Playing a startup game

How can some entrepreneurs keep on starting new ventures after they fail? Why do some entrepreneurs end up as a bitter mess after they fail? What is it that makes you unstoppable?

I grew up in an entrepreneur family. I saw my share of financial troubles due to failures, both bootstrapped and VC-funded. By the time I was 20 I was so jaded that I swore to never become an entrepreneur myself. I handed over my seat on the board and closed the door behind me.

Today I run a small but profitable product business of my own. I did fail several times before succeeding. The huge difference is that my failures didn’t make a dent in my finances.

When it comes to startups, gamblers lose and investors win. Bitterness and resentment arise when you think you’re investing but you’re actually gambling. So what makes you a business gambler? What makes you an investor?

Investor knows his odds

There’s a saying that says “You have to fail to succeed”. It’s often misunderstood. Success by learning from failure is a myth.

Failing does not teach you how to succeed. Not even when it’s a matter of life and death, like in cardiac surgery. This study shows that you actually learn from success, not from failure. Except if it’s other people who fail and you get to watch up close.

“You have to fail to succeed” refers to the fact that just 1-2 out of every 10 startups actually make it. If you live by that saying, you’ll plan for two possible outcomes - an unlikely success and a probable failure.

The current VC-funded startup success rate is 8-9%. According to Bloomberg only 20% of all new businesses survive over 18 months. That includes your bootstrapped startup.

When you invest in your startup, you have 80-92% probability to lose your investment.

Jason Cohen, the founder of WP Engine, compares your startup to playing in a roulette table. Only a gambler plays all-in. An investor knows that he needs to be able to play the necessary rounds to beat the odds. That’s at least 5 rounds if he is a bootstrapper and +10 rounds if he’s playing the VC game.

That’s why he also invests most of his wealth in safer asset classes, not to startups.

Investor sees the opportunity cost

Opportunity cost means that when you invest in something you can’t use that same time/money on something else.

When an investor calculates how much he invests in the business, either as money or as time, he also includes compound interest. If you can put aside the time/money to invest in your business, you could have used it to invest in other people’s businesses as well. If you know how to play the investing game, there are quite safe options that’ll get you 8% annual interest in the long run.

That’s the number to beat - not for example your current wages.

That’s also where the saying “Fail fast” comes from. You play to win, but you lose sometimes. The faster you can do it, the faster you free resources for new investments.

This is probably the biggest cause of bitterness. A penniless failed business gambler looks back and sees how much wealth he could have accumulated as an employee. Then come the stories of how he was fooled to believe that creating a startup was the best way to become rich.

Investor assesses the upside against the downside

For an investor, money is a game. Opportunities will be measured by comparing what you can lose and what you can win - and what’s the probability for each outcome.

Gamblers look just at the upside. Investors love opportunities that have a huge upside and a limited downside. They’ll hustle like crazy to get such opportunities - like Richard Branson did when he negotiated a money-back guarantee to the first 5 airplanes he bought for Virgin Airlines.

How can you limit your downside in a startup?

Doing a pure tech startup with no inventory limits the downside. Sharing the risk with a partner or an investor limits the downside. Paying yourself wages limits the downside.

When you play the VC-game, you sell part of your upside to investors. What you get is a bigger upside faster, but it’ll be a bit harder to win. However, the probability does not get down as much as many bootstrappers believe - they often compare the jackpot probability (8-9%) to their own survival probability (20%). Apples. Oranges.

That’s why you’ll see some of the funded founders looking down on bootstrappers. Many of them think that the bootstrappers risk just as much if not more and still accept a smaller upside.

When you play the VC-game, you should be paid. When you play the bootstrapping game, you should be paid for that too - or you should keep your day job that pays you. Yes, I believe that a smart founder pays himself a salary.

A salary? Why should I strangle my business with a salary?

Now, there’s a saying that if you let a beancounter run a business, she’ll strangle it into death. So you can take what I say here with a grain of salt. But I believe that you should take care of yourself over your business. Remember how many rounds of roulette you must be prepared to play!

You know Warren Buffett’s rules for investing?

Rule no 1: Don’t lose money. Rule no 2: Look at rule 1.

How do you do that in practice?

You diversify. Your business should not be your biggest investment. When an investor notices that too much of his assets are in high-risk investments, he does something called asset reallocation. Good high-risk investments grow faster than low risk investments. When that happens, you just move money from high-risk investments to low-risk investments to keep different assets in the right balance. A good investor does this no matter how great the situation is, because we all suck at knowing when to invest where.

That’s why I didn’t reinvest all FirstOfficer’s revenue right back into itself - I paid myself and used that money as a downpayment for a rental cabin. My cabin is already fully booked for the season. Now, 6 months later, I think I’m seeing signs of market saturation, telling that major investment/funding to FirstOfficer would have been a mistake.

Are you gambling?

Here are some warning signs to look out for:

  • Personally backing up business loans
  • Not forming a strong enough business entity
  • Having your spouse work in the same startup
  • Quitting your job as soon as your startup earns enough
  • Working like a founder/owner after giving up good chunk of shares
  • Not taking a proper salary
  • Working on evenings and weekends
  • Financially counting on your business success

How do you feel after reading this? Are you gambling on your business? Do you disagree with my points? Let’s discuss in the comments!