De-risking startups for founders

A proposal to dilute startup founders’ to dilute the risk and the problems that come along with it.

“92% of startups fail”. Many of us have heard that statement, and as a founder, it’s impossible that it doesn’t give you the chills each time you hear about it. So, we are in a complex game, in which the odds are against us. Why do startups fail? There are many reasons, some are internal like having the wrong team, wrong business model. Others are somewhat external like the product not being a hit or outcompeted. So, we can work to avoid most of these reasons or at least to lower the impact when they hit our startup. There is a bunch written about how to work on those solutions, so I kept thinking about what isn’t done that could potentially improve this situation.

A solution (with trade-offs)
Going back to the idea of being a – serious – game. The stakes are high, it’s not like poker where you have many hands and can look at the cards, you are all in from the start. Being such a risky journey, many would-be founders decide to stay at their current job. This makes sense since, the majority who take the leap end up failing, having an economic and mental impact.
So the starting point to think this is how to lower the personal stake and maintain the incentives to make their startup great. So if founders dilute their ownership there can be a way to also dilute risk.
An idea emerged after hearing two awesome Tim Ferris interviews to Basecamp counter-culture legends David Heinemeier Hansson and Jason Fried. They bootstrapped their startup and reached profitability from the start. After growing it, sold a part to unload some risk and avoid having “all the eggs in the same basket”. They sold part of their company to Jeff Bezos. Jeff got to own part of their profitable business with non-control equity. The founders got kind of a “half-baked” exit, keeping part of the company. This wasn’t a VC investment which required X returns, instead, they would share the profits at the end of the year. And that is a whole other story.
Rand Fishkin is trying some variation from this approach with his second startup SparkToro. But, I don’t like constraints, and I’m sure you are on my side. So, why limit everything to one and only path that implies no VC funding and being profitable from the start?

A transversal solution
The only ones that can make the call to de-risk their startup are entrepreneurs. Not everyone can dilute their startup risk by selling to an investor as the Basecamp guys did.

Founders can be equity issuers and receiver with a pool of peers. So, in a way is like playing VC and founder at the same time, with the difference that instead of paying with money founders pay with equity.
For this idea to work, the math is pretty easy. Let’s assume the 93% failure rate for a startup is accurate, there should be 13 founders from different startups that join the equity pool.
In this scenario, they will have at least 1.04 chances of having one of the founders not failing. The equity to share will depend a lot if the startup wants to go the bootstrapped way or the VC one. As an approximation 2% will work for VC funded startups. Investors will want the founder to have most of their stake in their own company so they still have skin in the game. With that approach, incentives shouldn’t change at such low stakes. The pool of founders will still work as a safety net in the worst case scenario.

Barriers and downsides
One of the main barriers could be the founders themselves not wanting to leave 2% of their equity at the table. After all, it will still be a high-risk alternative, in which they won’t have much control. All founders think that will belong to the successful minority.
A downside will be the administration of these small percentages all entangled between founders. New tools to make this work need to be developed.
The third barrier will be capital dilution. Even if a startup is successful and grows to be a big company, the shared equity will get diluted, but this can happen in their own startup too.
There could be a free rider problem, where one of the founders try to take advantage. This is another great reason to keep percentages low. Almost all their stake is in their startup, so there’s no real motivation for not trying as hard as they can to be successful. There could even be potential help between founders because of having shared interested. In the agreement there will be some sort of crossed vesting, so nobody that leaves the ship early.

Conclusion
This is one of those ideas that seem strange at first but makes sense from a game theory perspective. This a first version, and would love some feedback. If there’s another framework to think about or an assumption that could improve/break this model.

How will the next YC look like?

Things change, so it’s always good to be on the look for signals. I want to share what are some possible contenders to disrupt the startup scene, something YC did 13 years ago.

While I was filling the Y Combinator application they ask you about something you have discovered and a question came to my mind instead of an insight, but in some way, the question IS the insight. The question is pretty obvious since it’s the title of this post: what will the next YC look like?

Don’t get me wrong, YC is still the biggest known advantage for a startup that wants to scale, and I don’t think that is changing anytime soon, but what I’m trying to discover in this post, it what could disrupt the startup scene once again after all these years.

One way could be something to give founders such an advantage over all the current acceleration programs. It could also be something that is as good as current “solutions” to be a successful founder, but by being less known, the chances to take that advantage will be higher.

First I want to clarify that I intentionally mentioned the startup scene, and not the more common “produce the next billion dollar startup”. Here we can make a quick stop to analyze that the startup ecosystem is changing by itself with a wider diversity of paths. There are more and more indie founders (check out India hackers if you haven’t) for which the current VC model is not suited for most of them since they aren’t looking to scale as fast as possible in an exponential way, but to stay profitable and grow linearly, many of them bootstrapped. This will produce an atomization of the scene with smaller startups, where new innovation could boost them.

Unicorns by Zebras Unite

The clearest option that already has a big impact is Startup School from YC. After all, they have the most information about what startups need and how to help them. Doing it in a scalable way could change the scene completely.

Another option is Pioneer, founded by Daniel Gross, who runs AI on YC. This startup looks for the undiscovered “Einsteins” of the world. They do this through gamification. People from all over the world can apply, the ones chosen to compete will receive $5.000. They will compete for three months to see who has the best results, If they are among the first in their group they will receive an offer up to $100.000 and an invitation to the Bay Area. Next cohort’s application is open until October 21st. I think this model is really interesting because of the low barriers and the caliber of mentors with people like Marc Andreessen, Patrick Collison, Balaji Srinivasan and Tyler Cowen among other amazing experts.

Also, Stripe is a candidate for this with its Stripe Atlas initiative. They are enabling starting a business more easily, and have lots of metrics that can help them take action. I know this is not probably going to happen in the short term but some hints like Atlas’ guides focused on entrepreneurs and the acquisition of Indie Hackers show that there are intentions to at least collaborate in the ecosystem.

A not so well known contender is 42 Born to code, a free school to learn how to code. Right now they focus on programming, but their peer learning model based on projects would work perfectly for founders. So, it would be more of a change of focus. Also its worth noting that 42’s founder, Xavier Niel also started France’s biggest accelerator Station F, which has a more traditional program. At Linhub, we try to leverage on peer learning but for startup founders, following some of 42’s principles but applied to tech entrepreneurs. Instead of using pre-created cases, we use real-life cases from each member, so the solution has a real impact and people learn from experience. Another difference is that all of this happens online, so there are no offices like the fancy ones 42 have in their French and US schools.

 

Bootstrapped by Zebras Unite

There are also micro funds, like the recently created Tiny Seed Fund by Rob Walling who has bootstrapped Drip and runs MicroConf. This fund wants to back bootstrappers and let them grow without the expectations of becoming unicorns. This initiative by itself probably won’t have a huge impact, but if this is replicated by many investors, it could change the way we think about startups today. They would still be high-growth companies, but without stepping on the gas in the same way a potential unicorn would. There’s even an organization called Zebras Unite that goes further and states to be a “movement to counter existing start-up[sic] and venture capital culture”.

My final approach would be something unknown. It could come from a totally different place, like China or from a new technology, like blockchain.

Thanks for the feedback Ben Sheldon.