7 ms·

Build a Business, Not an Exit Strategy

142 points by melanie_io 14y ago

adambratt 14y ago
I don't think there's a real formula that will allow you to calculate the expected value as there's so many other variables that come into play. A lot of it comes down to the founder(s) personality, their immediate network, and the true need in the market for their business/idea. That said, this is exactly the way I've felt about most startups. You're making a time machine for people's Twitter? That's not a billion or even million dollar idea. If you can figure out how to generate revenue it's a small business at best. Thanks Melanie. This article was a breath of fresh air.
il 14y ago
This post is based on so many false assumptions that it's meaningless. Most small business owners/bootstrappers are NOT millionaires, most are just barely scraping by. Less than 3% of small businesses make $250K or more in profit. (http://voices.washingtonpost.com/plum-line/2010/09/boehner_concedes_only_three_pe.html http://voices.washingtonpost.com/plum-line/2010/09/boehner_c...) So if you consider "failure to make over $250K" as failure, 97% of small businesses are failing.
- adambratt 14y ago
  I think you may have missed the point here. Her point was that there are way more revenue generating businesses that have become successful without VC funding than those that have taken VC funding. Granted the successful VC funded companies will almost always be more successful due to the very nature of VC. Furthermore, most small businesses are local service based businesses. The average for profitable web small businesses is probably quite a bit higher than those as you have access to a much much larger market.
- melanie_io 14y ago
  That is a fair point. However, even if you adjust the assumptions for expected value to be 3% (vs 25%, which is what I use), it is still an expected value of $43,000, over 14x greater than that of your average "I want to be the next Instagram" app. I wanted to use 2 hypothetical examples with some reasonable assumptions just to show the staggering difference in probabilities of each scenario.
  - il 14y ago
    Yes, but then the expected value is less than getting a job.
therealarmen 14y ago
As with all things, it's not so black and white. I know it's popular to hate on venture funding here on HN, but the industry exists for a reason. There are certain business models that only work at scale, and in the meantime must be supported by VC cash. For bootstrapped revenue-generating companies, VC funding can be the difference between lifestyle business and IPO. Congratulations to the OP for building a profitable business, but let's keep in mind there are many paths to success.
- adambratt 14y ago
  I don't think it's popular to hate on VC on HN. Sure there are a small number of people who are bitter who speak out against it but I think most people on here are totally for VC funding.
jborden13 14y ago
I love this. It sets a realistic expectation for the vast majority of entrepreneurs. Odds are, you're not getting VC funding. If you want to be an entrepreneur, which should mean you are inherently risk adverse, get to revenue/profitability/CF positive as quickly as possible. Again, with the odds of landing VC funding so low, if landing VC funding is the foundation of your business plan, odds are you are fucked and so is your business. I own a B2B SaaS company that only took $20K from an accelerator, and we have just recently hit $1M ARR. Outside of the $20K, we did it through blood, sweat and tears. No angel money, no VC money. Not that I'm opposed to outside money, but I liked the challenge of CF financing a company (wasn't always easy), but our initial product fills a niche and doesn't ramp up to the $100M in 5 years that gets the VCs' investment weenies going. Instead of spending the potential enormous amount of time that it could take to raise money, we decided to just build a business. And we are doing that shit...
- ryanwaggoner 14y ago
  Could you email me? I'd like to talk more about this offline: ryan at dailypath dc
blacksmythe 14y ago
Although I am not going to fault the conclusion, there are a number of questionable assumptions in this analysis. One is that the expected value of an effort is not the probability of trying times the expected value of succeeding. Multiplying by 1% since only 1% of companies raise VC funds is not relevant. The correct proportion should be the percentage of companies that try to raise VC funds which are successful. Say this is 10%. Two is that you are not going to spend the 10 years used for comparison trying and failing to raise VC funding. After 6 months you should give up, and spend the next 9.5 years trying to build a small business (expected value = (90% chance of failing to raise VC funding) * (9.5years/10years)* $356.4k ~ $305k). Three is that the expected value of an exit is not the probability of a minimum exit cutoff times that exit value. There is a power law distribution to success, so the expected value of an exit is much higher than $100M * 2%. I'll be lazy and guess that the expected value is 3x higher due to the power law distribution of success (I imagine 3x is grossly underestimating here). This makes the expected value of the VC success $3.3k * 10x * 3x ($100k) + the expected value that you give up on VC funding and start a small business ($305k), or approximately $405k. Not nearly so obvious a choice as painted in this blog post.
YZF 14y ago
Hear hear. I've been saying a similar thing for a long time. If the business is so great why sell? The act of selling implies you think it's worth less than what someone else is willing to pay which is dishonest. If you thought it was worth more you wouldn't sell (under most situations, there are always exceptions). Why shouldn't a VC hold on to the great business they've built for the sake of future cash flow? A great business should be able to get funding. It also drives the wrong behavior. Instead of building a real business that lasts better build the appearance of a business that will fetch a good price. Such and such multiple of sales (what about profit? future cash flow?). Such and such many users (who may never pay you a cent). This behavior doesn't stop at the first exit, it perpetuates throughout the lifetime of many public companies; focus on looking good rather than being good. I always thought the original purpose of the stock market was for companies to raise money to go after bigger things- it seems the purpose today is to "exit". EDIT with another thought: To me, build a business vs. build an exit strategy should be orthogonal to VC vs. bootstrap. You can bootstrap and work towards an IPO and you should be able to VC without selling the business. I think everyone would benefit from a frame of mind that is about building successful, sustainable, long lasting businesses.
- runako 14y ago
  I generally agree with your post, but: >> If the business is so great why sell? The act of selling implies you think it's worth less than what someone else is willing to pay which is dishonest. There are a lot of reasons to sell any asset. Life changes, changing locations, or simply want to move on to some other area of interest after building a business for many years. Or since you've been sleeping at the office the last few years at the behest of your VCs, you just want to take a few years off. All of these factors affect how much your business is worth to you. (And only you; whether you have to sleep at the office has no bearing on the value of your company to a buyer, but it might make you receptive to a lower price). Ask a founder during one of the highs, she'll tell you her business is worth 10x-100x the price she'd quote you during one of the lows. Second, a company's value is relative to its owner. For example, The Coca-Cola Company can sell a lot more Vitaminwater in a year than its prior owners due to its global scope, relationships, etc. So Vitaminwater is worth more to Coca-Cola than to the previous owners (who would be able to extract less value from it in a given timeframe). Another example: Vitaminwater would be worth a lot less to IBM than it is to Coca-Cola. So when the company sold, it should have priced somewhere between the expected amount its owners could derive and the (higher) amount Coca-Cola could derive in the same timeframe. There's absolutely nothing dishonest about this. >> Why shouldn't a VC hold on to the great business they've built for the sake of future cash flow? This isn't the VC's business. Their LPs didn't provide them capital for this purpose, so operating companies in this fashion might be a breach of fiduciary duties etc. More to the point, they will likely be bad at it over the long term because their core business is essentially banking (and not operating tech or whatever businesses).
dmor 14y ago
It seems like each week or so we have an existential crisis on HN by an author who has realized the "go big or go home" mindset/lifestyle might not work for them. There is a HUGE fallacy in all this expected value rationalization for building a lifestyle business. You are going to DIE someday. You don't have unlimited time, and I'd rather take crazy bets toward building something risky and radical than be comfortable and safe with "a profitable, small web-based business in just a few years, take a great salary and work 30 hours week". Yes I know I could do that, I was able to do that at 19. I'm doing a startup because that isn't enough for me. That would be like retiring at 19. Blog posts like this feel like "why I settled at 20-something". Come on, really?! Ugh
- oinksoft 14y ago
  It's fine to say that you feel differently from the author and that you have a thirst for glory, a taste for risk. Suggesting that running your own business without ambitions of limitless growth ... that putting in a good work week, maintaining your own serious enterprise, and having a balanced life is akin to "retiring at 19"? I find that offensive and out of touch. I'm not sure what death has to do with all of this. Those of us not at VC-funded startups aren't sitting around twiddling our thumbs. A "don't you know your time is running out?" stance usually implies "you're wasting your time." Now, of course this is a startup website, so the most worthwhile thing you could be doing is building your startup, right? Shouldn't you spend all your time there? Well, it's also a "hacker" website, and there are ways to make your mark outside of the high-energy startup world. Look at that wonderful interview with the creator of Nginx yesterday -- there's a guy who was just working as a sysadmin, saw his own itch to scratch after a lot of work on Apache httpd, and his software has made a major impact. It probably provides much more value on the whole than do most startups.
  - dmor 14y ago
    The expected value of the authors approach is $0 (Why? because the whole expected value argument for a startup is about additional wealth beyond your salary + dent in universe potential), and it is settling to boot. It's offensive and waste of human potential. People striving to be average shouldn't be offended when they're told the course they've chosen will never make them extraordinary. It is reality.
EGreg 14y ago
The expected value is wrong here, because it imagines a distribution where you either go big or you go home with bubkis. The truth is that there are a lot of things in between. Owning 33% of a company that is making millions, and is funded, but not sold for $100M, gives you a nice income and you work on something you like. And all this time you were hiring great people and receiving a good income. If you compare that with the lifestyle business, where you have to grind it out, you have a lot more risk in the lifestyle business actually. So no, not only was the math in the calculation wrong, but really, VC is about scaling a startup (in the Paul Graham sense) into being worth tens and hundreds of millions of dollars and beyond. It's often worth it for the people you meet and the potential exit.
- aaronbrethorst 14y ago
  > Owning 33% of a company that is making millions, and is funded, but not sold for $100M, gives you a nice income and you work on something you like. Odds are that your VC isn't going to see eye-to-eye with this approach.
  - EGreg 14y ago
    Not sure where you get such a conclusion about all the myriad VC firms out there. Founders who are getting a nice income and are able to work on changing the world can do well for the company and its investors: http://www.youtube.com/watch?v=u6XAPnuFjJc http://www.youtube.com/watch?v=u6XAPnuFjJc
pg 14y ago
The critical mistake here is a misunderstanding of how probability works. If we know that x% of startups succeed, that doesn't mean that each group of founders starting a startup have x% chance of succeeding. Some people are orders of magnitude more likely to succeed than others. For those it's a good idea to start a startup. For the rest (a much larger group) it's a bad idea.
- guynamedloren 14y ago
  And how would one know they are orders of magnitude more likely to succeed than others?
  - pg 14y ago
    I've talked about this in several essays. Someday soon I'll write one specifically about that topic. Curiously enough, one of the best ways would be to apply to YC. We have a huge amount of data about which founders succeed, and we work very hard to identify the probable successes among the applicants.
    - guynamedloren 14y ago
      Looking forward to the essay. Slightly off topic, but how does YC feel about applicants that are currently employed by YC-backed companies? Somewhat conflicting, no?
- Negitivefrags 14y ago
  There is no misunderstanding of how probability works here. 100% of people who start businesses believe they can succeed, otherwise they wouldn't start one. Clearly given that such a high percentage of businesses fail, you are not qualified to judge your own chance at success. Therefore the only time you can know that your percentage chance is higher than the average is when you have a 3rd party that is skilled at evaluating such things that tells you so. In the absence of such, your chances just fall back to the raw figures that the article gives and so the analysis stands up.
nnq 14y ago
This is one of the few business advice pieces I've seen lately on HN that is both USEFUL and USEFUL OUTSIDE OF THE USA (or outside any other "growth accelerating" places that popped up in a few other corners of the world...), despite being specific and inspired by US based business experience only. Nice to see the other side of the pond is not really a "different planet" :)
albumedia 14y ago
Awesome post...useful advice for solo founders like myself.
thecosas 14y ago
Sometimes it seems that we miss the forest for the trees.
thecosas 14y ago
Why don't we strive to have "dent in the universe" mean "make the world a little better" rather than whatever the heck we want it to mean? Sure, be excited about tech, but be more excited about the possibilities it opens for the people using it.
peripetylabs 14y ago
Great article. The analysis is correct and to the point. This reminds me of an article about entrepreneurship in a small town in Germany, where they are known for high technology materials engineering. One interviewed businessman was shocked at the offers he received from large, multinational companies. His family business had begun generations ago, and his goal was not to get rich quick, but simply make a living doing what he enjoyed. That's my definition of success. To each their own.

142 points by melanie_io 14y ago

I don't think there's a real formula that will allow you to calculate the expected value as there's so many other variables that come into play. A lot of it comes down to the founder(s) personality, their immediate network, and the true need in the market for their business/idea. That said, this is exactly the way I've felt about most startups. You're making a time machine for people's Twitter? That's not a billion or even million dollar idea. If you can figure out how to generate revenue it's a small business at best. Thanks Melanie. This article was a breath of fresh air.

il 14y ago

This post is based on so many false assumptions that it's meaningless. Most small business owners/bootstrappers are NOT millionaires, most are just barely scraping by. Less than 3% of small businesses make $250K or more in profit. (http://voices.washingtonpost.com/plum-line/2010/09/boehner_concedes_only_three_pe.html http://voices.washingtonpost.com/plum-line/2010/09/boehner_c...) So if you consider "failure to make over $250K" as failure, 97% of small businesses are failing.

adambratt 14y ago
I think you may have missed the point here. Her point was that there are way more revenue generating businesses that have become successful without VC funding than those that have taken VC funding. Granted the successful VC funded companies will almost always be more successful due to the very nature of VC. Furthermore, most small businesses are local service based businesses. The average for profitable web small businesses is probably quite a bit higher than those as you have access to a much much larger market.
melanie_io 14y ago
That is a fair point. However, even if you adjust the assumptions for expected value to be 3% (vs 25%, which is what I use), it is still an expected value of $43,000, over 14x greater than that of your average "I want to be the next Instagram" app. I wanted to use 2 hypothetical examples with some reasonable assumptions just to show the staggering difference in probabilities of each scenario.
- il 14y ago
  Yes, but then the expected value is less than getting a job.

therealarmen 14y ago

As with all things, it's not so black and white. I know it's popular to hate on venture funding here on HN, but the industry exists for a reason. There are certain business models that only work at scale, and in the meantime must be supported by VC cash. For bootstrapped revenue-generating companies, VC funding can be the difference between lifestyle business and IPO. Congratulations to the OP for building a profitable business, but let's keep in mind there are many paths to success.

adambratt 14y ago
I don't think it's popular to hate on VC on HN. Sure there are a small number of people who are bitter who speak out against it but I think most people on here are totally for VC funding.

jborden13 14y ago

I love this. It sets a realistic expectation for the vast majority of entrepreneurs. Odds are, you're not getting VC funding. If you want to be an entrepreneur, which should mean you are inherently risk adverse, get to revenue/profitability/CF positive as quickly as possible. Again, with the odds of landing VC funding so low, if landing VC funding is the foundation of your business plan, odds are you are fucked and so is your business. I own a B2B SaaS company that only took $20K from an accelerator, and we have just recently hit $1M ARR. Outside of the $20K, we did it through blood, sweat and tears. No angel money, no VC money. Not that I'm opposed to outside money, but I liked the challenge of CF financing a company (wasn't always easy), but our initial product fills a niche and doesn't ramp up to the $100M in 5 years that gets the VCs' investment weenies going. Instead of spending the potential enormous amount of time that it could take to raise money, we decided to just build a business. And we are doing that shit...

ryanwaggoner 14y ago
Could you email me? I'd like to talk more about this offline: ryan at dailypath dc

blacksmythe 14y ago

Although I am not going to fault the conclusion, there are a number of questionable assumptions in this analysis. One is that the expected value of an effort is not the probability of trying times the expected value of succeeding. Multiplying by 1% since only 1% of companies raise VC funds is not relevant. The correct proportion should be the percentage of companies that try to raise VC funds which are successful. Say this is 10%. Two is that you are not going to spend the 10 years used for comparison trying and failing to raise VC funding. After 6 months you should give up, and spend the next 9.5 years trying to build a small business (expected value = (90% chance of failing to raise VC funding) * (9.5years/10years)* $356.4k ~ $305k). Three is that the expected value of an exit is not the probability of a minimum exit cutoff times that exit value. There is a power law distribution to success, so the expected value of an exit is much higher than $100M * 2%. I'll be lazy and guess that the expected value is 3x higher due to the power law distribution of success (I imagine 3x is grossly underestimating here). This makes the expected value of the VC success $3.3k * 10x * 3x ($100k) + the expected value that you give up on VC funding and start a small business ($305k), or approximately $405k. Not nearly so obvious a choice as painted in this blog post.

YZF 14y ago

Hear hear. I've been saying a similar thing for a long time. If the business is so great why sell? The act of selling implies you think it's worth less than what someone else is willing to pay which is dishonest. If you thought it was worth more you wouldn't sell (under most situations, there are always exceptions). Why shouldn't a VC hold on to the great business they've built for the sake of future cash flow? A great business should be able to get funding. It also drives the wrong behavior. Instead of building a real business that lasts better build the appearance of a business that will fetch a good price. Such and such multiple of sales (what about profit? future cash flow?). Such and such many users (who may never pay you a cent). This behavior doesn't stop at the first exit, it perpetuates throughout the lifetime of many public companies; focus on looking good rather than being good. I always thought the original purpose of the stock market was for companies to raise money to go after bigger things- it seems the purpose today is to "exit". EDIT with another thought: To me, build a business vs. build an exit strategy should be orthogonal to VC vs. bootstrap. You can bootstrap and work towards an IPO and you should be able to VC without selling the business. I think everyone would benefit from a frame of mind that is about building successful, sustainable, long lasting businesses.

runako 14y ago
I generally agree with your post, but: >> If the business is so great why sell? The act of selling implies you think it's worth less than what someone else is willing to pay which is dishonest. There are a lot of reasons to sell any asset. Life changes, changing locations, or simply want to move on to some other area of interest after building a business for many years. Or since you've been sleeping at the office the last few years at the behest of your VCs, you just want to take a few years off. All of these factors affect how much your business is worth to you. (And only you; whether you have to sleep at the office has no bearing on the value of your company to a buyer, but it might make you receptive to a lower price). Ask a founder during one of the highs, she'll tell you her business is worth 10x-100x the price she'd quote you during one of the lows. Second, a company's value is relative to its owner. For example, The Coca-Cola Company can sell a lot more Vitaminwater in a year than its prior owners due to its global scope, relationships, etc. So Vitaminwater is worth more to Coca-Cola than to the previous owners (who would be able to extract less value from it in a given timeframe). Another example: Vitaminwater would be worth a lot less to IBM than it is to Coca-Cola. So when the company sold, it should have priced somewhere between the expected amount its owners could derive and the (higher) amount Coca-Cola could derive in the same timeframe. There's absolutely nothing dishonest about this. >> Why shouldn't a VC hold on to the great business they've built for the sake of future cash flow? This isn't the VC's business. Their LPs didn't provide them capital for this purpose, so operating companies in this fashion might be a breach of fiduciary duties etc. More to the point, they will likely be bad at it over the long term because their core business is essentially banking (and not operating tech or whatever businesses).

dmor 14y ago

It seems like each week or so we have an existential crisis on HN by an author who has realized the "go big or go home" mindset/lifestyle might not work for them. There is a HUGE fallacy in all this expected value rationalization for building a lifestyle business. You are going to DIE someday. You don't have unlimited time, and I'd rather take crazy bets toward building something risky and radical than be comfortable and safe with "a profitable, small web-based business in just a few years, take a great salary and work 30 hours week". Yes I know I could do that, I was able to do that at 19. I'm doing a startup because that isn't enough for me. That would be like retiring at 19. Blog posts like this feel like "why I settled at 20-something". Come on, really?! Ugh

oinksoft 14y ago
It's fine to say that you feel differently from the author and that you have a thirst for glory, a taste for risk. Suggesting that running your own business without ambitions of limitless growth ... that putting in a good work week, maintaining your own serious enterprise, and having a balanced life is akin to "retiring at 19"? I find that offensive and out of touch. I'm not sure what death has to do with all of this. Those of us not at VC-funded startups aren't sitting around twiddling our thumbs. A "don't you know your time is running out?" stance usually implies "you're wasting your time." Now, of course this is a startup website, so the most worthwhile thing you could be doing is building your startup, right? Shouldn't you spend all your time there? Well, it's also a "hacker" website, and there are ways to make your mark outside of the high-energy startup world. Look at that wonderful interview with the creator of Nginx yesterday -- there's a guy who was just working as a sysadmin, saw his own itch to scratch after a lot of work on Apache httpd, and his software has made a major impact. It probably provides much more value on the whole than do most startups.
- dmor 14y ago
  The expected value of the authors approach is $0 (Why? because the whole expected value argument for a startup is about additional wealth beyond your salary + dent in universe potential), and it is settling to boot. It's offensive and waste of human potential. People striving to be average shouldn't be offended when they're told the course they've chosen will never make them extraordinary. It is reality.

EGreg 14y ago

The expected value is wrong here, because it imagines a distribution where you either go big or you go home with bubkis. The truth is that there are a lot of things in between. Owning 33% of a company that is making millions, and is funded, but not sold for $100M, gives you a nice income and you work on something you like. And all this time you were hiring great people and receiving a good income. If you compare that with the lifestyle business, where you have to grind it out, you have a lot more risk in the lifestyle business actually. So no, not only was the math in the calculation wrong, but really, VC is about scaling a startup (in the Paul Graham sense) into being worth tens and hundreds of millions of dollars and beyond. It's often worth it for the people you meet and the potential exit.

aaronbrethorst 14y ago
> Owning 33% of a company that is making millions, and is funded, but not sold for $100M, gives you a nice income and you work on something you like. Odds are that your VC isn't going to see eye-to-eye with this approach.
- EGreg 14y ago
  Not sure where you get such a conclusion about all the myriad VC firms out there. Founders who are getting a nice income and are able to work on changing the world can do well for the company and its investors: http://www.youtube.com/watch?v=u6XAPnuFjJc http://www.youtube.com/watch?v=u6XAPnuFjJc

pg 14y ago

The critical mistake here is a misunderstanding of how probability works. If we know that x% of startups succeed, that doesn't mean that each group of founders starting a startup have x% chance of succeeding. Some people are orders of magnitude more likely to succeed than others. For those it's a good idea to start a startup. For the rest (a much larger group) it's a bad idea.

guynamedloren 14y ago
And how would one know they are orders of magnitude more likely to succeed than others?
- pg 14y ago
  I've talked about this in several essays. Someday soon I'll write one specifically about that topic. Curiously enough, one of the best ways would be to apply to YC. We have a huge amount of data about which founders succeed, and we work very hard to identify the probable successes among the applicants.
  - guynamedloren 14y ago
    Looking forward to the essay. Slightly off topic, but how does YC feel about applicants that are currently employed by YC-backed companies? Somewhat conflicting, no?
Negitivefrags 14y ago
There is no misunderstanding of how probability works here. 100% of people who start businesses believe they can succeed, otherwise they wouldn't start one. Clearly given that such a high percentage of businesses fail, you are not qualified to judge your own chance at success. Therefore the only time you can know that your percentage chance is higher than the average is when you have a 3rd party that is skilled at evaluating such things that tells you so. In the absence of such, your chances just fall back to the raw figures that the article gives and so the analysis stands up.

nnq 14y ago

This is one of the few business advice pieces I've seen lately on HN that is both USEFUL and USEFUL OUTSIDE OF THE USA (or outside any other "growth accelerating" places that popped up in a few other corners of the world...), despite being specific and inspired by US based business experience only. Nice to see the other side of the pond is not really a "different planet" :)

albumedia 14y ago

Awesome post...useful advice for solo founders like myself.

thecosas 14y ago

Sometimes it seems that we miss the forest for the trees.

thecosas 14y ago

Why don't we strive to have "dent in the universe" mean "make the world a little better" rather than whatever the heck we want it to mean? Sure, be excited about tech, but be more excited about the possibilities it opens for the people using it.

peripetylabs 14y ago

Great article. The analysis is correct and to the point. This reminds me of an article about entrepreneurship in a small town in Germany, where they are known for high technology materials engineering. One interviewed businessman was shocked at the offers he received from large, multinational companies. His family business had begun generations ago, and his goal was not to get rich quick, but simply make a living doing what he enjoyed. That's my definition of success. To each their own.