
Build a Business, Not an Exit Strategy - melanie_io
http://melanie.io/2012/10/18/build-a-business-not-an-exit-strategy/
======
pg
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.

~~~
Negitivefrags
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.

~~~
pg
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.

~~~
Negitivefrags
That is not an example of JK Rowling judging her own abilities. Her abilities
were judged by the market when she published her books.

It's possible to know one is good at something, it's just not possible to
_judge your own abilities_.

~~~
pg
I'm not talking about an existing book. I'm talking about the case where she's
trying to predict the chance she'll be able to write a new book, before she's
started it.

Her previous books should give her confidence that she'll be able to write
another. That is one way in which she can _judge her own abilities._

------
YZF
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.

~~~
mdda
> 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.

~~~
YZF
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.

------
blacksmythe
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.

------
jborden13
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
Could you email me? I'd like to talk more about this offline: ryan at
dailypath dc

------
dmor
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

~~~
seehafer
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.

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

~~~
olalonde
But the same reasoning applies. What was Torvald's "expected value" at the
time he wrote Linux? Probably -XXXXX$ if we factor in opportunity cost.

------
il
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...](http://voices.washingtonpost.com/plum-
line/2010/09/boehner_concedes_only_three_pe.html))

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

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

------
adambratt
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.

------
nnq
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" :)

------
therealarmen
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
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.

------
EGreg
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
> 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
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>

------
thecosas
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
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.

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

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

