Start a Business, Not a Startup Part 4: The Advantages of Not Taking VC Capital
This is the 4th and final post in my series “Start a Business, Not a Startup.” In this installment, we’ll put everything together from the previous 3 posts. We’ll go from enumerating the shortcomings of startups to the advantages of regular old software businesses. You can navigate between the this post and previous parts below:
- Start a Business, Not a Startup Part 1: Introduction
- Start a Business, Not a Startup Part 2: The Money
- Start a Business, Not a Startup Part 3: Time and Customers
- Start a Business, Not a Startup Part 4: The Advantages of Not Taking VC Capital
Up to this point, I’ve been working to convince you that startups aren’t a great deal for co-founders. Most, this boils down to the business advantages of not taking VC capital. I’ve analyzed the data to prove that startup co-founders spend a lot more time achieving mediocre financial outcomes than their salaried peers. And if that weren’t bad enough, customers get left in the lurch when VCs pull the plug looking for the next home run.
But are non-startup businesses actually any better for the people that start and run them? I argue that the answer is a qualified “yes.”
Comparing Apples to Apples
When I refer to non-startup businesses, I’m not talking about coffee shops and restaurants. That comparison isn’t useful. It would be like trying to argue that trains are better than Oak trees.
When I talk about businesses, I refer to bootstrapped software companies. I would go so far as to include software businesses that take traditional non-dilutive loans to grow their operations.
The critical difference between a software business and a startup is the growth opportunity and speed of scaling. A business can target a small niche and grow slowly over many years. A startup doesn’t have that luxury.
Startups Aren’t More Successful than Businesses
Startups Aren’t More Likely to IPO
Back in 2014, the 80,000 team found that among a sample of 22,004 companies, 9% had IPO’d. [source] I think it’s safe to say that 9% of bootstrapped businesses do not have initial public offerings. And the extremely naive back-of-the-envelope arithmetic supports my theory.
Among companies that go public, the average age at public offering is 8-10 years [source]. Over the last 8 years, the number of companies founded in the US ranged from 2.8M in 2015 to 5.04M in 2022. [source] Only 477 companies went public in 2022 [source]. If 9% of companies founded in 2015 went public last year, there would have been ~500x more companies going through an initial public offering. So to the casual observer, it might look like VC-backed businesses are massively more successful than their bootstrapped peers.
But hold on there. Most businesses won’t go public. And that’s by design.
If you launch an app that helps calculate your score in the board game Wingspan, you have started a software business. But you would have trouble listing it on the NYSE. There are no stats that I’m aware of for how many new businesses in a given year have a shot at going public. With that said, my gut is that the number is vanishingly small. If I’m right, then it makes no sense to compare startups to businesses on the basis of IPOs. One of the key funding criteria for a startup is its capacity to IPO. Whereas the overwhelming majority of business owners never even contemplate that outcome.
So, I don’t think we can learn much from either category’s likelihood to IPO.
Startups Are Slightly More Likely to Be Listed in a Major Index
What about being listed in a prominent ETF like the S&P 500? Only the most successful of companies that have IPO’d make it onto that index. If startups are more successful, then there might be more of them in ETFs like the S&P 500.
Here too, we hit a dead end. The median age of a company listed on the S&P 500 is 62 years. But Karl Compton only founded the first modern Venture Capital in 1946. [source] That doesn’t leave a lot of time for startups to secure funding and grow enough to be included in the S&P 500.
Even so, we could analyze the S&P 500 to see if we find more startups than businesses. To test this, I did a deep dive into the histories of the first 100 of the S&P 500 companies (sorted alphabetically). Because no Wikipedia article mentioned Venture Capital explicitly, I instead sought to infer VC funding from 3 signals:
Founded After 1970
Although VC was technically available after 1946, its availability has grown dramatically in the recent past. I decided to take an arbitrary ~50 year period and assume that younger companies are more likely VC-backed.
Short Times Between Founding and IPO
Venture capital rapidly accelerates the growth of a company. If a company was founded in 1990 and went public in 1992, it was probably funded with VC money.
Companies in the Technology Industry
VCs don’t operate exclusively in the tech industry, but tech companies are better-than average vehicles for IPOs given their strong margins and low operating overhead. If I was on the fence about a company and it was in the tech industry, I marked it as funded by Venture Capital.
Using these 3 signals, 8 of the 100 seem likely to have started life as a startup. So startups are over-represented in the top public companies, but not overwhelmingly so.
Hot Take: Startup VC Backing is Just Signaling
In the previous section, I was able to provide some evidence that startups are more likely to get listed in the S&P 500, but not necessarily IPO. So there is some evidence that running a startup is correlated with more traditional successful financial outcomes.
But let’s not confuse correlation and causation.
My hypothesis about startups is that they are more successful not because they received venture funding, but due to a bunch of highly-correlated founder attributes. I posit that if you are able to get VC funding in the first place, you are probably already wealthy, connected, intelligent, and educated enough that you don’t need it. And critically, that the variables correlated with your success are your wealth, connections, intelligence, and education, not the check that a venture capitalist writes.
If I’m right that VC-backing is just a form of signaling like attending an elite university, then there’s a strong argument that you could achieve similar financial results to VC-backed companies without the dilution. You would have to be okay with it taking longer to build the company, but your financial outcomes would be better.
Vendata.ai Financial Outcomes from Bootstrapping
Having established that VC backing could just be signaling and nothing more makes it more plausible that you and your cofounder could achieve the same level of success with Vendata.ai as in our initial example. So now lets run the same example but build the company as a bootstrapped business from the beginning.
In this new example, you and your cofounder both take 50% of the company. You don’t leave a pool of shares for VCs or employees. You’ll self-fund company growth and employees will get cash, not shares.
You also don’t pay yourself for the first 3 years (no VC cash!). In year 4, you pay yourself the same $100k/year. Also unlike the first example, we will assume that the venture takes 2x as long (12 years) rather than 6. And in year 12, a strategic inquirer tries to buy the company.
Acquisition Adjustment Reminders
- 50/50 stock/cash split
- Risk of company succeeding for a decade is 30%
- Cash Reductions:
- Capital gains tax of 20%
- Stock Reductions:
- Risk premium for holding privately-held stock of 30%
- Yearly salary tax rate:
- 30% total tax rate
So with your salary and acquisition payout, your upside ranges from $2.4M + $2.1M + $560k = $5.06M ($20M acquisition) to $7.2M + $6.3M + $560k = $14.06M ($60M acquisition). Divide that out by the 12 years it took to earn the cash, and you get a yearly income of between $421k – $1.2M.
Your opportunity cost was working at Apple as an engineer for $500k /yr * 12 = $6M in pre-tax earnings at a ~40% marginal tax rate. $6M * .6 = $3.6M spread over 12 years = post-tax earnings of ~$300k / year.
What I think I’ve proven here is that at least from a financial perspective, bootstrapping makes more sense than taking VC funding.
Time Outcomes from Bootstrapping
As I established in a previous section, business owners work harder than employees. Data suggests that 50-60 hr/week is normal for business owners whereas employees tend to work only 39 hours. [source]
But remember that I’m not suggesting that you start a normal business. I’m comparing a software business to a startup. Running a small coffee shop or selling crafts on Etsy come with time requirements that are very difficult to automate. By contrast, most software engineers I know can’t do more than ~5 really productive hours of work per day. Most startup cofounders can’t productively code for 12 hrs /day. Their time is taken up with other administrative stuff.
If you were going to work for yourself with no expectation of selling the business, you would work only as much as you thought was helpful for your lifestyle. And if you work for yourself, you don’t have any of the BS that accompanies a normal 9/5 knowledge worker job. No pointless TPS forms, no unnecessary meetings, no long commutes, no pointless projects.
Business Owner Time Shifting
I think it’s reasonable to expect that business owners work more than employees for the first couple of years and then less than employees after the company has become established. If you average the overworking and underworking periods together, I think it’s fair to assume you could achieve ~40 hours per week.
Let’s see how that stacks up against startup hours:
So running a business rather than a startup is likely to cost a bit more in terms of time, but the total difference is small. The table above suggests it’s about 10% more total hours.
That means that the financial outcomes above probably slightly overstate per-hour earnings. With that said, this also ignores a lot of options that business owners have that startup founders do not. You could hire a team to run it for you at the 6 year mark and take $50,000/yr in passive income and go sit on a beach. Or you could just pay yourself more. Maybe you decide to move to a lower cost of living area and live it up.
There are lots of options that total ownership grants business owners that make both their time and monetary outcomes look rosier than startup co-founders.
Whew. This has been a long ride, but here are all the key points I hope that I was able to convince you of in the previous sections:
- What’s the Difference Between a Startup and a Business? Startups and businesses are quite different, even though one is a subset of the other.
- Why You Shouldn’t Start a Startup: The Money. Startups result in low co-founder earnings. If you care just about money, you should start a business or just work a day job at a big tech company.
- Why You Shouldn’t Start a Startup: The Time. Startups take a lot more time than being an employee. Startup co-founders either slightly substantially more or approximately the same as business owners.
- Why You Shouldn’t Start a VC-Backed Startup: Value for Customers. Startups make it more difficult to deliver value for your customers than if you started a business.
- The Business Advantage of Not Taking VC Capital. Bootstrapped businesses have substantially better financial outcomes than either startups or traditional salaried employment.
If you just want to play the VC-backed startup game because it sounds fun, far be it from me to take that away from you. But I hope that I’ve managed to at least nudged you to consider starting a business instead.
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