Should You Start Your Own Company - A Short Overview

Joseph W. Bartlett, Special Counsel, McCarter & English, LLP

Prior to preparation of a business plan, the entrepreneur should ask some hard questions. Hundreds of thousands of new businesses are organized in the United States each year; unhappily, most of them fail within the first year or so. Since the great majority of start-up companies are financed out of the pockets of their founders, the high failure rate should be a sobering statistic for would-be entrepreneurs. It may be fortunate for the economy as a whole that so few are daunted by the sober statistics, but it is hard on the individuals who do not make it. Nonetheless, available literature on the business aspects of organizing one's own firm rarely inquires into this threshold issue of whether one should set out on one's own in the first instance.

Much of the popular material on venture capital is potentially misleading in its ebullient optimism. It can be hard to keep one's head in the face of popular literature extolling the giant winners in the game—Jobs, Wozniak, Zuckerberg, and their peers, creators of new technologies which dominate the market and return hundreds of times the initial investment. The giants are an integral part of the mystique of venture capital, but an Apple Computer or Facebook comes along once in a lifetime. The odds against hitting that big are astronomical. Accordingly, books which record the anecdotal history of how Ken Olson organized Digital Equipment, how Ed DeCastro put together Data General, make fine reading, but the home-run expectations they promote can be dangerously intoxicating. A founder faced with the "go, no go" decision—whether or not to invest his entire savings in a new enterprise—is fooling himself if he stacks the reward side of the equation with the possibility of making hundreds of millions of dollars. It sometimes happens, of course, and someone has to win the lottery, but the vision of those sugarplums is not a sound basis for an intelligent investment decision. To be sure, it remains realistic for many founders to think of big rewards, perhaps even millions of dollars, albeit after a period of enormously hard work and great risk. Nonetheless, it is important to understand that in the vast majority of the cases—indeed, for the majority of the survivors—the returns on the founder's investment (and that investment must be calculated to include opportunity costs and sweat equity) are modest. Many founders find that, at the end of the game, they have either lost money or been working for a peon's wages.

There is a saying, attributed to Lord Palmerston, that many foolish wars have been started because political leaders got to reading small maps. Many businesses have been imprudently started because of the founder's inability to understand how difficult it is to achieve a double-digit compounded rate of return. Venture investments have, in fact, outperformed the stock market in the postwar years and, in many cases, quite handsomely. There have been periods when 25 percent compounded rates of return have been available to the investors; indeed, substantially higher rates have been achieved by many venture funds, and over long periods of time. But it is an economic impossibility to compound any substantial sum of money at a 25-percent rate of return indefinitely unless the investors are entitled to believe they will own all the assets in the world within one man's lifetime. It has been remarked that one of the greatest individual fortunes assembled in this country in recent years is that of J. Paul Getty, who started with a modest stake as a young man and wound up with a personal fortune in excess of $3 billion. It is a wildly successful story, but sobering when one considers that Getty's annual compounded rate of return on his initial few thousand dollars has been calculated at about 14 percent. In short, in reading the success stories reprinted in the popular books, the part to focus on is the hard work and risk involved. Enormous returns are contingent and should not be the foundation of the analytical planning process.

Joseph W. Bartlett, Special Counsel,

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