The Economics of VC Startups for Individuals
Posted by Bob Warfield on July 9, 2016
Should you take 1 eight-year startup job or 4 three-year jobs?
Is software a great industry to job hop?
His conclusion is, “No,” largely because he makes the case that you won’t make nearly as much money. His concerns are:
- You don’t vest much. He estimates 15% a year allowing for future grants.
- You may not be able to afford to buy the shares when you leave if the strike price is too high.
- If you get RSUs instead of options, you may get nothing when you leave.
I’ll address #1 in a minute, but let’s talk about #2 and #3.
Not being able to afford to buy the shares implies you’re joining the startup relatively late. The average startup requires 7 years start to finish to reach liquidity. How late does the startup have to be before you can’t afford to buy your shares? Tough to say. An early unicorn would certainly do it. But in most cases, my guess is you’re at least halfway through the 7 years. So you can no longer buy shares at say the 3 year mark.
Okay, but is that a problem if you join at year 3 and allocate 2 years to figure out whether it is worth staying the remaining 2? Unless things are still seriously hot after your 2 years are up (year 5), it seems to me you can still look at it as a 2 year stint and maybe just buy fewer shares. If the thing really is a Unicorn, you’ll need fewer. In other words, reason #2 is not as compelling as it seems–you don’t have to settle for nothing, you will get a chance to look at a few more cards in the poker hand during the 2 years, and you may simply wind up with a smaller return if you mistakenly leave early because you didn’t buy all of your vested shares.
Issue #3 I look at totally differently. Do you want to join a startup that offers RSU’s (Restricted Stock Units) instead of a options? Do you want to join a startup that gives you nothing if you leave after having given them 2 years? Personally, I just wouldn’t sit down to play at such a table. The house has things rigged too thoroughly in their favor. I’m sure there are endless anecdotes about companies with RSU’s that made fortunes for their employees, but remember-the odds are already heavily stacked against you (shortly we’ll see just how much). Do you really want this additionally risk? And are companies that operate this way more or less successful? Are they more or less likely to be good to their employees, people like you? Color me skeptical.
Now let’s get back to concern #1–“You didn’t vest enough to make real money.” You only got 15% of what you could’ve gotten instead of 100%. Let’s look at it somewhat differently. First, your resume looks terrible if you have a new job every year, so you need to stay for 2 years, not 1. That gets you 30% rather than 15%, a big step up.
Second, concern #1 is expressed as though making the money is a sure thing, and it most certainly is not. I prefer to look at it this way:
Should you take one 8-year job or four 2-year jobs? Which one has the highest likelihood of putting you in the money?
If we look at it that way, and make a few assumptions, it’s possible to model the two scenarios in Excel. In fact, we can handily run a Monte Carlo simulation and see what results we get.
Here are the assumptions I used for the simulation:
– You can either stay in 1 job for 8 years (about what it takes to go from 0 to liquidity in round numbers) or you can take 4 jobs and stay 2 years each.
– Your chance of picking a winner is 1/8. 1 in 8 deals wins. Overall 3 out of 4 VC deals fail to return the investor’s money. It’s a sure bet that a fair number that return the money still won’t return anything to you as the VC’s have all sorts of preferential terms in the deal. So let’s just say it is 1 in 8.
– If the 1 job guy gets a win, he gets 100%. If the 4 job guy gets a win, he gets 30% (2 years at Jason Lemkin’s 15% a year figure).
Now we do 5000 iterations of that in an Excel spreadsheet for a Monte Carlo simulation. Here are the results:
– The 1 job guy only has a 14% chance of getting his 100% of shares to return. I wonder how many would sign up for a startup if they soberly concluded those were the odds?
– The 4 job guy has a 42% chance of getting his 30% of shares in the money.
Way better odds for the portfolio effect of taking 4 jobs with 2-year stints. So now the decision is a utility curve issue. Say we’re talking $10 million. Do you want a 14% chance at $10 million or a 42% chance at $3.3 million?
Jason has said that absolutely the most important thing is to make your first few million–he should be voting for the 42% chance at $3.3 million if you’ve never made your first few million. He then advocates swinging for the fence to make 10x more, after you have your first few in the bank.
I’m not even sure that’s the right strategy, it is again, a utility curve thing. What’s your goal? How much will you sacrifice to get to that goal? How much is enough money?
How lucky do you feel?
Or, look at it this way:
You only have so many deals, so many throws of the dice, in your entire career. How many are left, particularly when you consider that many feel startups are a young person’s game?
I don’t feel startups have to be a young person’s game, BTW, but I do think you have to find some way of achieving a portfolio effect to maximize your likelihood of success. Otherwise, you’re working your tail off and taking substandard pay mostly to help your investor’s win big due to their portfolio effect while the greatest likelihood is you’ll make absolutely nothing.
PS: Now you’re wonder if your odds will be better because you’re smarter and this deal you’re looking at is just so good. Let’s say your odds are the same as the VC’s–1 in 4 deals will hit instead of 1 in 8.
What does doubling the odds do for you in the Monte Carlo simulation?
Recall we originally had a 14% chance of making 100% and a 42% chance of making 33%. If we double the odds per deal, we now have a 26% chance of making 100% and a 69% chance of making 33%.
I don’t know about you, but having the odds favor me on each 2 year stint to the tune of 69% sounds awesome. Heck, I might even succeed at more than one of the 4 stints, which would get my 33% up to 66% or maybe even more.