Everyone I know is tweeting about Dave Troy’s new post: What your “Good Job” is costing you. (That link love is indicative of how much I love Dave)
Now I am a classic example of a guy hiding out in corporate America, and while I generally agree with his themes, I thought the assessment was not appropriately risk-adjusted.
Here are the tricks:
1) He pushes aside risk of failure with a few comments:
- #1: “…failure cannot be counted strictly as downside. There is recoverable value in failure.”
- #2: “Too often people cite general statistics about entrepreneurial failure that include all entrepreneurs everywhere and in every sector; these metrics are all but anecdotal in nature.”
- #3: “Not being stupid helps (we already established you’re smart), and your position in social networks likely has more to do with success or failure than any other factor…”
- #4: “And please don’t counter that I’ve inaccurately accounted for the capital required to create a startup, how “impossible” it is to get funding, and how doomed you might be for whatever reason before you start: startup capital requirements are lower than ever before – you can get started for as little as $10-$50K with a seed of an idea and the right partner.”
Let’s break that down:
- What is “failure” of a 5 year business worth? I say, $100k, because, like him, I think it is worth a lot.
- Is 90% failure rate anecdotal? VCs seem to swear by it and they have money riding on their bets. I bet this is less anecdotal than one might think. Further, they use these numbers even with respect to their investments. I assume the deals they pass on have a higher failure rate. I don’t think that we should write off the fact that most new businesses fail. Of course, I apply an exit curve: 10% shot at $3m, 40% shot at $300k, 50% odds of $100k ($0 + $100k failure value).
- Does being smart reduce failure? Sure. Although I think that is taken into account in the failure rate. Everyone that quits their job to do their own thing thinks they are smart. Much of an exit is luck, in my experience. Loose correlation.
- “THE RIGHT PARTNER” – now there is an interesting rub. You just cut your equity in half. And I think a good partner is important to getting to your exit. If you can’t convince your best friend or someone else smart to do it, it may not be a great idea.
So the failure rate model needs to be taken down by half, except for the failure value.
So if we wanted to risk adjust the $3m exit your company could achieve, it might look like this:
$260k value of exit (NPV of 90% failure rate model with a partner and no investors).
Now, there are a lot of problems with this model. The 10% could be a $30m exit! What is a reasonable exit? Dave implies $3m, but that is simply a number pulled out of the air. I think there are a range of options. Maybe $3m is actually the risk adjusted number: 10% of $30m?
Is there a salary along the way? What if it looked like this:
2Y: $35k – struggling
3Y: $35k – struggling
4Y: $90k – taking off
5Y: $125k – nice business and exit
Now the value of the start-up is $535k.
All this illustrates the range of unknowns we are talking about here.
If there was a 1% chance of a $30m exit, it completely blows the model apart. The biggest mover of numbers in this story is the possible exit range. This is why VCs like people going after big markets: Big markets mean there is room for a big company. If you only have a few million in revenue, you can only exit for so much. Big exits require big upside potential for the company.