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Zvi comments on Who Wants To Start An Important Startup? - LessWrong
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To sound a note of caution... I spent a number of years acquiring various kinds of non-monetary capital that are useful for startups. Looking back with my current state of theoretical knowledge and memories, I suspect I may come to see this period as involving too little caution. The key concept acquired between then and now is Kelly Betting.
I still haven't worked through the applications of this concept to startups in a way that I feel is "settled", but depending on the precise nature of the risks and rewards and the bankroll of the typical person accepting startup equity in place of cash, the Kelly Criterion may indicate that startups should usually not be more than hobbies for "normal" (non-rich, non-certainly-immortal, declining-utility-in-dollars) humans. Note that if startups are roughly as risky as a simple Kelly calculation says they should be, this might still be cause for concern because most people who raise theory/practice issues with Kelly say that it over invests in risks.
I'm still exploring ways that the theory might line up with reality, but even my limited state of knowledge has caused me to scale back my startup enthusiasm in the last year or so. The math might come out more positive if you value the knowledge capital gained through startup work in the correct way, for example, but that's particularly tricky to calculate. If anyone else has thoughts on this subject I would love to read or hear them.
For reference, Robin already wrote about Kelly betting to claim that the present era is visibly unstable because most investment firms, and the economy in general, seems not to be engaged in a Kelly strategy at the present time. In some sense, Robin claimed, a financial system not dominated by Kelly-following-financial-entities would probably be a system that has no significantly old Kelly-following-financial-entities, because in the long run they "win" at finance.
Another source on Kelly betting that is directly applicable to startups flows with the "invest in the team, not the idea" dictum. The post "Optimal startup burn rate and the Kelly criterion" is no longer available in the wild but is retained on archive.org and discussed the optimal team size and experimental product cycle given a starting bankroll. (The blog is LaserLike and is not itself down.)
For what its worth, I'm not totally bearish on startups, and sort of have one cooking... I'm just trying to pursue startup stuff with an eye on keeping a bird or 6 in the hand while pursuing startup stuff in parallel. In this vein, if anyone is or knows a solid hardware hacker with RFID experience/interest, especially if they are ethical, planful, world-savey, "rational", and/or live in (southern?) California, I'd appreciate hearing from you. No particular startup interest or equity tolerance is important -- just hardware skills, character, and an interest in educational conversation :-)
I have extensive experience in this realm, including both independently re-deriving Kelly before learning about it and then working extensively with variations of it, in nominally Kelly-optimal conditions. Kelly is only optimal under a very strict set of criteria, and those criteria de facto do not occur in practice. It's a great guide to the landscape, but a terrible perscription in most situations. Common errors include misunderstanding what counts as a bankroll, inability to access large portions of the real bankroll, changing returns to investment size, the existence of limiting factors, having almost any real utility function, unknown unknowns and edge uncertainty which is almost always correlated, psychological impact and inability to precommit credibly to Kelly, outside perceptions and their impact on your bankroll or utility, not accounting for calculation errors, odds or outcomes that are impacted by bet size, and more.
I may write a top-level post going into more detail (feedback on this idea is appreciated), but here I will deal only with this particular case.
In a start-up, the bankroll definition and potential is one key. Your bankroll includes more than you think, and that's especially true in a start-up world where you can, even in failure, get more investment and start again, or join someone else's start-up, or just go back to a day job. Kelly assigns infinite disutility to going broke, and going broke is standard procedure in the startup world. Also, how you take your compensation is largely for motivation and signaling and to keep control of the company, all of which impact the result. In bankroll terms my investing in my own company, and taking $0 other than expenses from my start-up work was madness, but it was clearly the correct play and has paid off handsomely in numerous non-bankroll ways even if no money results!
Going full speed at a startup, even in failure, is often a winning play as you develop connections, reputation, experience, skills and other neat stuff like that, laying the groundwork for future success.
I'd be interested in reading that post! If you do, could you explain more about the grounds on which you'd be applying Kelly to this problem at all, though? I'm somewhat unclear on that -- see my other comment in this thread for detail.
In this problem, you're starting a business, and you can consider that business as a bet, out of which you hope to gain a job, income, investment money from your equity, reputation, experience, and so on, all of which can be abstracted. Alternatively, you can look purely at the equity vs. salary trade-off in the context of Kelly, which as I explained above is deeply flawed. It's not a great scenario for such calculations, but they can still provide insightful context.
That's kind of reassuring. I'm just starting to read about Kelly, and my first reaction was "and your knowledge of the final outcome comes from where?".
It also occurs to me that "Invest in real estate, they aren't making any more land" is an effort at Kelly prediction, and we all know how well that worked out.
It is a classic mistake to treat your estimates as known expected outcomes when calculating how much to bet. This is one reason why real world gamblers almost always use half Kelly or even quarter Kelly rather than full Kelly.
"Invest in real estate, they aren't making any more of it" is, in effect, a prediction of the expected returns to investment and/or the reliability of investment. Kelly would advise you on how to take advantage of the expected returns from real estate, once you nailed down your beliefs more carefully. For real estate, Kelly is rather horrified, as it finds many people investing far more money than they have into a single house. That sounds insane when you say it like that! However, a richer understanding of all a person's assets together with the tax advantages of mortgage interest, and the inability to cheaply adjust the size of that investment, can make that reasonable under Kelly if you think the bet is stable (e.g. that the house can't go to zero if it's insured, at least not in any scenario where you care much about that).
I think part of the situation is that naive investors don't quantify-- if real estate is a good investment, they don't think about how good it might be.
It's interesting to watch "Kelly" drift in and out of being personified.