Build a Business, Not an Exit Strategy

http://melanie.io/2012/10/18/build-a-business-not-an-exit-strategy/

by melanie_io • 14 years ago

142 81 14 years ago

adambratt4• 14 years 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.

il2• 14 years 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_c...)

So if you consider "failure to make over $250K" as failure, 97% of small businesses are failing.

adambratt4• 14 years 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_io6• 14 years 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.

il2• 14 years ago

Yes, but then the expected value is less than getting a job.

therealarmen• 14 years 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.

adambratt4• 14 years 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.

jborden132• 14 years 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• 14 years ago

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

blacksmythe• 14 years 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.

YZF2• 14 years 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• 14 years 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).

mdda• 14 years ago

> The act of selling implies you think it's worth less than what someone else is willing to pay which is dishonest.

Any trade involves both parties giving up what they have for what the other person has. Both parties believe they gain from the exchange. There doesn't have to be any dishonesty involved : Both parties can come out ahead of where they started (because they value what they had before vs having after in different ways).

A startup entrepreneur can reasonably value freedom+cash more highly than a cash-cow business. The business buyer may value proven yield above their other alternatives for their cash. Both people win by doing the trade.

YZF2• 14 years ago

There doesn't have to be but the way IPOs are set up there's incentive for dishonesty. At the very least, the buyers of the shares are at a information disadvantage compared to the issuer. If you were to personally buy an entire private business you would never accept the level of disclosure that people buying shares in an IPO have to accept. You'd have your experts review every corner of the business.

dmor7• 14 years 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

jkaykin• 14 years ago

Can't agree with you more.

seehafer2• 14 years ago

Posts like this always essentially boil down to one statement:

"The startup (in the pg sense of the term) lifestyle is not for me."

And that's ok. For most people, making a dent in the universe is not an existential need.

dusing2• 14 years ago

99.9999% of startups are not denting anything, or really even trying to.

oinksoft3• 14 years ago

I always forget the name of that startup where Torvalds wrote Linux ... he couldn't have made a dent without a startup, could he?

melanie_io6• 14 years ago

OR, most people realize that building a wildly successful photo app / car sharing service / daily deal site does not 'make a dent in the universe.'

adambratt4• 14 years ago

I both agree and disagree. If you're throwing in all your chips you better have an idea for a business that is scalable and has massive revenue potential.

That's where a lot of so called startups miss the mark.

oinksoft3• 14 years 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.

dmor7• 14 years 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.

melanie_io6• 14 years ago

I think you either did not read the article, or did not understand it. I am certainly not advocating 'giving up' in any sense. I doubt you would say that DHH or Tim Ferris have 'given up' and 'settled in their twenties.' I even say outright, that my point is to follow your own path, and make your own rules, rather than listen to the hype and tech press.

I am advocating for a worldview where getting VC funding is not an accomplishment in and of itself, and does not necessarily mean you are successful. By taking funding, you are giving up the opportunity to work for yourself. You are 'hiring a boss,' so to speak. And for me, after working for others for years in finance, and then as a CEO of a funded start-up, I decided I would rather forge my own path in life, prestige and press be damned.

dmor7• 14 years ago

With all respect (and I loved your previous company) I read it and quite frankly it read like this: "I raised $75K and flamed out and this is my rationalization for taking it easy right now". That's fine for you, but I don't think it is good for other entrepreneurs. I also think the expected value argument is poorly reasoned.

olalonde3• 14 years ago

Yeah, we have this same rant every few weeks on HN (I admit this one is pretty well written and features an interesting back story). The biggest problem I see with the expected value math is that it only factors in the money side of the equation. A lot of entrepreneurs (most entrepreneurs?) are doing a "go big or go home" startup for many reasons, money not necessarily being the primary one. If all Melanie cares about is money (I bet that's not the case), she'd probably have a higher "expected value" at studying medicine and becoming a surgeon.

Anyways, as a Silicon Valley outsider, it's weird to see those blog posts encouraging people not to take VC money. Is there actually so much pressure on taking VC money that people actually feel the need to write posts like this? Seems like a first-"first world" problem to me...

edit: Here's an interesting take on expected value by a statistician: http://simplexify.net/blog/2012/5/6/i-am-a-statistician-and-...

> So why do I still buy lottery tickets? Definitely not for the expected monetary return on investment. I think of it as a discretionary entertainment spend. I get literally hours of enjoyment from fantasizing what I’d do if I won. I happily spend $25 for two hours of entertainment at the movies, and I don’t judge the value of that experience based on its expected return. For me, a lottery ticket for the occasional big draw has just as much entertainment value, or more, than the many other things that I spend money on to entertain myself.

I bet this line of thought applies to a lot of startup founders.

jasonkester• 14 years ago

"Settling" for several hundred thousand dollars a year on a handful of hours of work per week? That doesn't sound like very many people's definition of the word.

"Settling" is usually used to describe accepting a somewhat bad situation because you know you're never going to find one that's better. The situation you describe above would be the fantasy of pretty much every human being on the planet.

"Why I solved my financial situation for good and retired at 19". Find me anybody apart from yourself who thinks there's no upside to that.

dstorrs4• 14 years ago

"I am doing a startup because...."

So, to you, it's not a startup unless it's what the OP calls the "go big or go home" approach. The OP asserts that that is not a critical element of starting up a business, nor a healthy one, nor necessarily one that will increase your odds of success.

Honestly your argument seems odd. If you were able to do a successful company ($2mm / year rev, $3mm exit after 10 years by OP definition) at 19, why didn't you? Why not use that money to fund your "bigger is better" startup instead of taking VC? Or did you?

kazevedo• 14 years ago

The way I read it, the post primarily advocates a focus on being sustainable and profitable rather than optimizing for a VC raise. You said as much yourself in the recent TC article on Referly's seed round, no?

As the common wisdom goes, the best way to raise money is to not need it. Whether you decide to take funding at that point to accelerate your growth is up to you.

While looking to raise capital and "go big or go home" is perhaps a good barometer of desired impact, I don't think it necessarily correlates to actual impact. From personal experience, there are plenty of companies that go through accelerators or do the "startup" route that are completely optimized for a flashy launch and raising a few $MM. Even if they do eventually prove to be disruptive and earn an exit, the definition of "impact" is a separate discussion, and, I would argue, not solely based on sale price or how many users you've obtained.

dmor7• 14 years ago

I'm not advocating for or against raising money here, but I think the post offers a very low intensity approach as a meaningful way to build a successful business. And for more entrepreneurs, especially first timers, I don't think that is going to work out.

EGreg4• 14 years 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.

aaronbrethorst2• 14 years 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.

EGreg4• 14 years 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

pg5• 14 years 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.

guynamedloren2• 14 years ago

And how would one know they are orders of magnitude more likely to succeed than others?

pg5• 14 years 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.

Negitivefrags4• 14 years 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.

TallboyOne• 14 years ago

I'm no mathematician, or even close, but I don't believe only a person's beliefs translate to their real-world chances of success. A lot has to do with your work ethic, motivation, ability to work long hours, focus, upbringing etc.

I also don't think 100% of people who start businesses believe they can succeed. I'm sure a large percantage are trying to wing it and hope they get lucky.

acgourley• 14 years ago

That's rational. Good luck getting any founder to think that way.

lusr• 14 years ago

What you said is true if you're young and you don't have much data to assess yourself with, but even if you're not pg and don't have a model of success well backed with data, the fact is that if you're 30 or 40 years old there are plenty of objective third parties you will have encountered throughout life who have assessed you for free.

For example, if you've been through a demanding course of tertiary education and performed better than average that says something. Indeed any endeavour that required a fair amount of intelligence, skill, and commitment where you came out above average says something: starting other businesses and having done better than average comes to mind.

In addition to the flaw pg pointed out, the second mistake the article's analysis makes is to ignore the number of opportunities you have; it seems to assume you have a single opportunity. In reality, you can make some less than optimal choices in life and still sometimes do just as fine in the end.

If you're young I don't see what's wrong with gambling a bit: if you're 20 and have zero data about how well you will perform, I believe it's still completely rational to aim high. If you don't get the $100 million exit by 25, you can reconsider your options. After 5 years of aiming high you'll have more than enough data to assess whether it's time to change your aim or to keep going.

hluska• 14 years ago

Mind if I jump in with an analogy?

In 2012, the Canadian Olympic team sent 281 athletes to compete at the summer Olympics in London. The World Bank reports that Canada's population is approximately 34,000,000.

Using a raw analysis, you could say that, "A Canadian has a 281/34,000,000 probability of reaching the summer Olympics." That is perfectly valid.

However, you cannot use that same technique to judge individual chances of success. Let's say that I am in a room with Brent Hayden.

Brent Hayden (a swimmer who won a bronze medal) is 6'4 and has a very athletic build. I am 25 pounds overweight, pasty faced from too much time in front of computers and completely void of hand-eye coordination.

Clearly, our individual odds of reaching the Olympics are different. The probability that I will make the summer Olympics is, in actuality, far below 281/34M because I am on the left side of the athletic prowess bell curve. Someone like Brent Hayden's probability of making the summer Olympics in, in actuality, higher than 281/34M because they would fall on the right side of the athletic prowess bell curve.

Those sorts of normal distributions happen in startups as well. Some teams are significantly more suited for the demands of startup lives (just like some couples are significantly better suited for the demands of marriage than others are).

pg5• 14 years ago

Your mistake in turn is to assume that it's impossible for people to judge their own abilities.

Lots of people think they could write a decent novel. Most are wrong. Suppose only .01% actually could. If your argument were correct, JK Rowling should assume her chances of writing a decent novel are .01%. She feels fairly confident that she could, but she has to discount that, because people are often mistaken about such things, and "fall back to the raw figures."

It is possible to know that one is good at something.

paraschopra• 14 years ago

There does seem to be some flaw in this argument. Within those people who have orders of magnitude higher probability of succeeding, how do you differentiate? My general point is the it is impossible to assign a probability to an individual's success (since there is only one data point). So for calculating probability, you will have to aggregate many individuals and see how many of them become successful. The OP's understanding of probability is entirely accurate if we talk about general set of people who are starting companies (assuming figures quoted are accurate).

Of course, within a set you can create many more subsets but that doesn't mean original set is wrong.

peripetylabs2• 14 years ago

I think the author correctly understood probability theory.

If a population is modelled by a random variable, each individual probability is unknown. What is known is the continuous probability distribution of the entire population.

Intuitively, this means you cannot know which individuals will succeed or fail, you can only know what proportion will succeed -- regardless of the merits of each individual.

The author correctly calculated mean outcome -- more precisely, expected value:

http://en.wikipedia.org/wiki/Expected_value#Univariate_conti...

guylhem2• 14 years ago

Indeed, and one way to improve that is to separate the random variable that represents the population by different random variables (say male immigrant with at least master level studies, female of less than 30 years, other males, other females) and calculate the success rate of each.

They may have a different probability distribution, even if the population average follow a normal law (central limit theorem)

If you invest is the most achieving group instead of distributing your investment across the population, you will have better returns.

EGreg4• 14 years ago

pg, not only are you right about this, but there is a greater mistake in the assumptions here -- namely that there can only be two outcomes: $100M with 0.002% chance, and $0 with a 9.998% chance. In reality, there is so much in between, which raises the expected value quite a bit.

rdl• 14 years ago

It's also totally meaningless to use the population statistics for "all new small businesses" and try to extrapolate to "scalable tech startups in silicon valley".

I'd have probably 50-80% odds of building a successful consulting business or other small technology business which scales directly on labor, generates ~$100k/yr in profit per employee (over salary), up to a few employees, etc.

I'd have lower odds of building a hugely successful consumer startup like Facebook. I'd hope it's a touch higher than for a random farmer in rural China, but still not that great.

I think I have better odds than many for building something in between -- a business focused infrastructure/security startup, maybe not a 1b user $100b business like Facebook, but also not a consultancy. Plenty of $100mm/yr revenue opportunities in the b2b space.

Even if the expected return for each type of business were the same over all people, I probably have a comparative advantage in b2b, and other people may have a comparative advantage in consultancy or in huge consumer startups.

nnq• 14 years 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• 14 years ago

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

thecosas2• 14 years ago

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

thecosas2• 14 years 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.

peripetylabs2• 14 years 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.

Build a Business, Not an Exit Strategy

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