Risk Distribution & Opportunity Costs in Entrepreneurship

Risk Distribution

In WIRED, “One Startup’s Struggle to Survive the Silicon Valley Gold Rush” by  Gideon Lewis-Kraus is a very long read for a magazine article but works to compare/contrast the social and economic lives of tech startup founders and employees at larger tech companies. Here’s a passage that stuck with me for hours after reading the story this weekend:

As the engineer and writer Alex Payne put it, these startups represent “the field offices of a large distributed workforce assembled by venture capitalists and their associate institutions,” doing low-overhead, low-risk R&D for five corporate giants. In such a system, the real disillusionment isn’t the discovery that you’re unlikely to become a billionaire; it’s the realization that your feeling of autonomy is a fantasy, and that the vast majority of you have been set up to fail by design.

This quote gets to one of the fundamental issues that distinguishes investors from management and scientists in their companies: Investors distribute their risk among multiple ventures. Founders, management, and key scientists are all in on the company they are building. This difference sets up a natural tension that shouldn’t be ignored.

Opportunity Costs

Over at The New Yorker, Epic Fails of the Startup World by James Surowiecki discusses the overconfidence of entrepreneurs, based on studies that show these folks overestimate the likelihood of success of their businesses. The end of the piece is what actually caught my eye:

The economy has come to rely on this Darwinian process to drive innovation. “Overconfidence means that many more companies start up than will ever succeed,” Brian Wu, a professor of strategy at the University of Michigan, told me. “That’s unfortunate for individual companies. The paradox is that it’s really beneficial for society.” In the delusions of entrepreneurs are the seeds of technological progress.

While  the overall result might be progress, the opportunity cost for the entrepreneurs starting these businesses rather than getting traditional jobs is not accounted for in this  analysis. (The loss of capital by the majority is also likely not a net benefit.)

Winning (Financially) at Biotech Entrepreneurship

As with everything, the biotech world is changing.

  • Biotech/pharma deals in this space have shifted to include smaller upfronts and large biobuck components, which shifts greater financial risk to earlier investors and employees.
  • Lean/virtual* biotech companies have become the norm, shifting the majority of hands on R&D to contract research organizations, where the employees don’t have the chance to participate in an eventual financial upside of the company.
  • Pharma appears to have reentered the consolidation phase of mega mergers, which limits the potential buyer/funder pool as these companies digest their large meals. (Brian O’Relli lists 30 biotechs that could be purchased for the ~$100B being discussed for AstraZeneca.)
  • Life science IPOs are happening but they are primarily fundraising events, not exits.

If you are thinking of building a biotech company (asset) because of the financial payoff, there are likely much more straightforward ways to trade your scientific/operational/management talents for good wages and benefits than a binary bet in an industry with high failure rates and increasingly long term financial rewards.

But….

I am thankful for the opportunity to build Quintessence, something that I had the chance to do because of our equity investors. And I appreciate the people in my personal life supporting the many tradeoffs that this job entails. For me – in my situation – I wouldn’t change the path I’ve traveled.

 

*Mini-rant: Small biotech companies with a handful of employees aren’t “virtual”. At Quintessence, there is nothing virtual about the patients who enrolled in our clinical trial, the shareholders who have contributed capital or the work our scientists have done to advance our drug.

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2 comments on “Risk Distribution & Opportunity Costs in Entrepreneurship

  1. Paul V. Radspinner
    May 23, 2014 at 3:38 pm #

    Excellent post (and rant- I agree wholeheartedly)! If we made this choice as entrepreneurs based upon the capital efficiency model for the entire economy I’m guessing Google, Apple, Genzyme and Genentech would not exist.

  2. Roger Frechette
    May 27, 2014 at 8:56 pm #

    Good post, and a nice bit of reality for would-be entrepreneurs. Don’t really get the mini-rant though. The word ‘virtual’ has subtle variations in meaning, including: ‘having the essence or effect but not the appearance or form of’. So a (traditional or bricks and mortar) biotech company discovers and/or develops treatments for serious medical conditions with a large staff of scientists and executives housed in a large (expensive) facility. A virtual biotech has analogous objectives but does the work with a small permanent staff surrounded by consultants and contractors. Both are viable approaches and the virtual approach (not always called this) has been for a while – I’ve been doing virtual since 2001. For a given degree of success, the virtual model can certainly be more cost effective (or capital efficient if you prefer), and sometimes, a large infrastructure is actually needed for properly attacking a particular problem.

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