You Need to Know What You Are Betting On

Popular convention is that startups are high risk, high reward, while public companies are safe but less likely to make you rich. 

This is only sort of true. Startups follow a power law—only 1% return 10x the invested capital. 

The dirty secret is that public stocks operate similarly. Only 2% of public companies are responsible for 90% of the aggregate wealth creation in U.S. stock markets. 

A more use-one-finger-to-push-your-glasses-up-your-nose sort of way to restate this: wealth creation is almost wholly concentrated in a minuscule percentage of companies, regardless of whether the underlying security is publicly tradable. So the advice I was given when I started my career—work at a startup to get rich instead of working at a corporation—is false. 

A career is essentially a trade where you pour your single most highly concentrated asset (your life) into the most highly diversified asset of all time (a 401K retirement fund) until one day you die. Perhaps the advice to “work at startups and get rich” is a case of survivorship bias. It seems like the lifeblood-to-Vanguard-trade doesn’t work—instead, it’s a trade of lifeblood for stock options. You either make it rich or you make nothing, as noted by my own startup career, where I have literally never had a 401K program and have yet to have a major exit.

However, this is too simplistic a read on the data. What matters with equity isn’t total wealth creation, it is being able to time the sale of the asset. The midwit take on the power law would be that an investor should hold a stock as long as reasonably possible. If you have some asymmetrical advantage of getting at these 1% of startups that then turn into those 1% of public companies, you should keep that stock for decades at a time. The ideal strategy is to find the next Microsoft and keep that stock for the next 40 years.  

But that’s, like, kinda impossible. If it were as simple as “buy at the bottom, sell at the top,” every Adderall-snorting Robinhood user would be drowning in Lamborghinis. Unfortunately, because the future has the pesky attribute of being unknowable, timing the sale at the top is very, very hard. Firms that are currently attempting to invest at the seed stage and hold through a company’s public lifespan, most prominently Sequoia Capital, are essentially betting that they know the companies they are holding better than their founders, who tend to not understand their own company’s potential. 

After all, the value of two of the most startlingly successful technology companies, Microsoft and Tesla, have both been underestimated by their founders. Bill Gates owned 49% of Microsoft in 1986 and has reduced his ownership to about 1%. If he had held, he would be worth about $1.22 trillion today. Instead, he has diversified away to about a $112 billion net worth. Elon tweeted in 2020 that “Tesla stock price too high IMO,” causing the price to drop 10%. He has also continued to sell off his shares. 

This graph visualizes the top wealth-creating companies since 1926 relative to their age in the markets.