I agree with the generalization - the odds are higher that a first-time, somewhat-poor founder will be tempted by a 7-figure exit that doesn't help the VC, than someone with 5M in the bank.
On the other hand, I think start-up founders are, as a group, more risk-tolerant than almost any white collar worker in America, and there are plenty of us who will never give up on a good company as long as it's growing.
As for me, I've never wanted the money to play with, I just wanted into the bigger game. Give me 5M, and I'm just going to put it back into play. I want to make spaceships and robot cars and other wonders I can't afford to try right now.
Someone I know runs a startup which just got an acquisition offer which would have given him $5-7m, a few years out of college with the acquirer was paying 1.1x their current valuation. He chose to turn it down since he thought his investors (one of the top few firms around) would find him unfundable for future startups. Instead he's choosing to 'swing for the fences', something which may or may not work given their current momentum.
Several lessons in there, including not raising at too high a valuation that limits your exit options.
Generally a good post, though it's funny that Diego used a Fred Wilson quote right before his point about bi-modal returns, when Fred's one of the (few) VCs that's spoken out against such:
That's a remarkably clear and sensible strategy - I am glad you posted it. Also it gives a lie to the 1 winner, 2 profitable 7 busts theory of VCs I had heard from some bloke in a pub twenty years ago.
Seems there is logically a space for properly salaried startup founders with significant bonuses for hitting the mega-heights. If there are people you have sufficient confidence in (2% chance of getting to $100M) then give them get rich slowly salaries with bonuses for hitting the VC friendly valuations (bonus on valuation/investment rather than exit). Obviously in this scenario the founders would have little equity - more first employee level.
This model could make more willing to try and bring more big payouts in (VCs would have more equity) although it would cost them more on the ones that don't get there.
The downsides are if the founders need to make it work is what gets startups off the ground in the first place or if the VCs feel more need to meddle.
An alternative is to stick to the current model but for the VCs to be ready to buy out the founder with the early exit option and then employ them from that point with MUCH smaller equity for the founder.
VCs should expect and build in at least two "money problem" liquidation events. The first, smallest is to give the founders enough to buy a house. The second, if they really believe a billion dollar exit is on the cards is to hand founders millionaire status, and all their early employees a house.
People aren't fools. At twenty years old anyone can live on Ramen and dreams. At thirty ensuring your wife and baby have a roof puts stress on a founder that will easily out weigh almost anything competitors can do.
If VCs want big returns, pony up halfway through, or lose.
What, in general, would prevent a VC from buying-out the founder? If the VC aims for a bigger potential payout than the founder, wouldn't they want a bigger portion of that payout?
Presumably the same thing that prevents them starting the start up in the first place. Which is either they aren't capable (call that the nasty hypothesis), or they know to spread their bets over many founders.
VCs commonly do oust founders, rather than buy outs (presumably it's cheaper)
Just as an aside, it is crazy that Bay Area prices have gotten to the point that you need to win in a startup to buy a house. It really seems like a much better decision to rent indefinitely or buy somewhere in the Midwest, where house prices are 1/20 the cost.
What I meant was that if a founder spends say 3-5 years building up a start up to get to series A (The first VC round), and they do not get any liquidity out from the
round they are just going to turn off. If you are still living on ramen after 10 or even 5 years, its your psychology that is driving you, not a well rounded approach to business.
BTW, house prices are mostly insane, but they are insane because we cannot design cities right, and almost everyone wants to live in a city. (Or more accdurately have the amenities of a city)
I think this is something pg recommends, but a lot of these things fall into my mental "just in time" bin - when I am looking for VC funding, I will look up the reference.
House prices are high because the people who spend resources corrupting and deceiving planning committees and urban regulatory bodies are, as one might guess, people who own a lot of real estate.
Combine regulatory corruption and price inelasticity and you get expensive real estate.
I cannot believe that a world-wide bubble-like increase in house prices over the past four decades is down to back-handers to planning committees at golf clubs, in Spain, Crimea, Italy, Wisconsin and London.
I think simply that there are an awful lot of people who want to live where the jobs are. In cities. And there are few nice places in cities, partly because that is the nature of the urban beast, but mostly because we design cities badly.
Cities can be badly affected by poor planning decisions - and those are driven more often by lack of regulation than active corruption. I mean many cities are blighted by 1960s tower blocks and concrete jungles. Those were not put up by corruption - they were active policy. The wrong policy but still not corrupt, just f'ing stupid short sighted and moronic.
VC's are money managers, playing the odds. VC's also want to build long term businesses and sometimes the founders are not the right people for that: they had the idea and the drive, but 2 years down the line, their attention is on the next thing. So in that case its beneficial for all involved to "solve their money problems" and get the right person for the day to day job at hand.
I've financed PE's for years (a further stage to VC's) who tend to either buy fast growing companies direct from VC's or once listed and you rarely see the original founder by that stage (c. 5-7 years down the line).
Wow if I had 100k in the bank as that article assumes I would invest every penny of that in to my new venture and aim for becoming profitable as soon as possible before even considering a VC investment.
I would rather approach them in a position of being a sustainable, profitable business than to ask them to invest in my idea before I had committed all my own available assets.
It's not really that simple though. $100k doesn't last as long as you'd like...especially if you're a first time entrepreneur. You really need time to make mistakes.
If you're able to be sustainable without funding then that's awesome but it's less about the $100k than it is about focusing on the right things. That comes with experience, usually.
I'm on my second startup. First one raised $500k and we blew it. Focused on all the wrong things.
This second one I approached much differently. I did invest about $100k (not including lost wages) into it and still wasn't successful at the end. Again, in hindsight I focused on many of the wrong things. That's why I go back to needing time to make mistakes.
I did wind up getting a grant from the Shuttleworth Foundation within about 8 weeks of not having a single penny (minus what was in 401k).
I'm not advocating raising funding. I would have done it since I knew I needed the extended runway. But it was my last option. And getting a grant from the foundation was a happy medium between the two.
Basically, starting up is not for the feint of heart and you will make mistakes and you won't anticipate making them...which leaves you in really tough spots.
I see where you're coming from, however I really do believe it is possible to build a great business on a shoestring.
I think there is a lot of comfort to be had in having more cash in the bank but not having much sure does focus you on making sure you are delivering a great product that your customers are willing to pay for from day 1.
I started my current project on practically nothing, with an idea and cheap rackspace cloud account. A year on we have 5 people, sure it would be great to have the luxury of a large amount of funding but I think running on a budget does have an upside in that it forces you to always focus on customer satisfaction and profitability.
Growth is just slower on the organic route and that is the main thing that concerns me.
“[…] VCs have a different vision than founders. Founders are like parents, saying "keep my baby alive!" VCs swing for the fences, and hit alot of outs along with the homers. To the VC it's not a baby, it's just another baseball.” — Lee Campbell, http://waxy.org/random/arsdigita/
Decent VCs will let entrepreneurs cash out partially in order to have their incentives more aligned. Not all VCs are decent, though. It is pretty ridiculous when people who make $1-million salaries working 9-to-5 object to a founder taking out enough to buy a house.
It reflects really badly on our society how much pitching and pain an entrepreneur has to endure just for a sliver of a chance at basic autonomy. Four decades ago, it was slightly harder to get extremely rich and solve "the money problem" outright (note: there is no such thing; when people get $5 million, most start wanting to compete with the $50-million crowd) but if you were smart you could get an R&D job with complete autonomy over what you worked on, how and when. That's gone now.
I think that if VC-istan is where you want to be, however, starting as an entrepreneur is the wrong way to go (although it's better than being a non-founder employee). You're better off doing everything you can to become a VC, getting established enough that you always have a VC job as a backup, and building enough connections that you can raise money, and then starting a business if that's your inclination.
On the other hand, I think start-up founders are, as a group, more risk-tolerant than almost any white collar worker in America, and there are plenty of us who will never give up on a good company as long as it's growing.
As for me, I've never wanted the money to play with, I just wanted into the bigger game. Give me 5M, and I'm just going to put it back into play. I want to make spaceships and robot cars and other wonders I can't afford to try right now.