I write a lot about building companies. At one point in the past, I wrote: "If you care about raising a huge round from a top-tier VC, then you need to make very deliberate choices." I want to dig deeper into what I’ve learned about what such deliberate choices might look like. My usual caveat is that my thoughts are only about building extremely valuable companies. There are many other ways to build smaller and less risky companies.

Risk-Adjusted Returns

I'll start with something that might feel weird to a startup person, but I think you should learn about the concept of risk-adjusted returns. Risk-adjusted return is the return on investment compared to cash.

The more I learn about building a company, the more I come to terms with the fact that all companies eventually become assets in someone’s portfolio. Your company may start as your baby, but it will sooner or later become a vehicle for financial returns. While you , as a founder, care more about the mission, later-stage investors will primarily look at the risk-reward profile. When a company is put on the public market, unless you are a meme stock with tremendous retail investor support, large financial institutes will determine your value based on your risk-adjusted returns. Analysts will dissect every piece of you and determine an appropriate risk-adjusted valuation.

The Sharpe Ratio is one of the most commonly cited measures of risk-adjusted returns, and it is defined as:

Sharpe Ratio = (Return - Risk-Free Rate) / Variance of Return

The higher the Sharpe Ratio, the more attractive the investment is from a risk-adjusted perspective. Let's say you can return five on an investment, the risk-free return is one, and the standard deviation is one. Then you will get between 3-6 in return in 68% of the cases. In 2% of cases, you will get between 0-3, and in 15% of cases, you will get between 0-4. If we changed the standard deviation to 0.3, i.e., cut the risk to one-third, you would get above 4 in returns in 99.95% of cases.

Venture Capital

In recent months I’ve kept returning to this report from Morgan Stanley, “Public to Private Equity in the United States: A Long-Term Look.” In it, we find several interesting exhibits:

Observations from Founding a Company

I will try to merge earlier exhibits and conclusions with my own observations from early-stage company building. My most recent update of “main challenges when building a company” includes the following:

Conclusions as a Founder