The Risk Of Being A Company Founder vs. The Risk Of Being A Venture Capitalist
In the comments, there’s a discussion of the risk profiles of Venture Capitalists and Company Founders.
Wertz says: “I personally think that being a founder is the much, much harder job — we have a portfolio of companies, a founder only has one! Our losses are being more than outweighed by some of the winners, an option a founder doesn’t have. Venture Capital is definitely harder than it looks like from the outside but the toughest job is still that of the entrepreneur!”
The founder and the VC are both in the same industry. They’re both trying to get a return on their investment. They’re both trying to succeed in the face of risk. So why is one riskier than the other?
The founder is working with the risk of small numbers. Really, one number: One. One company.
The VC is working with the risk of larger numbers. Usually at least twenty companies in a portfolio.
When you’re dealing with the risk of larger numbers, you can use risk management techniques like spreading your bets, hedging your bets and taking advantage of power laws.
When you’re dealing with the risk of small numbers, you can’t use large number risk management techniques. You’re all-in, so you can’t spread your bets. You’re all-in, so you can’t hedge your bets. You’re all-in, so the return to your company is the only return that matters.
When your risk is small number risk, you use the tools in A Spy’s Guide To Taking Risks.
When your risk is small number risk, you look for the necessary conditions of bad things happening. You look for substitutes to ensure good things happen. You build a simple model of & and OR operators. You learn to elevate the OR operators high in your model for good things. You learn to limit or remove the necessary conditions of bad things. You learn to create fallbacks and time to react.
The story in A Spy’s Guide To Taking Risks is about my first day in alias. I had to use all of those tools to get past a car crash, avoid the Border Patrol and detect surveillance. Because I was working with a small number risk: Either I got arrested or I didn’t. One or the other. Success or failure.
A company founder also has small number risk. They’re creating a product or service that has a lot of necessary conditions. And that one product or service needs to find a market. Which means the minimum necessary conditions of success are: Product & Marketing & Delivery = Success. Plus, there’s getting paid, customer service and iterating the next product version. Underneath the product are more necessary conditions. Maybe a lot of necessary conditions, depending on the product’s complexity.
A VC has larger number risk. Because of power laws, they need only one or two of the companies in their portfolio to provide significant returns for success. For the VC, the equation is: Company A OR Company B OR Company C . . . . OR Company N = Success.
And that’s what the data looks like on Boris Wertz’s chart:
Half of the companies in his portfolio lost money. But the other half made up for it.
That’s the benefit of large numbers.
But company founders and spies aren’t working with large numbers. Company founders and spies aren’t able to use the tools VCs use. Company founders and spies face small number risk.
Which means there’s a different set of tools to use.
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For more on handling small number risk, see A Spy’s Guide To Taking Risks.