May 2014
(Based on a Presentation to My Parents)
“Most new jobs won’t come from our biggest employers. They will come from our smallest. We’ve got to do everything we can to make entrepreneurial dreams a reality.”
– Ross Perot
“I like to call in sick to work at places where I’ve never held a job. Then when the manager tells me I don’t work there, I tell them I’d like to. But not today, as I’m sick.”
– Jarod Kintz
I’ve had to explain to my parents my professional life and what that means. I’ve got 3 years left to graduate university, am basically a washed up artist, the founder of a startup and my parents want me to get a job. It’s a conversation I’ve been dreading.
The startup path is a world most people don’t understand. It is unintelligible in the same way meeting someone who speaks a different language is hard to follow. This is because it is counter-intuitive. They think differently. Many many things in the startup world at face value seem to make absolutely no sense.
My favourite instance of this is talking to friends who are in finance because they provide the starkest contrast. They are routinely shocked that startup investors will invest in companies knowing most of the time they will lose all their money. Yet they still do it. What they are hoping for is when they finally succeed, it pays for all the losses and then some. It’s a risk tolerance that looks borderline insane because it is seemingly the opposite of succeeding. You keep losing until you win.
The reason it seems so alien is because most people are brought up in the mold of linear consolidation whereas a startup relies on compounding growth. Einstein was on to something when he said compound interest was the most powerful force on Earth. I think the emphasis he was talking about is the compounding part, not so much the interest.
This is easiest seen in the way people teach children to save money. When you save money and invest it, what you are doing in theory is the same principle. They are both ways of taking the amount of wealth and resources at your disposable and using it as a cantilever to create more. It’s just that in a startup the founder can often get a better return rate. So the startup becomes an approximation for saving money.
It astounds people just how big a tiny company can get and embodies perfectly the phrase from little things big things grow. Google, Apple, Microsoft all started as 2 people sitting in a garage. Today they are some of the most valuable companies in the world.
What is first obvious about the graph is what is not on it. 90% of startups fail, resulting in next to no wealth created for the founders. Jobs are almost universally safer than a startup. These failures are not reflected in the chart. Likewise long term stability is uncertain, redundancies are common and in a lot of jobs there is a plateau which is difficult to go past. These are not reflected either.
So the graph assumes a best case scenario. This is also a normalised curve. It is the median trajectory of a successful company. It’s not done with hard data and doesn’t incorporate exceptional or edge cases. In fact, it’s probably on the conservative side.
You’ll notice that for the first few years you earn less than a job. That would be the major hurdle to get over. A lot less. In fact the first few years of a new venture the founders earn barely anything. It takes 3 years for the startup to hit its upward momentum and start to grow. That 3 year mark is usually the turning point if the company will succeed or fail. At 3 years if it doesn’t start to grow it probably isn’t going to.
So if the startup doesn’t succeed, that’s 3 years wasted with little to no income as well as the missed opportunity cost of what you could have made if you’d had a job. In a startup all the wealth is deferred so if you don’t make it to the finish line you get nothing. Whereas in a job it’s immediate, even if the company fails you still get paid.
The intersection point is when the startup achieves parity with a job and usually occurs 5 years into it. Then the compunding growth takes over and catapaults the company into a big success and out-returns a job by an order of magnitude. The trick is surviving to that point. 30% of new ventures die in their first year and it iterates recursively with a further 30% dying every year until they hit the 3 year mark and accounts for the high failure rate.
If you do survive, 10 years into the company it will be big. The real payoff of a startup doesn’t happen in the beginning, it happens a decade down the line when it becomes a big enduring company. But it means spending a large chunk of your life on this one thing. Founders should know what they’re signing up for choosing this path. But if you ever want to be rich, the only path to do that is to start your own company.
The time horizon on the graph is only 12 years. If you draw it out something crazy happens.
The major idea is compounding growth. It’s a type of growth which comes naturally to product companies. That means when you get to this point, it would be silly not to keep going because the most important part is compounding. The growth is a proportion of what it was previously. The hedge for this is time. If you started a company and decided it would still be around in 30 years, I would guarantee that wouldn’t just be a big company. It would be a huge company.
The compounding factor has taken over and accelerated the wealth creation. It’s hard to see but the wealth created by the job is increasing as well. But it is increasing linearly. The two methods of wealth creation are now in contrast over a long timeframe.
In the startup, the amount the company has grown in the time from year 25 to year 30 is greater than the sum of all of the entire growth in the 25 years before that. But in the job it has increased by a fixed constant amount that may also be increasing, but not at the same rate.
Companies of course fail, but that’s a different story for why that occurs. At some point the growth stops being exponential and starts to become linear, but this is because it has gotten so large that it can’t grow very fast anymore because it has saturated a market and needs to enter new ones. The growth can also stop altogether if technology changes and disrupts the company.
But how does investment affect all this?
The more investment taken on increases the dilution of the founders which makes the startup curve begin to converge on the job curve. The greater the investment and the more founders get diluted, the more the startup curve will look similar to the job curve. Which also means the less investment is raised the less founders are diluted, the more the startup curve will diverge from the job curve.
What results is the more money you raise from investors the more linear the VC startup curve will be. If you raise a lot of money and get very diluted it will quickly begin to look like the job curve. The less money you raise, the more the curve will resemble the startup curve and you will end up with greater absolute wealth. Implicitly this is the proof to try to avoid raising more money than you need.
This doesn’t really matter if the company will be acquired early on because the byproduct of investment is it grows much faster and the dilution is offset by the growth rate. But the recoil from this capital injection happens later on when the company reaches maturity. You’ve sold so much of the company that you don’t own it anymore.
Typically the company will be large but the founders will end up with a very small piece of it, typically less than 10% and have given up board control. This is how you see in movies where the founder who starts a company gets fired from it, then they dress up in a cape and become a supervillain.
Because startup financing is the most expensive form of capital present. You give up way more than just stock and take on things you may not want, like accountability to shareholders and being held to their agenda and economics instead of yours. The argument ends up becoming, if a company can make it without raising outside capital, then it should try to. But can the startup even succeed without raising outside capital? Some companies are just expensive to do and can’t.
If you look at the landscape of big companies, you’ll find most succumb to raising some form of capital. In fact, you’d probably struggle to name a big company that hasn’t. This is because there are other benefits of bringing on investors. I think a major one is receiving mentorship and a sounding board to provide direction.
Another big reason is to bring on specialised expertise. Like if you wanted to make a specific deal or take a company public, it’s worthwhile to have an investor who has done that before and can help since it’s not the kind of thing you want to get wrong.
But it’s important to see exactly what is happening. It’s easy to see the growth spurt at the beginning and mistake the molehill for the mountain. If this is going to be a big enduring company, the difference between the two curves is what is owned by investors. And it’s common to hear founders say the biggest troubles faced in their company was not caused by competition but by their own investors.
In the abstract to maximise wealth creation a founder would start a company and then run it forever and never exit, benefiting from the compounding time investment. It would grow infinitely. But this doesn’t happen in real life because a lot of that wealth only exists on paper and founders don’t have the nerve to keep it going. Different skillsets are required for a big company than a small one.
Seen like this is how empires are built. Not just in the corporate sense but how entire countries and industries start to dominate. In this context, those 5 hard years at the start doesn’t look so hard anymore. It’s easy to say that with a birds eye view but not so when you are in it, experiencing the hardships and lows of a company. In reality, it’s really really hard. One of the hardest things you can ever do.
It’s well documented the emotional rollercoaster that is a startup. The intense euphoria and crippling depression is felt by many entrepreneurs and comes to define the mantle. A job is not something you would call an emotional rollercoaster. So in many ways a job is superior in that they are probably more emotionally healthy though can cause intellectual lethargy.
When people are emotionally erratic, it makes them a burden on everyone around them like their family and friends. If starting a company is a leading cause of this, then it’s probably not the best path to take and getting a job is better for a healthier work life balance.
There will also be the depressive part where you will see everyone around you like your friends getting jobs and making money. Whereas if the company is making no progress, it can easily feel like you’ve stalled and are forgetting the bigger picture in place of a speck of paint. It’s human nature to compare yourself to your circle of friends and it’s really hard not to feel a tiny bit jealous.
A new company is in a state of constant uncertainty where a small push in either direction can usually result in it succeeding or dying. This is made worse by the need to constantly put on a front of being capable and formidable and that everything is going well even if they really aren’t.
People take jobs precisely because they are stable and constant. There is little risk involved and you can still do meaningful work with a fixed safe outcome, consistent emotional state and less stress.
Stress is a byproduct of responsibility. When you’re the founder of a company, you have the eventual ultimate responsibility. The buck stops with you because the company will live or die off the back of your actions and will influence the livelihoods of all those who depend on it. It’s exacerbated because you made a ton of promises and raised everyone’s expectations of the company so in your mind is like letting everyone down.
The peak represents a near death experience. I think every company goes through at least one near death experience, if not several. These range from everything from a founder being hit by a bus to being sued by a bigger company.
It’s also super stressful. All of the tiny problems tend to add up so when a big problem comes along it crushes your morale. As weird as this will sound, it’s probably a good thing it’s super stressful. What I mean by this is if you succeed, you become rich. So if it was too easy then it wouldn’t be as useful a character building exercise. It would almost be unfair. The stress is the proverbial counterweight to the benefits which are large amounts of wealth.
It’s like in an Indiana Jones film, he has to enter the tunnel and defeat all of the booby traps to get the treasure. The traps also stop villains from getting the treasure and misusing it. You might even say the task of overcoming booby traps teaches the necessary discipline to be able to wield the treasure correctly. I like to believe if you’re a good person and become rich; then you’ll help lots of people and sooner or later good things will start happening to you.
The massive drop is when the company gets acquired and the rollercoaster is over and all of the stress is finally lifted from your shoulders. Another variation of this is when a company is so automated the stresses are abstracted away like by having a solid consistent base of customers with a capable management team. The final loop at the end is when you start getting harassed to donate to gala fundraisers.
Summary
I once heard this great story from a wise angel investor that perfectly summarises the difference between starting a startup and getting a job.
In a job, you work really consistently hard and earn $100,000 per year every year for 10 years. You have a great comfortable life and if you save and invest wisely, after 10 years you might have $500,000. In a startup, you work really consistently hard and earn $25,000 per year every year for 10 years. Your life is really difficult and uncomfortable and if you make the right decisions, after 10 years you get to flip a coin. If it’s heads you get 10 million dollars. If it’s tails you get nothing.
But if you can manage to earn a large salary from the startup. Then what’s stopping you from starting one? In nearly every scenario you should. This actually is an opportunity for investors. An investor who is ok with founders taking large but not exorbitant salaries is going to get all the amazing entrepreneurs who previously would never start a company because they needed the consistency of a job. And that’s a lot of value. Nearly every successful entrepreneur at some point had a job before they started their companies.