Jackson Fish Market
Posted on June 1, 2009 by hillel on Industry

Given the odds, is taking venture capital the best way to get rich?

The fantasy goes something like this:

  • come up with an idea
  • take venture money
  • align with the VCs to grow the business as best you can with the firm target of an exit
  • hold on to enough equity so that when the exit comes you and the VCs both get rich
  • maybe some of your employees hang on to enough equity that they get rich too
  • retire on your boat

It’s a reasonable fantasy. I get it. In a recent post we discussed the difficulty for founders in holding on to equity and control in their own companies once they involve venture capitalists. And as you can imagine, if it’s hard for founders to hang on to equity, then employees have an even slimmer chance. But what about the money?

I tend to not factor in the money that you get from the mythical huge exit because they’re so rare. But what kind of money can you expect to earn in terms of profit?

A couple of blog posts have gone around citing profit per employee figures from 2008. This one and this one.

Some tidbits:

Revenue and profit per employee in 2008 (in USD)
Company Employees Revenue per employee Profit per employee
Google 20,164 1,080,914 209,624
Microsoft 91,000 663,956 194,297
Baidu 6,397 499,961 163,844
Apple 32,000 1,014,969 151,063
Cisco 66,129 597,922 121,762
Adobe 7,335 488,056 118,856
eBay 16,200 527,238 109,844
Intel 82,500 455,588 64,145
Oracle 86,657 258,837 63,711
Dell 76,500 798,706 32,392
Amazon 20,600 930,388 31,311
Yahoo 13,600 530,037 31,199
IBM 398,455 260,080 30,957
HP 321,000 368,735 25,947
Sun 33,556 413,637 12,010

Now I’m not saying making 200k in profit per year per employee is an easy feat. And frankly, even making the 12k that Sun has made is an accomplishment in my opinion. But I do know this, making 200k in profit per employee is a lot easier when you five or ten employees than when you have 20,164 like Google does in the chart. Even getting to 100k per profit per FTE will help you kick Oracle, Amazon, and Dell’s asses.

Now, critics will point out that that profit per that many FTEs ends up being quite a bit of money. And that’s fair. Except for one small problem. How much of that profit ends up in the hands of the hands of founders? Well, it depends. It’s often a surprisingly small amount. Remember, these founders often (not always) end up without huge percentages of their businesses.

I believe that profit per FTE is one of the single most important metrics there can be in a business. And I hope someday to get our number to very high. The main difference is that I hope to make that number high not only by earning lots of revenue, but by aggressively keeping the number of employees it has to be divided by as small as possible. And since there will be no investors, there are only two remaining constituencies to split the money between: employee-owners and employees. If I can pull 500k a year out of my business, it’s like I have 10 million dollars in the bank.

The astute (and even not so astute) may point out that for my 10 mil equivalent I have to keep working. Fair enough. I don’t get it in one lump sum. However, so many entrepreneurs tell me how they love working and will be doing it the rest of their lives. So why not do it the rest of your life, pull the cash out of your business with lots of profit and very few employees, and ultimately retain significant control over your own destiny?

I could have done better at math, but I need some help designing an equation that includes all these factors:

  • chance of your idea taking off
  • chance of you retaining control while your idea takes off
  • chance of you retaining enough ownership to make money when your idea takes off
  • chance of your company getting to a liquidity event
  • chance of your business becoming profitable year-over-year
  • amount of profit your business generates
  • number of people who have the right to some of that profit
  • likely amount of money you’ll get in such a liquidity event
  • likely amount of money you’ll be able to pull out of the business each year
  • number of years it will take for the money you pull out of the business to equal the amount you’d get in a liquidity event
  • likely number of years you’ll have to work to create a business that reaches a liquidity event

You get the point. I think I need to hire Umair Haque to figure out how to turn this into an apples to apples comparison.

To me, taking that longshot at a venture backed liquidity event that leaves you with enough money to be rich is akin to playing the lottery. But building your own business that you control feels a lot more like the ideal of entrepreneurship that many people claim to espouse. And I claim, that in the latter case, not only can your odds of succeeding be higher, but when you do succeed, instead of having won the lottery, you’ve created your own personal cash printing press. Cash that you can use as if it were dividends from some big payout, or that you can reinvest in new projects to scratch your entrepreneurial itch. And in our future, hopefully, both!

As usual, I have no problem with the VC –> “liquidity event” standard path. But I am fascinated by people who think that it’s the only path to creating a “real” business or “real” wealth. I am always genuinely surprised by how many people take the VC path, especially for businesses that don’t seem to require it. It feels to me like they’re choosing to take the low percentage shot. But maybe I’m missing something.

Join the discussion 9 Comments

  • Reply

    Dave

    June 1, 2009 at 5:11 pm

    Amen. I founded two companies (not enough for a good sample, but…) With the first, we took venture capital. Taking VC made our lives easier in the process. We took nice salaries, vacations, etc. But it failed. And in a pretty painful way (part of taking venture capital is ramping up to large numbers of employees; less fun when you have to lay them off).

    The second was mostly bootstrapped (I took a little angel money from some people we knew). We were acquired. For less than $10M, but nonetheless, enough to be happy with the outcome. I now have a small business that generates some cashflow without too much involvement on my part.

    The big secret: The first million changes your life. The second doesn’t. I suspect $100M isn’t that different from $1M. So why take on that kind of risk?

  • Reply

    Erik

    June 1, 2009 at 6:05 pm

    What if you won’t survive without VC money?
    What if the competition is faster because they take VC?
    What if the competition has more opportunities because of the connections of VC?
    If you can build a business the provides you with 500k pa for the rest of your life, congratulations. But how high are the chances that you business will be around for such a long time – especially if you happen to be a tech startup?

  • Reply

    Hans Solo

    June 1, 2009 at 6:52 pm

    Never tell me the odds

  • Reply

    Dharmesh Shah

    June 1, 2009 at 9:52 pm

    Great topic.

    The E.V. (expected value) for founders of venture-backed startups is actually pretty low given the low probability of a high-value exit.

    The numbers I’ve read in the past is that the founders of venture-backed startups that go through about 3 rounds of capital wind up with about 6% of the equity (on average).

  • Reply

    Mark Essel

    June 2, 2009 at 2:46 am

    I would imagine specific businesses need to “fast track” their development to beat competitors. Outside angel/venture money helps make this happen by allowing a startup to attract effective talent. Nowadays it is much more possible to start out with just your spare time and a few grand for legal expenses to get the company breathing, but if you look at the largest and most successful companies you’ll see that there was a method for attracting outside talent in sufficient quantities to tip the industry in their favor.

  • Reply

    Ron Kornfeld

    June 2, 2009 at 1:16 pm

    It’s the VC anti-dilution and liquidation preferences that make moderate exits (the most likely scenario) a bust for the common shareholders (founders and employees). And, since VCs need a liquidation they will never let you distro cash as you have described. You can point to past successes and see the role that VC money played but that’s a trailing indicator. For most web/tech/social companies of the present (and future) more modest capital raises and practical liquidity models utilizing angel money will drive the best outcomes for the team.

  • Reply

    Brad Hefta-Gaub

    June 2, 2009 at 1:26 pm

    Another great post Hillel.

    Big props to Hans Solo too, for coming out his Carbonite deep freeze and laying some of his wisdom on us. :)

    WRT Erik’s comment, I think this is a classic misreading of Hillel’s argument. He’s not saying that you can make a business work on no capital. And he’s not saying that all business require the same amount of capital. If you have a business that requires large amounts of capital to be successful, then you probably DO HAVE TO look into capital sources like VC.

    But I would say that as it relates to web software, more and more businesses are able to be created on smaller and smaller amounts of capital. There’s a great deal of evidence to support this perspective.

  • Reply

    Rajat Arya

    June 2, 2009 at 2:27 pm

    Great post Hillel.

    David Heinemeier Hansson at Startup School 08 – something similar – in terms of attacking the Fortune 5,000,000 instead of trying to create the next wave.

    Check out his presentation here:
    http://www.omnisio.com/startupschool08/david-heinemeier-hansson-at-startup-school-08

    I don’t agree with everything DHH has to say but this presentation is absolutely correct.

  • Reply

    Dan

    June 4, 2009 at 10:02 pm

    A few considerations:

    One important variable is that with VC, you’re playing with Other People’s Property. If you have an idea that requires a few years to break even and a few people to work on it, you can risk a half mil of your own money (assuming you’re independently wealthy) or you can do it on someone else’s dime. If it fails, you’ve drawn a salary for doing something fun; if it succeeds, you get to share in the upside.

    You compare taking VC to playing the lottery. That’s fair in many ways. But you say: “I tend to not factor in the money that you get from the mythical huge exit because they’re so rare.” While uncommon, those results are so huge that they do play an important part in the expected returns calculation – just like in the lottery.

    Finally, let me point out that you’ve built a wonderful services company that is, I think, moving towards building products. As compared to product companies, service companies are generally much faster to get to cashflow breakeven and not venture backed. These points are correlated. It’s inherently riskier and more expensive to start a company that builds products because you don’t have a customer who’s promised to pay you for your work. Exceptions abound, but it’s a useful starting point to “should I consider VC”. If one of your goals is to build a product, the answer is more likely yes than if your answer is to serve really delicious vegan desserts, for example.

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