"Too many founders let emotions and egos cloud a decision that is really a number crunch. Once you accept that there will always be richer and wiser people out there, you'll find that they didn't get that way by taking dumb bets."
Maybe I'll always live in a crummy apartment and have Ramen for Thanksgiving but I completely disagree with this. How I choose to spend the next 3 years of my life is hardly just a number crunch. How I spend time doesn't just have a numeric value attached to it. I respect the author's analysis and to each his own. But, for me it's much more about learning, growing and building than a straight math problem. If at the end I don't die with the most toys I'm really OK with that.
Well, if you're so inclined you could use part of the 500k to bootstrap another projcet and continue your happy startup existence only with less Ramen. (Unless you just really like Ramen, of course).
This is true, but a live one in the hand may be worth more than $500K in the bank. It all depends on your own estimation of the probability of eventual success, and your ability to accurately make that estimation in the first place.
Exactly - at least for me. Emotion has to enter into it because it's about whether you're ready to move on when the money makes it a fairly close decision like this.
Making money is not antithetical to learning, building, and growing. In fact, I'd argue that the more you do of the latter, the more you earn of the former.
Ok, so here's a question I've had for a while. I was wondering if I should do a Ask HN for it, but I'll ask it here for now.
What do you do when offered money for a slightly profitable service that has a small but loyal customer base ? This is in the event that your service will be shut down after acquisition. The math points to taking the deal but it doesn't seem a very nice thing (to me at least) to pull the rug on your customers.
Has anyone had to face decisions of this sort or known someone who has had to ? How did you/they go about it ?
It is a personal question: which is more important to you? Keeping the loyal customers happy or the thrill or the exit, the money, etc.
The important thing to remember is that there is no right answer. This is real life, you aren't required nor expected to be altruistic, but you can be if you'd like.
Is doing a startup foolish? If you're doing it as a way to earn a better living, it certainly is!
It's all about thresholds. With anything between a decent and really good salary (say 75k to 200k), your life is pretty much the same except for the level of luxury in what you own. You still have a mortgage to pay and if you lose your job, you need to find a new one very soon or you'll be draining your savings and defaulting on debt payments within a few months.
If someone offers to buy your startup and that would get you over a major threshold (eg. clear the mortgage and debts, enough cash left to carry on current rate of spending for a couple years), it would be foolish not to take it, especially if you have kids. Get a bit of rest and aim for the higher thresholds on your next startup.
You're looking at it purely from a money perspective. There is more to it than just that.
Yes, you can make $100k/year at a "job" but you may be living a miserable life delegated as a gear in a gear box with no freedom of creativity.
On the other hand, yes, your chances of having a $500/k exit are slim, but how is your quality of life effected? Are you happier? Are you able to spend quality time with the people in your life instead of bitching about your shit head manager?
Actually, our MBA completely botched the risk portion of his calculations, which are built on a completely incorrect premise. The 20% probability of getting $2.5M does not translate to 100% probability of getting 20% of that amount, i.e. $500k.
He wrote: "Let's see how you, the founder, should make out if successful." This means that the whole scenario depends on the plan succeeding, so his calculating the risk-adjusted return is incorrect. If successful, the founder will get $2.5M; if not, he'll get anything from 0 to that amount. Also, there is a non-zero chance that the company will be worth $100M after three years; shouldn't that be included too?
When you start your company, you think of it as an innovative product, not a probability. If you start thinking of it in terms of probabilities from the very beginning, you are not going to succeed.
This analysis makes a few assumptions which are wrong. The consideration of 20% VC back startup success rate is an pure investment analysis. This is the consideration if you are Sequoia, not if you are the founder.
As a founder you have far more intimate understating of your company and would be far better positioned to determine what the probability of success is. While founders may seem overly optimistic, they are not a stupid bunch and should be able to make objective analyses, especially if they were able to build a company that has attracted VCs.
So if you change the 20% success probability to 35% based on the founders understanding, the risk adjusted return would be 852K. Additionally a 10% probability of selling at $10 million would increase the founder’s share by another 500k on top of the 852K. For these reasons the author is simply wrong in his financial analysis. Statistical averages are inappropriate for one off situational analysis. Why would a founder use the 20% industry average success rate when they would be far more informed than an outside investor?
Additionally an entrepreneur has other considerations such as ability to start another valuable company, how much they enjoy the work, if they are in a new technology space and have a 0.1% chance of building a billion dollar company, or the social perception for a CEO of a startup. These are considerations that a VC does not really care about and will not model.
The author sounds more like a VC making a routine investment analysis than an entrepreneur that was betting their future trying to build a company that they are passionate about.
He totally dismisses Groupon's rejection of Google's offer, when there were almost certainly some sort of earn-out. I'm sure if Google were offering $8B in cash with no performance requirements, they would have taken the money. But that's not how deals work, and Groupon could very well have decided an IPO would lead to a much surer return.
I would expect a less shallow analysis from a finance guy.
TRue. Add to that, reality is a distribution of outcomes, not just a single percent chance. Nobody's mentioning the 'tail of the curve' where you make $1B in 7 years. And everything in between. Integrate P(evt)*Yield(evt) over all outcomes for a real valuation.
Anyone else who doesn't understand his example? If my company is valued at $1M and someone invests $1M in it, why do I still own 50% of the company after the investment, as the author said? Doesn't this mean the company is actually valued at $2M?
Suppose your company is valued at $1M, and you own all of it. Your holding is worth $1M. Obviously.
Suppose now someone comes along to invest, and they put in $3M to the company. What percentage equity should you each now hold?
Simplistically, your holding should still be worth $1M, and their holding should be worth $3M. The company is now worth $4M, comprised of the $1M it was worth to begin with, plus another $3M in cash (or promises or whatever). You should have $1M of that, so now you own 25% of the company. The investor should have $3M of value, so they own 75% of that $4M total.
So on the surface, neither of you have gained. Except now the company has a shed-load of money, and so it can invest and trade more aggressively, thereby increasing its value. As a result, the company increases in value, and your 25% holding goes up in value.
Pretty much all trades and investments can be assessed like this, but with some refinements, in particular, factoring in the expectation of success.
Consider pitching for an investment. You value the company at $1M, you want $500K, so after the investment the company will be worth $1.5M and you will own 67% of that. Based on that assessment, you should be offering 33% equity for that $500K. But the investor will disagree with your assessment, saying that the company is now, currently, before investment, as not worth $1M. Perhaps they will say that without investment your company is only worth $500K. As a result, post-investment your company is worth $1M and you should each get half the equity. The gain for you both is that now, with the cash (and possibly expertise) of the investor, perhaps the company really is now worth $1.5M, so your 50% is now worth $750K, and the investor has immediately gained $250K (on paper).
The mis-match in the assessments of an owner and a potential investor is an area of considerable research and discussion, sometimes heated, but the above (very simplistic) analysis is a useful starting point. It largely matches the analysis he gives about selling to a competitor at $500K versus taking investment at $500K hoping to grow the company to $5M (giving him 50% of that, with a 20% chance of succeeding, making it worth an expected $500K)
The $1M in the example is the pre-money valuation, $2M is the post-money valuation. If your company is worth $X and I inject $Y into it, it automatically is worth $(X+Y) - there's no question about how you value cash in the bank.
GiftZip is one of the first companies to graduate from the City of East Lansing's technology innovation center (TIC). The TIC also houses The Hatch which is a student incubator run by Michigan State University.
Maybe I'll always live in a crummy apartment and have Ramen for Thanksgiving but I completely disagree with this. How I choose to spend the next 3 years of my life is hardly just a number crunch. How I spend time doesn't just have a numeric value attached to it. I respect the author's analysis and to each his own. But, for me it's much more about learning, growing and building than a straight math problem. If at the end I don't die with the most toys I'm really OK with that.