Saturday, August 15, 2009

Why The Odds Are Stacked Against Entrepreneurship (vs. VC)

In a recent post on Growthology, Paul Kedrosky asks why so many B-school students that he meets want to be VCs rather than entrepreneurs. This is my response:


While entrepreneurship as a whole is a very positive ROI endeavor, the odds are stacked against the individual entrepreneur.

Even venture-backed companies only succeed about 1/10 times; it's the fact that those success deliver such outsized returns that make the VC model work.

(Note--by "success," I mean a major hit; the rule of thumb is that of 10 companies that get VC funding, 6 will go to zero, 3 will meander along as middling successes, and 1 will be a hit)

Let's say that an entrepreneur can start a new company once every 4 years, and has a peak period in his or her career of about 20 years (age 30-50). That gives you 5 swings at a home run.

If your chance of failure is 90%, after your career as an entrepreneur is over, you'll have a 59% chance that none of your companies ever succeeded.

On the other hand, thanks to the portfolio effect, VCs have a much better chance of recording a hit or two, and a nearly 100% chance of collecting 2-3% management fees on the capital they raise.

Now don't get me wrong...VC is a tough business, a fact most entrepreneurs don't appreciate, so the analysis above is a gross oversimplification. But it is true that while the average (mean) entrepreneur does better than the average VC, the median VC does a heck of a lot better than the median entrepreneur, who sacrificed his or her career to the greater good, and probably would have made a lot more money sticking to a corporate career.


Paul said...

I have failed at every single business and business idea I've ever tried. Never had one single success since I was 16 and started my first business. So I'm batting 100% Fail.

That doesn't mean I have no accomplishments, just nothing to be proud of. And yet I still give it a go. Every few weeks I come up with yet another 'great idea' and try to get it off the ground and making money. I've got a new one now (non-porn, sorry! - and retail centric, not internet) that wouldn't be $10's of millions a year, but revenue would be $5-10 million. Home run? Not to these guys, but maybe the right angel.

I see VC's AS entrepreneurs. They found the business, then they find the business. No different than anyone else. Though I agree, the percentages are much better at making a living.

Ashwin said...

Just one extra note about the last line. The entrepreneur may have made more money in a corporate career but most often, entrepreneurs are entrepreneurs only because entrepreneurship is the only place they see themselves in.

Foobarista said...

If you're a B-school guy, you're probably more interested in joining something than in starting something off the ground. I don't have any stats, but I suspect (based on anecdotes) that most company founders didn't go to business school, while the vast majority of VCs have.