Diminished Returns

The hope of turning a good idea into a fortune entices many people to start a business. But the reality is often much less rich. After factoring in the long hours and the risk most entrepreneurs take by committing their resources to the business, the typical entrepreneur's payoff is surprisingly small.

After looking at more than 19,000 businesses funded by venture capital firms from the late 1980s to 2005, economists Robert Hall of The Hoover Institution and Susan Woodward of Sand Hill Econometrics, a company that creates analytic tools for private equity firms, concluded that more than 66% of startups either failed or yielded their founders little money. True, for those that successfully went public or were acquired, the average payout to founders was $9 million. But, say the economists, "a large fraction of the total value to entrepreneurs arises from a tiny fraction of the startups."

Although many entrepreneurs overestimate their odds of success, some do have a more realistic view. The economists also used the Sand Hill data to calculate how much money it would take to entice entrepreneurs with varying appetites for risk to sell their companies before the first round of venture capital funding. Those who felt they had nothing to lose would sell only for an amount equal to the average payoff of $9 million. But more cautious entrepreneurs would be willing to sell for as little as $600,000. With venture funding lasting an average of 49 months, that's the equivalent of less than $150,000 a year. In the end, what separates entrepreneurs from their corporate peers may be a strong stomach—and a good dose of optimism.

    Before it's here, it's on the Bloomberg Terminal.