A version of this article previously appeared in Forbes.
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The Answer: “Yes and No”
Jason concludes that:
- A top founder takes much more risk, at least on paper, but can make a lot more than even the best VC of all time
- A pretty good VC probably makes more than a pretty good and successful founder
- A mediocre VC makes a lot, lot, lot, lot more than a mediocre founder and if lucky and has good partners, can make more than a pretty good and successful founder
Jason’s comments caused me to compare my career as an entrepreneur and a VC with Rincon Venture Partners. I began by calculating the size an exit must be for a VC partner to generate the same amount of money they might have earned as a member of the founding team. This analysis is particularly timely, given the recent tidal wave of successful entrepreneurs who have become Angel and venture investors.
To be very clear – I am not shedding any tears for myself or other venture capitalists. I am humbled to have a career which is practiced by fewer individuals than play professional baseball. There’s no question that many VCs (especially those who manage large funds), are underworked and overpaid.
To explore the operator vs. investor returns question, I thought back to my own experiences as an entrepreneur. In 2012 I sold a modest business that I co-founded for $2 million and split the proceeds evenly with my business partner. I was very appreciative of this windfall, as the company was essentially a lifestyle business that my co-founder and I never expected to sell.
As shown in the following chart, for me to gross the same amount as a venture capitalist, one of our portfolio companies would have to exit for a massively larger amount.
Note: 20% carry is fairly standard, although a handful of firms demand a slightly higher percentage. Also, the above figures do not consider the substantial transaction fees or escrow holdbacks associated with company exits.
For instance, if a firm has three partners who equally share in the firm’s carry and the firm owns 10% of the acquired venture, the exit must exceed $150 million for each partner to gross $1 million. If there are only two partners and the firm owns 15%, an exit of $67 million will result in a $1 million payday per partner.
As Jason noted in his Quora response, the degree of risk taken by entrepreneurs is immensely greater. In a downside scenario, VC’s are clearly better off. Even if their fund fails, they will receive a hefty salary during its ten year life, although they will likely be unsuccessful if they attempt to raise a subsequent fund.
Thus, it’s entirely appropriate that founders net substantially more than the VC partners associated with their company. For instance, in the above scenarios, a founder who owns 15% would gross between $22.7 million and $10 million – far more than the $1 million distributed to each VC Partner.
Will A Change In The Tax Law Make A Difference?
A few of the 2016 presidential candidates have indicated their intent to change the rate at which venture returns are taxed. Currently, carry proceeds are taxed at the long-term capital gains rate of 20%. If these rates are changed as currently proposed, venture capitalists would pay an additional 20% to the Federal government. This would effectively increase the delta between what an entrepreneur nets from a company’s sale, versus that of an investor.
Will such a change cause some venture capitalists, especially the former operators who are new to investing, to exit the industry? Possibly. It may drive some back to an operational role (a good thing) and it might encourage others to check out and hit the beach (a bad thing).
However, most investors are unlikely to make a drastic career change based on losing 20% of their future capital returns. Although a tax hike would be unwelcomed, it would not change the fundamental reasons that the investors are no longer operators - the exhaustive hours, overwhelming stress and catastrophic downside risks.
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