Thread by @moritheil

Good thought, doesn't really apply to lifestyle entrepreneurship though.

(Well, it can for the owner - it won't for the COO.)

And it's difficult getting compensated what you're worth by someone on their first venture.

#biz

https://twitter.com/ImSamThompson/status/1382122378520621057

Suppose you're already a successful entrepreneur.

Your skillset is worth at least $300k/yr.

Alice and Bob have started a small biz, and would like to have your connections, know-how, and unflappable cool.

Their #biz nets under 100k/yr.

Of course they're not going to cough up $300k/yr in cash - that would be a bad use of money even if it were possible.

So they have to give you partial ownership.

How much?

"Oh, but it's my baby!" cries Bob.

He wants to part with only 10-15% of the business - maybe 25-30% if you come on with some capital.

You will then fight tooth and nail for a reasonable valuation and a sufficient share so that your time and money are not devalued.

Suppose you put no capital in.

You're busting your ass doing 90% of the day to day work so that a CEO can spend more time with his family, chill on the beach, and "conceptualize" the next big move in a field you know more about. Probably not a recipe for job satisfaction.

Suppose you agree to buy your way in. The company happens to need some cash - call it $150k.

Increasing ownership by 15% for 150k means the company valuation is $1M. That's OK at 100k/yr, but what if it's netting 50k/yr? You're not getting a bargain, and you're taking on risk.

Even if you don't think investing at 5% earnings yield is terrible, how long is it going to take you to get ahead on this vs. working for yourself?

What's that 10% ownership stake that you get in return for working worth? Well, 1st year, 100k - you would be down 200k instantly.

Suppose in 5 years you build that #biz up from making $50k/yr to making $500k/yr.

Success!

Well, not really. You can't sell your ownership easily and your 10% from working gets $50k/yr, which is only worth $500k at a 10% cap rate.

The 5 years you spent were worth $1.5M. You're at -1M on this!

It does look somewhat better if you own 25% of what is now a $5M company. Your share is worth $1.25M, meaning you're still down 250k on your labor alone, or 400k when your 150k cash is included.

So you can 10x company net profit and still not make enough for it to be worth your time over a 5 year period.

What if you take a much bigger share?

At 50% your ownership would be worth 2.5M, ahead of the 1.5M the 5 years were worth.

The thing is, entrepreneurs are not trying to give up 50% ownership of their small businesses. Especially if it's not Bob but Alice and Bob, each reduced to 25% when you take 50.

Even then, that 50% only works out if you successfully 10X the company. 4X it and you're in the red.

You are gambling on all these little pieces lining up and working together.

Don't get me wrong - as an entrepreneur you should love a challenge!

But as an investor?

There are much easier and less risky plays. You could sit on the beach 5 years and still double your money.

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