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Founder Failure Insurance: Pooling equity

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Re: Founder Failure Insurance: Pooling equity

#11

Post by klochner »

malandrew wrote: post #6
ezl wrote: post #4

Earlier quoted context omitted.

i don't think pooling is about loss _minimization_ so much as accepting that startups are often risky. the idea would be to give up a VERY small sliver of your upside in hopes of participating on other wins. I understand founders' desire to "maximize their upside potential", but if you cash out for 100mm, the incremental 5mm you give up has relatively small utility after the 95mm you cashed out. However, in the more…

Risk spreading reminds me of this Dogbert cartoon I came across back when I worked in finance: http://dilbert.com/strips/comic/2008-12-13/ Basically, risk spreading suffers from unintended consequences. There are however other alternatives to the portfolio approach that do make more sense. My favorite is the concept of a keiretsu ( http://en.wikipedia.org/wiki/Keiretsu ). This approach makes sense, especially when yo…

That cartoon is lampooning the MBS pooling that let agencies rate bundles of loans as AAA even though all the underlying securities were more risky. Bundling actually does reduce risk, but in the case of the mortgage meltdown of 2008 it was missing the forest (systemic market-wide mispricing of loans) for the trees (slightly reduced risk).

In this case, the founders already are invested in the dead cow, and so it can make sense to diversify to reduce risk. It's doesn't increase the value of their shares, it just makes the overall portfolio less risky.

The analogue to the MBS fiasco would be if the U.S. hit another depression, the whole YC class would be likely to flop, so the diversification wouldn't help, but in "normal" market conditions, the whole group would benefit from the few winners and get a payout in more scenarios.

Re: Founder Failure Insurance: Pooling equity

#12

Post by masterzora »

Stand-out quote:

in a sense, trading any of your company for other companies might be a negative expected value play

In general, insurance is a negative expected value. After all, that's how insurance companies make money: by charging more than they pay out. The key with insurance, however, is that it is purchased to cover a catastrophic event. That is, all the money you pay into it will hopefully be more than the money you get out of it but if you end up needing really expensive medical treatments or your house burns down you need to be able to afford to move forward.

With founders and the "founder failure insurance" there is significantly less of this, though. If you fail you don't get an immediate payout, or even a guaranteed payout, failure is not a catastrophic event (in the sense of needing a lot of money fast) for most, and it's actually possible to do well and make money from this.

Really, a more honest way of describing this is as a bet that you will lose, though that's not a complete picture, either.

Intriguing idea nevertheless and something I'd consider if I were a founder.

Re: Founder Failure Insurance: Pooling equity

#14

Post by jfarmer »

ezl wrote: post #5
jfarmer wrote: post #3

First Round Capital did something similar a few years ago with their portfolio companies: http://redeye.firstround.com/2010/01/sharing-and-exchanging.... Speaking personally, I want to own as much equity as possible in a company I start. 3% is a ridiculous amount of common stock to go towards something like this.

3% of all my companies to date is worth exactly zero. The idea isn't to say "everyone should throw X%" into a pool. It's for you to pick a number that makes sense for you and find a group of founders that wants something similar. Founders who are absolutely certain of their future success only do worse by pooling equity. The more likely you are to succeed and succeed big, the less likely you should be to contribute t…

And giving away a big chunk of equity like that is a signal to future investors, employees, and partners that you think 3% of your current company will be worth something similar.

Re: Founder Failure Insurance: Pooling equity

#15

Post by ljd »

masterzora wrote: post #12

Stand-out quote: in a sense, trading any of your company for other companies might be a negative expected value play In general, insurance is a negative expected value. After all, that's how insurance companies make money: by charging more than they pay out. The key with insurance, however, is that it is purchased to cover a catastrophic event. That is, all the money you pay into it will hopefully be more than the mo…

I could be wrong, but I believe insurance companies don't charge more than they pay out. That instead, your premium is equal to how much their actuary tables say they'll have to pay for someone with your level of risk.

They make all their money through their investment portfolio. Essentially, they earn interest on your premium until they have to pay it out.

Re: Founder Failure Insurance: Pooling equity

#16

Post by jekdoce »

ljd wrote: post #13

Adverse Selection[1] is a big problem with insurance in general. Insurance of this nature has adverse selection problems in spades. The people that think their startup is likely to fail will be most likely to contribute to the pool. [1] http://en.wikipedia.org/wiki/Adverse_selection

A properly designed simple market would take care of this.

Re: Founder Failure Insurance: Pooling equity

#17

Post by ljd »

jekdoce wrote: post #16
ljd wrote: post #13

Adverse Selection[1] is a big problem with insurance in general. Insurance of this nature has adverse selection problems in spades. The people that think their startup is likely to fail will be most likely to contribute to the pool. [1] http://en.wikipedia.org/wiki/Adverse_selection

A properly designed simple market would take care of this.

I'm not necessarily sure that I follow. How do you create a market for participant selection?

Re: Founder Failure Insurance: Pooling equity

#18

Post by masterzora »

ljd wrote: post #15
masterzora wrote: post #12

Stand-out quote: in a sense, trading any of your company for other companies might be a negative expected value play In general, insurance is a negative expected value. After all, that's how insurance companies make money: by charging more than they pay out. The key with insurance, however, is that it is purchased to cover a catastrophic event. That is, all the money you pay into it will hopefully be more than the mo…

I could be wrong, but I believe insurance companies don't charge more than they pay out. That instead, your premium is equal to how much their actuary tables say they'll have to pay for someone with your level of risk. They make all their money through their investment portfolio. Essentially, they earn interest on your premium until they have to pay it out.

In general, insurance companies derive profit both from taking in more than they pay out and from investing what they take in. Historically speaking the idea is for the insurer to have a positive expected value on the premium alone but some companies (and possibly entire types of insurance? I'm not an expert by any means) these days are willing to lessen underwriting profits in exchange for market share and, therefore, more investment money.

Re: Founder Failure Insurance: Pooling equity

#20

Post by qq66 »

ljd wrote: post #15
masterzora wrote: post #12

Stand-out quote: in a sense, trading any of your company for other companies might be a negative expected value play In general, insurance is a negative expected value. After all, that's how insurance companies make money: by charging more than they pay out. The key with insurance, however, is that it is purchased to cover a catastrophic event. That is, all the money you pay into it will hopefully be more than the mo…

I could be wrong, but I believe insurance companies don't charge more than they pay out. That instead, your premium is equal to how much their actuary tables say they'll have to pay for someone with your level of risk. They make all their money through their investment portfolio. Essentially, they earn interest on your premium until they have to pay it out.

Even still, it would be a negative expected value play for the insured, since they give up the investment returns on their premiums to the insurance company.
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