The Startup Riches Myth: Sell Your Company For Multi-Millions And Still Not Be A Millionaire
As I head off on my 12 month journey to build YakezieNetwork.com into a online advertisement exchange in the personal finance space, I remind myself about the long shot chance of success. I’ve always wanted to be an entrepreneur since middle school, and finally after 20+ years here’s my chance.
There’s an idyllic notion that once you’ve sold your company for multi-millions of dollars you’re filthy rich and never have to work again. I admittedly have this automatic mindset whenever I meet someone who said they sold their company to one of the tech giants. Even if they are still living in a one bedroom apartment with their wife years after the sale, I just think they are being frugal.
By also believing everybody makes 10X more than the value of their car based on my 1/10th rule for car buying I’m able to keep motivation high to work harder since even a Toyota Corolla driver is clearing $200,000 a year nowadays. The goal is to give into the illusion of wealth in order to eradicate self-entitlement.
There is startup fever here in the San Francisco Bay Area partly because of all the stories we hear about 1,000 bagger returns in companies such as Google, Facebook, Instagram, Twitter, Tumblr, AirBnB and more. Sure beats investing in stodgy dividend stocks doesn’t it? Real estate is on fire and it seems like everybody in their 20s and 30s are tech millionaires. Given we have a culture of stealth wealth in San Francisco where you can’t tell a rich person from a poor graduate student, the possibility is real that your unassuming neighbor is rolling in the benjies.
The fact of the matter is that the vast majority of startup founders never make it past year three and even less sell for multi-millions of dollars. Even if a founder sells her company for $30 million dollars to Apple, she probably could have done better working a day job all those years instead, with much less stress! (Related: Joining A Startup Will Probably Make You Poorer Than Richer)
In this article I’ll share with you a very insightful conversation I had with a man who ended up selling his company for tens of millions of dollars circa 2010 three years after business school (Should I Get An MBA?). You’d think as a 30-something year old, he’d just be kicking back on his own private island somewhere blogging right? Not so at all. But before we go through this fella’s example, let’s go through one of my favorite business assumptions first.
A LIFESTYLE BUSINESS OR A CHANCE AT MEGA MILLIONS?
In 2010 I asked everyone in a post entitled, “The Comfortable Lifestyle Business Or The Big Payout”:
Would you rather make $15-000-$30,000 a month and “work” only 2-4 hours a day? Or, would you rather make minimum wage working 12-14 hours a day for two years with a 25% chance of selling your business for $100 million dollars and netting yourself a cool $25 million? If you don’t, all you are left with are your experiences.
The answers were pretty mixed based on the comments (cut the numbers in half if you don’t live in Manhattan, SF, LA, HK, London, HK, Paris, Amsterdam). The reason why I asked this question back then was because I was already beginning to formulate my exit strategy from my job on Wall St. I had been working for 11 years and had just started to get a taste of the online business world and its potential. Given I was tired of working 12+ hour days, I opted for the lifestyle business instead.
I never really questioned my decision because money is a means to an end, namely a better life. Working 12 hour days for another several years sounded very unappealing because I already amassed a livable passive income stream. Fast forward to today and I’ve somehow managed to achieve my lifestyle business goal.
It’s interesting how the mind works once you put things down in writing. Your goals become tangible, thereby increases your potential for success. I had completely forgotten about this business dilemma until I met the potential client. I didn’t ask how much he sold his company for back in 2010, but it’s safe to say anywhere between $20 to $40 million dollars based on his feedback.
I asked him the very same question I asked all of you three years ago, and he unequivocally selected the lifestyle business to my surprise! Here’s a guy who sold his company for around $25 million dollars after just five years of operation and is choosing a $180,000 – $360,000 a year lifestyle business instead. I asked him to elaborate further as to why.
THE MATH BEHIND SELLING A MULTI-MILLION DOLLAR BUSINESS
Let’s say you successfully sell your internet startup to Google a mere five years after founding for $25 million dollars. You probably worked 14-16 hours a day everyday, but at least you were working on your baby. Here’s a typical way of how to get there based on my client’s experience for those who aren’t familiar with the startup world.
Step 1: It’s the year 2005 and after working on your brilliant idea for one year, you raise $1 million in Angel money in exchange for 10% of the company. Getting a $10 million valuation is a huge accomplishment in just 12 months of operation. You can’t just suddenly value your company at $10 million without large user and revenue growth so you must be doing something spectacular. You and your equal partner are left with 90% ownership.
Step 2: Grow your business to the point where you raise your first venture round of funding for $3 million in exchange for 25% of the company. You want the $3 million to acquire more users and solidify your company’s market share through more marketing. You and your partner are left with 65% ownership.
Step 3: Hire employees to help build your business further. By the time this person’s company was sold, he had a staff of 40. Give total equity of 20% spread across 40 employees as incentive and part of their compensation package. You and your partner are left with 45% ownership.
Step 4: Raise another $3 million at a slightly higher valuation in exchange for 20% of the company. Business is now booming and spending is a must to keep up and beat the competition. The company is not profitable yet, hence the need for cash to stay alive. You and your partner are left with 25% ownership.
Step 5: Competition is very intense and it’s the year 2007 where everything is just going up, up, up! Raise another $4 million for a 10% stake as business is expected to keep growing at the current pace for the next several years. Your company is now worth about $40 million! You and your partner are left with 15%.
Step 6: It’s the year 2010 and the worst of the financial crisis is over thank goodness.You sell your company as early investors and employees want out. You’ve found a buyer for $25 million, which is much better than $0 if you sold at the end of 2008 or 2009 because nobody wanted to buy an EBIT negative business. At one point the business could have been worth $60 million if you timed a sale perfectly. 10% of $25 million is still $2.5 million. Your stake is worth $1.25 million before tax since you have an equal partner.
Step 7: Your accountant advises you to take a 33%, 33%, 34% payout of the $1.25 million over three years to minimize tax liability. Meanwhile, given you worked at a startup, you made at least $50,000 a year below market for five years in exchange for equity upside = $250,000 opportunity cost. All told, your proceeds after taxes is about $900,000.
If you take into consideration the $250,000 in lost income you would have made working for an established firm, you really only net about $700,000. $700,000 – $930,000 is not chump change after five years of work. But remember, the $900,000 after taxes was distributed over three years after he sold. It’s very difficult to build a huge business by yourself. You need a team of people to help you get there.
During the five years of creating the business he went through enormous stress, relationship breakups, employee arguments, and countless meetings with investors. He appreciates the experience but he would never do it again. His biggest mistake was raising too much money and therefore giving too much of his company away. When things are booming, it’s easy to have the urge to spend, spend, spend since valuations keep on going up. He’s now started a new Y-combinator company and is being much more careful with fundraising. He’d rather not raise any money at all!
My client reminded me that if you successfully build a lifestyle business, then you should have more than enough time to go for option #2, the home run business. Given I only have to work 1-4 hours a day on Financial Samurai (writing content, responding to inquiries, networking, etc), I can spend the rest of my time building YakezieNetwork.com to be the #1 personal finance online advertisement network. Here’s a post I wrote on Yakezie.com describing the value proposition.
The race is on to try and build a business with the YakezieNetwork.com before the Financial Samurai revenue stream runs dry. One can never tell what the search engines will do. As long as the content here is helpful and shared by all of you to your friends, traffic will stay steady or hopefully increase over time. If Financial Samurai does disappear, I will be sorely disappointed. However, with a now six figure passive income stream I should be able to at least give my second entrepreneurial attempt a good go for 12 months.
Readers, anybody ever join a startup up that sold for mega-millions? How did you do financially and what did you do next? Do you think there is a startup riches myth that is swaying people away from traditional stable jobs? Would you shoot for a mega-million payout or a lifestyle business that pays you $10,000-$20,000 a month that requires only three hours of work a day from anywhere in the world? If you established a lifestyle business, would you still try and pursue a home run business?
Photo: Sailing in the Bay. If you want to sit in the big boy’s chair, you’ve got to go and take it. FS, 2013.