in Startups

The Backwardization of Risk/Reward in Startups

I’ve always thought it weird that there is a perception that risk is front-loaded for startups, i.e. the person(s) who start it take all the risk. In some ways, the risk of starting a company (especially a web startup) is lower than ever:

  • there are great grant/tax credit programs like IRAP and SRED
  • there are more incubators, angels and providers of small seed funds than ever
  • its faster than ever to go from concept to commercialization -> you can have paying customers in < 6 months

It just isn’t as hard as it once was to raise $20-$50k and/or have a company generating a few thousand dollars in revenue to cover the early founder(s) costs. The big “risk” is that your life & business align to this cost structure. Your business needs to be able to run with only 1-3 people at first. Your life – no fancy sports cars, no big mortgage, no massive piles of credit card debt, etc. I’d hypothesize, there is a strong parallel between managing personal finances and being able to start a company.

Another big “de-risker”. You have control as the early founder! Only you can lay yourself off. And you control the culture and lifestyle of the company, i.e. you are a lot less likely to hate your job or get fired for hating your job or leave suddenly or have a heart attack or just generally hate life.

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Reward-wise, you have a huge chunk of the reward. Shares, not options. Big founders cut. Maybe no vesting. Dividends. There are a lot of paths for you being well rewarded for the risk you took. On top of that, your experience as a first-time entrepreneur will make the second time around all that much smoother, it’ll be easier to raise money, easier to hire, easier to find business partners, and so on. You can have a career as an entrepreneur.

Now, lets compare that to what is traditionally thought of as the “low-risk” employee, lets say employee #8. Poor employee #8 takes on massive life risk, and often gets very little in reward.

Reward-wise, they get something like .5% of the company, so on a typical $20-$30mm exit they get $100-$150k. Hardly life-changing money. If you are a super-star in the company you may get granted up to 1 or 2% but they’ll be vested over an annoyingly stupid schedule such that you’ll have to be at the company for 6-8 years to “earn” them.

Now compare that to all the risks of being employee #8:

  • you are far more likely to get laid off than any of the founding team
  • you are far more likely to get laid off than a non-startup job
  • you may simply not get paid a few times… missed payroll is no uncommon event
  • you probably in fact took a pay cut, or at best, you’ll miss out on bonuses when there are a few tight years
  • you will likely work a lot longer hours
  • there’s no “fast” trade-off, you’ll need to work there 4-7 years to earn your $100-$150k stock option reward, and you may have given up way more than that in time & salary to get there

So, in summary, its a lot better to start your own company than to be employed by a startup. And in many ways its less-risky and better to start your own company than to “have a job”. And I wish I could make more people take the entrepreneurial leap themselves because its simply not as scary as it seems.

  1. Employee

    #8 isn’t necessarily taking on a huge life risk. In the even of a layoff, if they’re good founders and investors generally want to keep them “in the family”.
    Lots of large, supposedly safe companies lay off employees all the time. Only then you generally have fewer transferable skills and a smaller network of people actively hiring. That said, your friends and family wont’ blame you for having taken a big risk as they would have if you were laid off from a startup. We’re not really rational :)

    Being an early employee is a great way to see the process of starting a company without taking on as much responsibility. Especially when the pay is low, founders try to attract top talent by offering better conditions and better learning opportunities.

  2. Ahh, a post like this makes it harder for us start-ups to hire #8….. :-)

    In seriousness, our numbers #s 6 to 17 were definitely tough hires,
    because you do have to convince people that the product and company is
    going someplace, but once they’re in, it’s a great learning experience.

  3. Maybe moreso in the US than in Canada, the Great Recession and its aftermath has shown that corporate employment has become as risky startup employment. Silicon Valley actually has one of the highest unemployment rates in California (partly reflecting changes in the nature of the region, with dozens of web analytics positions going begging while dozens of hundreds of silicon engineers are on UI and many looking at hitting their 99 week limit, if not already, reflecting the drop in chip starts) where it once had the lowest.

  4. @twitter-14551705:disqus being an employee is a good way to learn, but isn’t starting your own company is a much better way to learn? (with a much bigger reward :) )

    Alternatively, I’d propose a different reward structure that evolves overtime. Eventually there are key employees who maybe are of more value than the founders. The reward structure should handle that somehow. Sometimes it does as founders get kicked out and diluted down and employees granted up. And sometimes during an acquisition key employees get more “incentive” to stick around than early founders.

  5. Dan, you already know this. The reason why founders get the most potential reward is that they take the most risk when next to no one believes what they are selling. They will go months-years slogging through the Valley of Death until they prove something, only then is employee #8 willing to join. Employee #8 doesn’t start their own thing because they are not willing to go through being nothing to everyone.

    I am in the enviable position of having slogged through 3 years in Death Valley with and now being lucky enough to secure just enough funding through Startup Chile to create the conditions to get us to breakeven. I appreciate that my early supporters have sacrificed their time to help me fulfill my mission, but they have not sacrificed even 1/100th of what I have. Employee #8 doesn’t take the real risk of absolute failure pinned on being a founder. Reward is appropriate for the risk.

  6. I don’t know that I agree about the point of consequence of absolute failure being pinned on the entrepreneur. The consequence of absolute failure is identical for founder and employee #8… they both have no job. Also an entrepreneur who took a shot and failed is generally an acceptable, ok result on an entrepreneurial resume and he in fact may have an even better chance at his/her next startup. On the other side, getting laid off always sucks on an “employee” resume and is always a stigma.

    But absolute failure is rare, in most cases startups enter zombie startup land where the founder lives on, hoping for his next pivot to work out, but employees 4 through 8 are dead.Having said all that, for startup stories like your own where you had to slug it out, then I think the more classic risk/reward parameters make sense. But think about situations where startups raise a small amount of capital fast and hire a few people. Those “few” hires are taking on almost identical risk parameters, but the reward is drastically lower.

  7. Dan, I believe you are understating the challenge of getting to the point of hiring that 8th employee. Obviously most startups don’t make it nearly that far. You make it sound like using IRAP, SR/ED, and $20k from an incubator gets you to profitability in 6 months easily. That is in fact exceedingly rare.

    You also neglect to mention that founders often forgo salaries for the first months before getting that first, small bit of financing or revenue, often at great opportunity cost by quitting a six-figure job.

  8. I guess I’m not so much saying that founders don’t take risk (I do think its lower/easier now than it was 5 years ago). In some startup stories the road is long and hard.

    But clearly once you get to employee #8 things aren’t suddenly sunny and happy, right? There is still a ton of risk from years 2-5. Does it make sense that the founder has say 50% or 90% of equity while employee 8 or 2 or 3 has 1% or less? I think my two points are this:

    1. More people should start companies, its not as scary as it seems

    2. If startups want to hire employees, they need to adjust the option pool. This is part of the reason why startups are having a hard time hiring. Why should I take a huge amount of risk as employee #8, when I can start my own thing and take on similar risk with much higher reward?

  9. Hey Dan,
    While starting my own startup is by far the better choice for me (I took the entrepreneurial path and don’t want to ever go back), your data might be a little exaggerated, which – in my opinion – could make your argument weaker.

  10. I don’t know, as a startup employee I feel more driven now to become an entrepreneur down the road, but I feel without the experience of being near the ground floor as an employee has helped me gain the knowledge I either didn’t have or didn’t think I had.

    While I’d agree being an entrepreneur would be a fantastic learning experience, I think sometimes there are things that need to be learned as a startup employee first before stepping out into the entrepreneurial waters.

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