Pie Chart Shrapnel, originally uploaded by urbanraven
Rob May, who has created quite a following at Businesspundit (and is something of a blog mentor), linked to my founder’s stake post yesterday afternoon with the following comment:
Matt Winn writes about the founder’s stake at exit for VC funded startups. It’s low enough to make you think hard about taking VC money.
I guess I’m not surprised. The topic requires a more nuanced discussion which I hope the below provides.
As recap, the numbers I cited, which come from Tim Janke, who runs Inception Micro Angel Fund, were the following:
- On average, a first-time entrepreneur who has successfully built a business with several rounds of capital ends up owning 7-8% of the company at exit;
- On average, the second-time entrepreneur (as in has one success notch in the belt) ends up with an ownership stake in the mid-20s at exit.
I haven’t seen formal data on the topic so the above should be taken with a grain of salt. But let’s assume that it’s accurate. If you’re a first-time entrepreneur that craves control, the above scenario might not be so attractive. It’s hard to raise a bunch of money over multiple rounds and maintain a controlling stake. Beyond the economics, institutional investors are likely to demand certain rights that pull some control from the entrepreneur. That being said, nobody raises venture money to run a “lifestyle” business. The venture-raising entrepreneur is there to, in the words of Wil Schroter, “Go big or go home” (though Wil is notably a proponent of bootstrapping). A 7-8% ownership stake represents a big pot of money if there’s a successful exit, something the above data assumes. In fact, it’s a significantly larger stake than a CEO who is brought in to run an existing startup might typically receive (and whose stake would ordinarily vest over time).
Moreover, if the founder’s stake is exceptionally large, there’s likely to be a disconnect between the exit value the founder is shooting for and the exit value which will represent a success for his venture investors. Such misaligned incentives create real deltas in both strategic and tactical mindsets.
The above stakes shouldn’t be “low enough to make you think hard about taking VC money.” If you’re interested in taking VC money, you’re interested in “going big” - the difference between bootstrapped stakes and VC-backed stakes should be more than made up for by the difference in likely equity value at exit.
This is no simple topic, and there’s no “right” answer (i.e. founders want different things). If you’re interested in reading more about the control vs. wealth opportunity issue, check out Noam Wasserman’s “Rich or Royal: What Do Founders Want?”
Matt,
I don’t know what most entrepreneurs think, but for me, the 7-8% is not an issue of control. It’s nearly impossible to take on decent amounts of investment capital without giving up control. I see it as a valuation issue. The longer you can wait to take VC money, the higher the value of your company at that time, and thus the larger stake you get for a given level of investment.
Your comment about boostrapped vs. VC-backed stakes is an interesting one, and I bet the data is a pretty funky curve with some surprising discontinuities. Now if only someone has that data to put on Swivel…
Rob:
Thanks for commenting, and for the link! Experienced entrepreneurs, it seems, are much more likely to take institutional capital “day 1″ because they’re shooting to build another hit and see capital raises as a necessary but distracting part of the business and so want deep pockets to start. It may behoove first-timers to “get big cheap,” as David Cowan puts it, in order to maintain a sizeable stake in the company and accomodate for the inexperience, but a 7-8% equity stake in a venture-backed business should represent big bucks if the company is even moderately successful. My sense is that if an entrepreneur finds a fit with a decent firm, she won’t be “thrown in with the sharks.” Everyone wants a big payday and smart investors will ensure that the key players are all properly rewarded for success. If they don’t, the likelihood of that success will decline dramatically. The “invisible hand” is a powerful tool.
Best,
Matt