Investors sometimes say mean things about these “lifestyle businesses” but you don’t have to care what investors think.
There's nothing wrong with a lifestyle business, as long as it's run like a business. There can be decent exits (purchases by competitors, private equity, etc). But the employees seldom see a big payoff. In return, you usually get a pretty comfortable work experience.
Startups trade salary and benefits now for maybe huge payoff later. The maybe in previous sentence is important, most startups fail.
Some business are build to stay there, grow and earn enough for founders to make them upper middle class/rich for the rest of their lives. It is different then Facebook like success, but most would count that as successful too.
Yeah this is an obvious but oft-overlooked fact. As a VC you can manage the high rate of failure of startups by investing in many of them simultaneously.. that's what the whole model is based on.
As an employee, not so much, you're probably doing 2 fulltime jobs worth of work for one single company very likely to fail.
This is why working for shitty pay in return for non-founder equity is a very -EV financial move (I'll allow that maybe it makes sense for some people as a learning experience or whatever). And this is without even getting into the fact that your company could have a very successful exit and your equity could still evaporate due to dilution or outright clawback of options (ala Zynga's pre-IPO moves), or any number of dick moves from the founders/investors.
The best example of this is when RIM was sued by Minformation. After several offers by RIM to settle for around 60-70 million, one of the RIM attorneys said, "I have no idea why they won't accept our offer. You could give every employee of the company $5 million with what we're offering."
When they finally won (and then lost) that $147 million dollar settlement, how much you think the employees saw of it??
I believe this, coupled with demand, is what is driving the cost of engineer salaries in the market today. Equity allocations mean almost nothing to candidates -- as they should.
That doesn't mean you get a pass on offering equity; you just have to match it with a market salary.
I have often thought that it would make sense for employees of different companies to pool any equity. You already take on enough risk being employed by a startup business without adding on your equity risk too.
More seriously there is a number of ways of doing this. I would imagine the simplest would be to create a trust and have everyone give their equity and options to the trust.
The bigger issue is how to ensure that people don't game the system. The assets being put into the pool need to be accurately valued so people don't put in what they know are worthless assets. Of course there is there is the reverse situation where those already in the pool undervalue new assets.
Most of the effort of this idea needs to go into setting up the rules so that everyone does the right things and everyones interests are aligned. While I think this might be hard, I don't see anything that can't be solved by some smart people.
Derisking makes economic sense, but incentive stock options are mostly nontransferable. You're describing a market for shares of a privately held company, which the SEC doesn't want (except through some very specific protocols like JOBS Act crowdfunding).
The stock or stock options aren't really being sold as such, just given to the pool. I am wondering if the pool members could continue to hold the options, but enter into a secondary agreement to share any gain with their fellow pool members. This would be a derivative of some sort I guess.
The problem is that when a company goes big and someone gets a good exit they personally own that money until they make good on their secondary agreement. It would be easy to rationalize that it was specifically their personal hard work that helped make the company succeed. And since it's their money they have a big enough war chest to fight giving it to the pool. Or they can just skip the country. If the payoff is big enough there are plenty of folks who wouldn't mind trashing their reputation. And then that's the end of the pool.
Don't get me wrong, it seems like an interesting idea. I would love to have some way for my un-diversified work portfolio to get diversified. But short of creating a sweat equity only market/exchange I don't really know how you'd do it.
Even that has problems because people could fake a startup well enough to gain access to the returns creating a free-rider problem. It's probably easier to cook up a bunch of buzz and interest over an orchestrated 3 month campaign (esp. with a Kickstarter) than to actually do a startup. And since you're faking it you can promise the world and raise huge money from unsuspecting dupes with no intention of (much less a plausible method for) making good on your promises.
Great idea, in theory. But even if you simply shared equity across, say, a 20 or 30 person company. The agendas, the politics, the perceived golden handcuffs because of equity ownership. Hard to start a business with 20-30 people. Even if those are your 20 best friends.
Now multiply this across dozens of companies. Plus, most startups give options, not equity unless you are a very early employee.
I think you get most of the benefit of diversification with as few as 8 stocks [0], so if you kept each of the pools small you could avoid a lot of the scaling issues.
I feel it's a good lesson that people new to the industry often learn. And working for a startup is a lot of fun; you get to wear a lot of hats and a 23 year old software developer gets way more responsibility at a startup than they would working at Microsoft or Google.
If you're fresh out of college, what do you have to lose? You either get underpaid for a few years and learn some valuable lessons (one of which being equity in a startup has a value close to zero) or you get lucky and can retire before you're 30.
Not an office manager, but I know an executive assistant who was making $4-500K before she retired, working for a Fortune 100 CEO. She was incredibly effective but hated the stress of the job, so she kept quitting and the CEO kept raising her pay until she eventually couldn't take it anymore.
There is the issue of control. Not having external investors means you can do what you want with the business. The value of this freedom is worth a lot to the business owner.
This is the big reason for me. I've built my business on my values, and it is incredibly satisfying to see it succeed against competitors with different values.
Another problem with raising money: if you raise early, you probably don't yet know if you have a VC-appropriate business or a lifestyle business. If you turn out to have a lifestyle business and you've raised VC, it is amazingly depressing - as in, "I'd love this business if I owned all of it and I'd be happy with a small exit".
I don't know much about VC, but these sorts of claims are always surprising to me. Is it really moonshots or bust when you raise a VC round?
Even with a 2x liquidity preference, don't you just need to double the invested amount in order to have personally broken even on the VC deal?
Say you have a $10M business (pre-money), and you raise $5m at a 2x liquidity preference, giving up 50% of the company in the process. That would leave you with a $15M post-money valuation. So long as you can use that $5M to turn you from a $15M business into a $20M business, didn't you just break even on the deal?
I'm know it's not an outcome that the VC is looking for, but it would seem to be a fine outcome from the founder's perspective.
My point isn't that it is moonshot or bust - but that you may (like a friend of mine) find yourself having raised $5m to create a business that is very nice, but won't scale to the level the VCs expect or want. And the exit might be good or might be bad depending on market timing. But the contrast here is that he'll often talk about how much happier he'd be if he'd just bootstrapped the company. Now you can make the argument that he may not have been able to - but the point remains - he's got a good, non-scalable business where his investors are expecting him to magically solve for scalability. Not a great place to be.
Your numbers are a bit off compared with what I'm thinking as well - "say you have a $10m business" - that misses the point - he starts the business and there is little to no revenue. He raises a bunch of money but doesn't know if he can create a business that can get bought for $20m. He takes the money and then discovers he has a nice $2m business - but he can't scale it anymore. Because he doesn't have a great growth plan, no one is buying him out for 10x revenue. Thus he's a bit stuck.
I think this happens a lot more than people realize. At that point, it's like being stuck in a bad marriage with lots of kids. No easy options.
The worst part about it - if the company exits at a low value, it's likely to be classed as a 'failure' - even if it is profitable and has happy customers.
It's impossible to know in advance which companies will only scale to a certain size - hence the problem.
I guess the solution is to only take on money when you can show that you have a scalable business that just needs more investment to fly higher.
If you have sold 50% of your business to the VC, then you no longer have control of the business. (Seed-round investors may have stock; employees and/or cofounders certainly will.) You won't be able to close a deal that the investors don't like.
My understanding is that even if you take less, so that investors don't have outright controll, VCs will have incentive and substantial power to push small wins toward becoming either big wins or big failures. And they begin that push early, so that it's easy for VC-funded startups to end up in a grow-or-die situation, even if they theoretically might have taken a different path.
Note that there's some selection bias involved. If a VC thinks that the business is only going to be a $20m business, they won't invest. They also won't invest if the founders seem like the kind of people who will stop early. They're in the business of finding 10:1 odds on 100:1 money.
As an aside, it's a little dangerous to do valuation math like that. The valuations at A-round levels are highly speculative. If you take your $10m company and add $5m in cash, in theory it's a $15m company. But it's mainly fantasy. It's very different than a $15m operating business whose valuation is based on revenues and profits.
There's nothing wrong with a lifestyle business, as long as it's run like a business. There can be decent exits (purchases by competitors, private equity, etc). But the employees seldom see a big payoff. In return, you usually get a pretty comfortable work experience.