people want with people you love to work with. The rest will work itself out.

I tend to think of these steps as analogous to lifelines in "Who Wants to Be a Millionaire"; some people can make it to the million with no help, some need lifelines and just others cash out (not to mention those unfortunate souls who guess wrongly).

Yes, the odds of a single founder exiting for 10M is greater than 3 founders exiting for 100M, however, the article fails to take into account the odds of a single founder start-up being profitable vs a multi-founder start-up being profitable. I believe the second case is much more likely due to the sharing of responsibilities, overlapping skill sets and the ability to bounce ideas off one another.

There's always going to be a trade-off, things aren't so black and white.

Since when does one need to be profitable in order to exit? :)

One other thing is that Tax man takes ~25% (capital gains)

Generally, short-term (assets held less than one year) is taxed at your personal tax rate.

Long-term (more than one year) is currently taxed at 15%, but will revert back to 20% beginning in 2011.

[EDIT: based on US law]

That's why it's important to know about 83b election to cap the tax rate at 15%. Any start-up lawyer/law firm worth its salt would do this for you as part of the pile of forms to sign when you incorporate.

great post

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