The ROI on being an entrepreneur vs. an employee
marcbarros.com
marcbarros.com
The equity value of a founder's shares is an order of magnitude higher than an early hire, or two orders higher than a late A or B round hire, and 3-4 orders higher than a pre IPO employee. No one gets rich as a regular IC hire at series B or C, even at a Google -- it probably tops out at 10-15mm, vs 15b for the founders. Even more so at companies less successful than Google.
On top of that, founders get supremely preferential tax treatment. Founders shares are generally bought near nil, and the entirety of gains are long term capital gains. If you do it right with QSBS and moving to WA before the sale, it can be taxed at zero. An employee often ends up paying hella AMT on almost all gain from ISOs since he didn't early exercise (or, early exercises at substantial out-of-pocket cost), and gets less freedom to sell in later financings, less return in a sub-optimal exit where the sale is covered with preference but "retention grants" are given to founders, etc.
I think the optimal strategy is to work for the most prestigious and successful companies purely as a learning and reputation building exercise, and then either be a founder or consultant to make money. It might be possible to enter a slightly earlier (series b) company as a director or better and still get a reasonable amount of equity (1%+ in a 100-200mm company), but otherwise either going for the tax advantaged, high variance outcome as a founder, or the high cash, flexible, also tax optimized outcome as a consultant, is the best way to actually get paid.
Entrepreneurship has never been an economically rational decision. You do it because you have to do it, or because you can't force yourself to work for someone else anymore. If you just want to gamble, go to Vegas.
"Certainly" is an inappropriately strong word. Even if you assume a salary of $150,000/year, in order to reach $300,000/year you would need to make $150,000/year in stock options, which comes out to $450,000 total if you assume it takes 3 years to get from series B+ to an acquisition/IPO. Of course, it could take longer. Or the median outcome could occur and neither event would happen.
So even in the unlikely scenario that the company goes from series B -> liquidation event in 3 years, and you get 0.25% equity (I'm assuming unreasonably generous stock options here for your average engineer, especially given the base salary), the company needs a $180MM liquidation event for the math to work out. This of course assumes that all stock is equal and your investors don't have a liquidation preference or anything like that. It also assumes the company doesn't take additional financing that dilutes the option pool.
I'm not counting angel rounds as a series A here. I'm talking about the big rounds that are invested to scale the business of an already-successful product. Companies that take these kinds of rounds can still fail, but the rate is nowhere near the same as for an early stage startup. And there's still upside in it for the employees: if you get .01% at a $100M series B valuation, and the company eventually IPOs for $1B, you've walked away with a grant worth $100,000.
We're only a factor of ~4 apart -- make that .02% and a $2B exit (or .01% at 50M for a $2B exit, or...), and you're basically there. And we haven't even talked about raises and/or retention grants, yet. So perhaps "certainly" was a strong choice of words, but it isn't totally ridiculous, either. Being a later stage employee at a hot company is a pretty good deal.
I joined the company I currently work for about a year after they raised a series C round. Most importantly, I get a pretty competitive base salary, but I also have some stock options. Even in the best case scenarios I think I'm looking at new car money, not mid-six figures. From talking with other coworkers, joining shortly after the series B round would have increased my options by roughly a factor of 3, in which case that "new car money" becomes "down payment on a house" money. Which is great, I'm not complaining at all, but it's not enough such that anyone post-series B that I know will be making a few hundred thousand per year.
A guy on another thread stated that he is happy because the NSA is not making people disappear in the USA like the KGB did in cold-war communist Russia.
Now I'm reading that a 15 million personal bank account (where you are practically a millionaire) doesn't make you rich. It's just okay. I guess, if you are not richer than Elon Musk then you're not considered rich.
Pretty much anyone would call that "rich." The exception are people who have a issues around money and their only definition of rich is 'more than everyone else.'
My definition of "rich" is being able to do something (fund businesses) which you fundamentally can't do while earning a salary. You could do that at an extremely limited scale either as a well paid employee or as 5-15mm exited founder.
It's a pointless semantic argument, though. My real argument is that founders are making 10, 100, or 1000x what others are making in virtually all positive outcomes, and not actually doing badly in negative outcomes (sometimes better, due to soft landings; sometimes worse, due to forgone salary).
For what its worth I've worked with, and know several dozen people who were non-founders and achieved that goal. I also know a few people who were not founders and got to the ranks of the .01% (the 1% of the 1%). Folks like Dan Warmenhoven who joined NetApp as its CEO after it was founded but before it was public, similarly Tom Mendoza (also at NetApp), Geoff Baehr who I got hired at Sun after it was public and who did quite well for himself.
Being a founder has a bigger payout in a successful exit, being an employee has a better rate of return. The reason is that an employee has the freedom to say "Ok, this isn't working, eject!" and a founder doesn't. As the author points out, Founders that eject at the first sign of trouble find it hard to ever get funded again. Back in the dot com bubble they were the joke entrepreneur the wantrapreneur. They came out in the bubble to found a company and collect a big payout, but they had no idea why people got big payouts. Kind of like cargo cultists making landing signs hoping that somehow that will cause a plane to suddenly appear on final approach.
I really believe its great when people are passionate about something and they invest every fiber in their being to make it happen. It doesn't always work but it is thrilling to be on the journey with them. It it much less fun to work for someone who is "just trying to get rich", they make poor choices. As an employee you can bounce bounce bounce until you find the right fit and the passionate people and ride it to the exit. As a founder you have to ride it and it you have to give it your all and you have to only step off that horse when you've exhausted every possible alternative. Anything less and your done. Yes, when it wins, it wins bigger than the rank and file, and when it loses it can destroy any advantage that extra sized piece of pie gave you because at the end of the day 10% of 0 is still 0.
Founders do much worse in negative outcomes than employees do. I don't know if its two or three orders of magnitude but it is significant.
It's entirely possible (likely, even) to get rich, even by my definition, if hired as a CEO into most unsuccessful large corporations, let alone successful ones.
I think most people have a much simpler definition of "rich": never ever having to work for someone else (employers or customers).
Being a 1099 consultant is a bit worse; I've always done the "product company which does a lot of client services as well, and usually with multiple principals" -- which solves the PSC-fucking-of-professionals issue. I think if you're smart you can get a lot of this benefit from 1099.
OTOH, a lot of people don't consider living in a government provided trailer, in hotels, etc. and eating on per diem/DFACs/with clients, only going on trips because there's a client engagement or conference, etc. to be a net win vs. ~30% income tax.
(I am not an attorney; I am not your attorney. I am not an accountant. This is not legal, professional, or financial advice.)
Building a business is probably the best way to make a large lump sum of money. Unfortunately the business is more likely than not to fail before bearing fruit and even after successfully running the business for large profits over time competition, laws, and factors out of your control usually kill the business. Due to the inherent risks and stress involved the book states that most successful people would not advise their children to start businesses but to get professional degrees, especially the kind that can work for themselves or consult such as law, medicine and accounting. Not so much the non-professional jobs such as business management.
A more realistic model would assume your wage growth starts at, say 8-10% your first year and then tapers off to 0-1% after 10 years or so.
1: http://www.comparebloomington.us/include/reportsmedia_157_15...
I don't think that the average employee is aware that an entrepreneur/founder/self-employed person can save a lot of tax if they structure it right and are meticulous about it.
A self-employed person earning $70K a year can be better off than an employee earning $100K.
Small payroll income so that you fall within a low income tax bracket. Top up salary with dividends as they have a much lower rate of tax. If you have a live at home wife, make sure she's employed by the company in some form, eg. you can pay her the minimum wage for secretarial duties. Ideally falling within the tax-free lower bracket. Unlike regular employment, you can start claiming a lot of everyday things such as food/transport/home office electricity/internet/etc. as business expenses, thus meaning you can claim 20% VAT (sales taxes) back depending.
Ultimately, there's also the final payout if you manage to sell the company. If it were classed as regular bonus income, you'd be taxed at 45%. Instead you get charged as capital gains at 18-28%. You can also get entrepeneur relief on the first £10m which means you only get charged 10% instead of 28%.
NOTE: Some of these are loopholes like dividends and employing family. They tend to get cracked down on every now and again (I'm not even sure if they're valid now)
But when you get down to it, there are a heck of a lot of potential savings over standard income tax (currently 40% on anything over £32k, 45% over £150k)
I believe the using dividends for tax avoidance is either no longer effective or has been cracked down upon.
You can also give less to the government on your VAT if your profit (or revenues, I can't remember which!) is below 150,000 GBP. Rates vary between 9% and 15%.
So it's still worth it, but not quite as much as it used to be before IR35.
For consultants/freelancers/contractors - dividends can be fine, if you can mitigate your exposure to IR35 (typically a bigger issue for contractors). Groups such as the PCG can really help here, but really the key thing is ensuring that any contract can't be thought of as disguised employment (control, substitutability and mutuality of obligation being the keywords) - speak to a Lawyer or a specialist accountant for advice or other clued up contractors for advice.
The tax position on dividends is also a bit more subtle than above; if your total personal income is less than the £32k (minus allowances), then you're going to get the dividend tax credit back so the div is tax free. Granted the company is paying corp tax at 20% on all profits; but also it gives you options to defer company income becoming personal income, building up the company's reserves. As I understand it, you can wind up the company and get entrepreneurs relief which is also a worthwhile target for consultancies.
I'm assuming your work is legitimate self-employment, i.e., the people who pay you do not control your hours, tell you how or where to do your job, etc. If that's not the case, the law probably considers you an employee rather than an independent contractor[2], and you should be paid as one (W-2) - and you could get in trouble if you try to deduct expenses that are only valid for an independent contractor.
(I'm assuming you're self-employed, not incorporated.)
[1] http://employment.laws.com/self-employment
[2] http://blog.intuit.com/employees/1099-contractor-vs-w-2-empl...
It's somewhat of a pain getting this all going but once you do, you are operating as a corporation. Corporations do not pay income tax as such - they do have some filing fee type of taxes, but basically the taxes you pay come out of your payroll. So you do not pay tax on income that your company earns until you withdraw it from the company account via payroll. However, you can spend directly from the corporate account on anything that is reasonably considered a business expense. Computers and equipment, of course, can be purchased. Your company can pay the phone bills, internet connection, travel expenses, business lunches, etc. You can also charge your company rent as well if you are working out of your home.
What happens is that you wind up paying yourself a meager salary on which you pay normal tax just like everybody else. So for instance, your company earns $80. You pay yourself a salary of $15k and the remaining $65k money is spent on operating expenses and is a tax write-off. You only pay tax on that $15k. You're likely to even get a small tax refund check instead of a huge bill from the IRS. In some extreme cases you might pay yourself even less, or even come in at a loss and pay no income tax. There is nothing illegal about this as long as your write-offs can be legitimately considered a business expense.
This is also great because with payroll setup you are in a position to pay employees and sub-contractors via payroll as well and eventually grow your company with the proper financial system in place.
I would highly recommend having an accountant set this up for you and file your taxes though because it is a ton of work and requires understanding the ever-changing tax laws.
Are you sure that is correct? I am neither an accountant, nor even American, but IRS.gov says:
"The profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends. This creates a double tax. The corporation does not get a tax deduction when it distributes dividends to shareholders. Shareholders cannot deduct any loss of the corporation."
(source - http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employ...)
For the 2011 tax year, Wikipedia pegs the US federal income tax rate at between 15% and 35% (depending on income level).
(source - http://en.wikipedia.org/wiki/Corporate_tax_in_the_United_Sta...)
I think that only applies to C corporations, though I'm curious now about US tax law. Do tax shelters like you propose exist? Do you have any more information??
You get a choice: you can either have a pass-through entity (owners are taxed as if they received the income directly...even if they never actually receive it) or a deferral entity like a corporation (corporation is taxed, but its owner are not taxed until/unless they receive a dividend).
Moreover, even if you choose a pass-through entity like an S-Corp or LLC, the IRS places certain threshold requirements on the amount of income you must pay yourself, and on the self-employment taxes (FICA) you must pay.
Edit to add citation. Also, I'm assuming you're talking about an S-Corp, since it would make not sense for a C-Corp. From http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employ... :
"If most of the gross receipts and profits are associated with the shareholder's personal services [i.e. not from other employees or capital], then most of the profit distribution should be allocated as compensation."
If you're only paying yourself $15k of the %80k your company brings in, and that $80k comes from payment by clients for work that you personally did, then you are definitely on the wrong side of the tax code.
I can't help but notice that your quoted text says "most of the PROFIT distribution" rather than "most of the GROSS INCOME distribution" The company can't pay out more than it brought in.
Obviously if you don't have $65k in expenses then you can't claim them. But, working as a contractor can have a lot of expenses - travel, office rent, utilities, etc. Giant corporations claim these expenses, a single-person company is entitled to the same deductions.
In 15 years of business I have been audited twice by the IRS with very minor amounts due (< $500) and nothing to do with deductions or expenses. The reason I bring it up is simply to illustrate that I'm not just lucky or flying under the radar. One time it was my mistake of a missing payment in my records and I simply paid the amount due. The other time was the IRS's mistake and I successfully contested it. If I had anything to hide I sure as hell would not be contesting an IRS audit for some small amount of money. My point is that I am in no way hiding or trying to sneak around tax codes. I do not encourage anybody to do anything illegal. I only encourage anyone to claim the maximum amount of legitimate deductions that they're entitled to claim. I also highly recommend having an accountant handle it for you who knows the tax laws and ensures that you are operating within them.
In general the deductibility of expenses to the corporation is a huge advantage (of a C, S, or LLC), if you're a "professional" with a lot of expenses. OTOH, going from "dollar earned by C corp" to "salary paid by C corp, with both sides of the various withholdings, UI, etc." to "personal income" to "personal income with taxes paid" is MORE of a tax hit than just regular wage income. S/LLC give you the passthrough tax advantage but still have higher filing costs. It only really becomes worthwhile around $20-30k in side income for purely tax reasons.
There are plenty of non-tax advantages to incorporating, of course -- some level of asset/liability protection (most debts are firewalled at the corporation as long as you correctly treat corporate assets and liabilities as distinct from your own), the ability to take outside financing or do collaborations with other people, etc.
(I am not a lawyer; I am particularly not your lawyer.)
Normal corporations pay federal corporate income taxes directly -- and, as employers, they pay the employer share of federal payroll taxes as well.
It is true that there are kinds of corporations whose income is passed through to someone else and assessed against that person (notably S Corps, and T Corps in certain circumstances.)
I used to be an 'independent contractor'. I work for companies doing ecommerce / Java / Consulting work. I work a fixed term contract and leave when the project is complete.
I set up a limited liability company with me as the director and the only employee. When I get a contract (work), the client hires my company rather than hiring me directly. Depending on your specific tax laws, you pay a lot less tax using this kind of setup i.e. you pay yourself a low salary and the rest in (low tax) dividends.
This is the standard way most IT contractors operate.
(IANA Lawyer or Accountant)
So, say you live in a very relaxed tax environment, you can incorporate your LLC, sell software services to US companies and pay small taxes in your country.
References to:
- http://www.law.cornell.edu/uscode/text/26/861
- http://www.law.cornell.edu/cfr/text/26/1.1441-1
- http://www.irs.gov/pub/irs-pdf/i1042s.pdf
NAME_OF_COMPANY LLC is a single member LLC, and as such disregarded for federal tax purposes as a separate entity from its owner, FULLNAME, a resident of COUNTRY and a nonresident alien for US tax purposes. According to Section 1.1441-1 of Treasury Regulations (page 3 of the attachment) , payments made to a whole owned domestic entity that is disregarded for federal tax purposes and whose single owner is a foreign person, shall be treated as payments made to the owner of the entity. This means that payments made to NAME_OF_COMPANY LLC for federal tax purposes are considered to have been made to FULLNAME. The Regs go on to explain that the single owner of the US disregarded entity must furnish a From W-8 with his name and address to the US payor . An ITIN is required only to claim a reduced rate of withholding under treaty, but since in this case the payments were made for income from sources WITHOUT the United States, no withholding is required to begin with, so there is no need to claim any treaty benefits at all and provide an ITIN as a result.
If you want I can contact you with an specific accountant and you can discuss the details with her.
A noncitizen actually can use the USA as a tax haven in ways similar to this (I'm not sure of the specifics of this particular situation). IMO there isn't a whole lot special about non US people not owning US taxes when outside the US.
A US citizen or permanent resident is taxed on global income (you do get around your first 95k/yr deducted if you are out of the country enough, which is why I went diving for 4 months at the end of a contract and net made more money than returning to the US that year). A corporate entity being treated as disregarded just exposes that income the us person's global us tax liability.
(Again, I am absolutely not a lawyer; this is not tax advice)
N.B. I don't know why somebody downvoted me for clarifying the previous point.
In fact, what he's described works even better without the LLC, as the organizing an LLC in a state gives that state jurisdiction to tax sales to customers in that state! (State tax laws work differently than federal tax laws and are generally not affected by tax treaties.)
http://webcache.googleusercontent.com/search?q=cache:kvX1Y03...
However, if you want to build something that you own, are passionate about, and are comfortable with the possibility of not having much money for many years then being an entrepreneur is definitely a worthwhile endeavor.
It's good to remember, after the hype surrounding large exits, that the chances of creating a similarly valuable company are incredibly small. So yeah, if you're in it for the money it's probably not worth it.
So 0.00006% of the time you start a billion dollar company and take home $300MM. 67% of the time you fail and take home $0. The rest of the time you fall somewhere in between, and so your expected value is $300,000. Divide that into an average of 4 years and your expected value is $75,000.
So if you're perfectly rational, you should be willing to work as an employee with no equity for an extra $80,000 over whatever you'd pay yourself as a startup founder, because your expected value is higher.
I would look more simply at all the people I know that are entrepreneurs versus those that work in a job.
At least 50 percent of the entrepreneurs have over $1 million In assets and in a few cases over $10 million
Zero employees that I know have over $1 million in assets
I think it is far more likely to be wealthy as an entrepreneur, it's possibly a bit safer as an employee.
Unless you're a relatively close personal friend, there's basically zero reason for someone who earned over $1M in non-public transactions (notably salary) to tell you about it, though.
You don't know anyone who has been at google / apple / facebook / amazon / microsoft / etc for more than a couple years, had a few notable accomplishments, and been promoted once or twice?
1. Instead of looking at averages for entrepreneurs (and stock-holding employees) it should look at expected values. Those take probabilities into account. So with a 0.1 chance of a $100MM payout[1] gives you an expected payout of just $10MM for ~7 years of very hard work. Not too shabby, but not spectacular either.
2. "Assuming you don’t have any exits and you work 65 hours a week while running a company (compared to 50 hours per week with a regular job)" ... while I agree that people work this much and more, the funny part is how a lot of cold hard research proves that working that much makes you less productive and lowers your chances of a serious payout.
Now can someone make this for freelancers? I feel like we're somewhere between employees and entrepreneurs. Salary definitely grows quicker than 6% and risk is definitely smaller than "pure" entrepreneurs.
[1] billion dollar exit, let's say $100MM actually gets into a founder's pocket
Peldi started Balsamiq on nights and weekends, and now it is supporting half a dozen families.
We were lucky to able to learn so much in our former jobs at Macromedia and Adobe. If he hadn't had the courage to leave, if the stars hadn't aligned just right"
If that is not a real, tangible definition of a successful startup, I do not know what one would be. Having been part of at least one failed side venture startup, I know how hard it is to build a product and how much harder it is to build the right team.
https://blog.supportbee.com//2010/12/02/delivering-wow-custo...
I'll bet there's a lot of '$ made' graphs for entrepreneurs that don't go up much, or even go down; and a few that are hockey-sticks. There's really no point of averaging the two out into a scenario that rarely/never happens.
For someone working in tech on a good salary this should be closer to 50%, easily.
Even paying a high rent, and heading out every night one should be saving at least 25%.
The average savings rate from 1959 to 2014 was 6.82%. [1]
[1] http://www.tradingeconomics.com/united-states/personal-savin...
If you're living in California and making $125,000 per year at a job, you're paying $33,000 in income taxes alone. Your 50% savings rate would be $62,500 - after taxes you have $92,000, so the person can live off of $30,000 per year. Rent alone can easily run $1,500 to $2,500 per month. This is an impossible scenario without even getting into the real costs of existing (ie bills, families, debts, vehicle & getting to work, accidents, problems, charity, social life, doing things).
My ex, who lives in Los Angeles, and makes $70k per year in the medical field, can't save more than $400 to $500 per month max after all costs and taxes. That savings is inevitably slashed in half due to once-per-year events that cost a few thousand dollars to fix. Her only salvation is her 401k.
If you want a family, it's a different story.
[1] http://hosted.ap.org/specials/interactives/_business/debt_ad...).
When I ran the numbers through my head before making the original comment I assumed the savings would be 25-50% of take-home pay, so with the necessary taxes taken out. Which I would argue should still be more than a measly 6% of the total.
The other point to make is that a mortgage would count as savings, since you're paying off a rather large purchase as opposed to paying rent. That and most people would be putting the savings away to buy a residence in the first place.