@Dave Asprey – Thanks for the nice words and comments. But, ummm… why are you not taking a job at Cisco? :) You are right on the opportunity costs for the entrepreneur if they do not achieve a good outcome for their company – the risk does not merit the reward. Conversely, we both know entrepreneurs who did exceptionally well at VC backed companies. I think the bigger question, if the compensation between your two options is relatively equal, goes to motivation and work satisfaction. There is a reason that you, Dave, have not worked for a large company for some time and why you have done four early-stage venture backed companies…. My last point – you assume that CSCO will increase $10/share over four years. Their share price was $18.93 on 9/27/04 and closed Friday (ignoring today) at $23.82. You would have had to do some good market timing to get your $10/share increase (it did rise nicely in Oct 2007) on those shares that were vested to get the compensation you describe.

However, here’s the problem with venture funding right now. In 2001, the last “dip” (as opposed to today’s crater), there was a reasonable expectation that exits, when they did happen, were big. Like $100m big. But with the markets where they are, and the increasing acquisition of startups in the $20m range, the economics of being VC backed don’t work as well as they should.

A founder of a typical vc-backed startup might expect on average to end up with 7% equity at exit. That means about 4+ years of hard work at about $150k annual salary (for the first 2+ years), relatively high for a startup CEO. But if the exit is $25m, the equity is worth about $1.75m, if there is an exit at all. So over 4 years, salary + equity = $2.35m, not adjusted for risk. Risk adjusted, you’re looking at much less. Not so long ago, when exits were north of $100m, that number would have been $6.75m not adjusted for risk. Entrepreneurs accept the risk but want the rewards that match it.

On the flip side, let’s say an entrepreneur takes a VP job at say Cisco. Base + bonus = $275k with maybe 100k options. Say the options increase in value $10 over 4 years (conservative). So over those same 4 years, this entrepreneur makes $1.1m salary + $1m in options = $2.1m, but the risk is much, much lower.

More than one entrepreneur I know has looked at the current economics, the amount of hours a typical CEO spends, and the median exit values, and determined that a VC backed company isn’t compelling like it used to be. That said, it’s awesome to have enough money to last 18 months, and no angel is likely to do that, so Allan’s point is valid.

But if the same entrepreneur raises $500k from angels, starves for a year, but maintains say 30% equity, and builds a company he can sell for $20m, the rewards match the risk.

So that means that VCs – even the technically smart ones with operational experience like Allan – will have to work hard to convince entrepreneurs to accept the risk with the lower reward, or they’ll have to reduce the risk. The two ways to do that are to leave the entrepreneur with more equity, or to pay him more. Who knows, that may make for a more successful investment.

@Tim – Building a business to run it off profits is absolutely a valid business model. That being said, I don’t think that those businesses are those that are started by entrepreneurs looking for VC funding.

@Josh Seth – I do think that the financial meltdown does equate directly to the business of startups and their funding. If the economy continues to worsen then there will be fewer consumers of products and of the companies themselves. I’m agreeing that time is now for innovation and assert that startups need to think about how they are funded between now and eventual economic recovery.

I do believe, though, that the next blossoming market will be in some sort of micro-lending groups that affiliate to make multiple investments in a variety of markets, with each individual investor only putting a small percentage of their overall investment in any individual company or market. While this lessens the risk it also lessens the reward, but with inflationary pressures killing the dollar and debt-ridden large capital market corporations returning no dividend or profitability, I’d say the venture capital market could have some excellent opportunities to profit.

Being an entrepreneur for 21 years, I’ve always said one thing: save during a Fed-induced boom, and start new businesses during recessions. If you can weather the Fed-induced bust, you can come out well ahead when their next boom cycle begins. All of my most stable businesses were started in recessions, after a period of heavy savings during the previous boom cycle.

Right now, with the business market in chaos, is an excellent time to reach out to those with money. There are hundreds of billions of dollars sitting in safe but unattractive investment forms that are waiting for a decent risk/reward ratio. If you’re not considering either VC or AI for your business venture, you’re going to miss a wonderful stage of the business cycle: the death of debt-laden competition, the resistance of the risk-adverse from expansion or startup, and a relatively aggressive small capital investor group that really wants a decent return on their money but is willing to take some risk.

That’s why I’ll be contacting some angel investors in the next month for the business I’ve been nurturing for two years to profitability. Recession? Only for those who didn’t save during this last boom. For those who increased their savings of capital, this could be another boom market, but with less competition and fewer barriers to entry.