April, 27
by Mo Houston

How to calculate the expected value of a startup vs. a small business

When you think about the 1% that is the success rate of most startups (at least in the United States but generally worldwide), you wonder how people calculate the expected return and assess their profitibality with regards to such an endaveour.

How to calculate the expected value of a startup vs. a small business

Melanie says it best in her enlightening blog post incentivizing people to build lifestyle businesses instead of startups in which she basically calculates the expected return (after taking into consideration success rates and other relevant statistics) of hyper growth startups that end up exiting at $100M+ valuations and lifestyle businesses that make around $1M in revenues a year. The expected return, after taking into consideration the 1% success rate of the former, spliting equity between co-founders, and the success rate of actually making it into a $100M+ exit ends up being around 3 Grand. Not what you expected right? That’s because you’d have to multiply $100,000,000 by 1% then again by 50% then again by 2% then finally by 33% (which is the highest amount that the founder will probably own after dilution at the said exit) and you get exatly $3,300. Remember, this is NOT the value that a founder would get if successful, but rather it is the expected return based on the realistic probabilities outlined above.

According to statistics, the success rate of small businesses in the US is 44%, a surprising leap from the mere 1% for startups. Doing similiar calculations to the aforementioned gives us an expected return of around $356,400 with an expected exit of $3.6M. Ok that’s not as cool as the former exit of $100M+ but look at the odds.

What I suggest most aspiring entrepreneurs should do is plug one more thing into the equation in order to make both of the above expected values more precise, and that’s your credentials, in addition to the how, when and where. For instance, whether you have relevant experience, whether you have succeeded at a similiar endaveour before and whether you have relevant mentors all factor in to highly increase (or maintain constant) your chances at startup success. As for the other way around, I don’t really believe that not having the aforementioned criterea will decrease your chances with regards to the calculations we just made, because the percentages that we took into consideration don’t actually factor in relevant outstanding credentials.

Original image credits: Idyllic Software

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