Reconsidering Career Optionality
In startups the biggest risk is not that you'll fail, it's that you won't get enough actual shots on goal to succeed
In a recent post, I described how the best scientific minds are stuck in academia, the best operators are stuck in large consulting firms (like McKinsey) and the best engineers are stuck at FAANG companies.
One of the reasons they do this is because they don’t know what to do next.
I don’t know what I’ll do with my life, so I’ll get a degree.
I don’t know what I’ll do with my degree, so I’ll get a grad degree/MBA
I don’t know what I’ll do with this MBA, so I’ll go into finance/consulting/FAANG to figure out what I want to do.
One way of justifying this path is that they see it as accumulating optionality as if they are gaining badges and skills that let them do more stuff. And, by getting high-paying and high-status jobs, they are capping their downside: “Heads I win, Tails I don’t lose.” What can be bad about that?
One risk with pursuing optionality is that it prevents you from taking risks. In focusing so much on acquiring options to cap your downside, you also cap your upside by being too comfortable to take risks, life-style wise and reputationally. You get an MBA, work a few years in finance or consulting or FAANG, and before you know it you’re 30 and you haven’t taken any risks. Is that what you plan to do with your wild and precious life?
The promise and perils of optionality
The average ambitious person spends too much time accumulating optionality and too little time taking actual risks with high upside potential for themselves or the world. People often pursue optionality because they perceive that going after something big like, say, starting a company, is financially and socially risky. However, the bigger risk is not that you fail, it's that you don't get enough actual shots on goal to do something amazing.
Ambitious people compete insanely hard to accumulate options for the future, instead of figuring out what they really want to do and doing it. That's like spending your whole life filling up the gas tank without ever driving. This lets you off the hook of doing the hard work of figuring out what it is you want and what you should be doing with your life.
The secret is that taking risks provides optionality as well, via learning and differentiation. If you go to an ivy league school or elite consulting firm, however, you're merely one of many. Even something as prestigious as a Harvard degree makes you only one of 315,000. If you start a company, you can truly become one of a kind—you'll be one of a very few who started the way that you did. Many ambitious people, even though they understand this intellectually, still prefer the more conventional path of accumulating optionality. Why? Several reasons: prospect theory, the fear of looking dumb, and a fundamental misunderstanding of the risks involved.
Prospect theory (or loss-aversion theory) states that people value gains and losses differently. People fear losing more than they want to win. Because of this, they prefer outcomes that lead to lower expected utility as long as they can avoid losing instead of maximizing their utility. For example, if you offer someone a 50/50 bet, with a 50% chance of losing $50,000 or winning $100,000, people will generally not take this bet, even though the expected value is $25,000.
Not only are people loss averse, but they often find it is easier to follow everyone else than to chart their own path. Charting your own path is not easy. There is no rulebook; you are forced to think for yourself, which is a time-consuming and challenging exercise. It can be quite scary, and the downside risk is that you end up looking scary or dumb. But it’s ok to look dumb. The goal is not to look smart the whole way. Better to look dumb for a bit, but genius at some point, than look merely decent the whole way by taking the safe path.
I think the biggest career mistake young people make is they’re afraid to look dumb, so they follow safe paths that cap their downside, not realizing that they also cap their upside.
But isn’t it smarter to make a safer bet than a startup?
The final reason that people prefer conventional paths of accumulating optionality is because they mistakenly believe that working in a "safe" job has a higher expected value. We can call this the naive model of risk.
A presentation by Paul Gu imparted this framework: Imagine a four-year period where you have two options. You can make $300k/year at FAANG. Your total four-year comp is straightforward to calculate: $1.2 million. Let's say a startup offers you a job with a $100k base salary and 4-year 10,000 ISOs. You take 10,000 multiplied by the preferred price and subtract 10k multiplied by the strike price. You end up with $150k in startup equity a year over four years. Your total four-year compensation is $1 million, less than the job at FAANG. A rational actor trying to maximize financial returns would choose the job at a FAANG company.
But this is the wrong way to look at it. Why? You can take risks with the government's money. The above model doesn’t take the unique tax structure in the US into account. The long-term capital gains tax rate is significantly lower than the income tax rate, which means that the startup option has a higher expected payoff than the FAANG job. ISOs aren’t taxed until you sell your shares. If you hold them for more than a year, you only pay capital gains tax, which is usually half of the income tax rate. Additionally, because ISOs aren’t taxed until you sell them, you let your options compound without being taxed. If you play your cards right, you can get a massive return by working at a startup.
(Credit, Paul Gu).
You might respond, “that may be the case, but startups are risky! Your options could be worthless!” This is true, but, assuming you’ll get enough shots on goal, starting or joining startups are not as risky as you think.
The odds of startup success are better than you might believe
As Applied Divinity Studies noted, if you can get into a top tier accelerator program as a founder, your odds of becoming a billionaire are 1 in 40, low, but high enough that the expected value of attending a top tier accelerator program is $25 million. This is by no means a lottery ticket, these are very robust odds. In fact, it’s more than double the expected value of getting a Harvard MBA!
Employees can get rich, too. For example, 1,000 Coinbase employees became millionaires when Coinbase went public (just from Coinbase equity, not to mention their crypto holdings…).
Your chances get even better if you factor in shots on goal. If you had a bet with 50% chance of winning $100k, and a 50% chance of losing $50k, would you take the bet? Most people wouldn’t due to prospect theory, but it is still a great deal (your expected value is $25,000). But what if you could play that 100 times? Your probability of profit goes up to 99.9%! If you get enough bets, and you take enough smart shots on goal, you’ll eventually be successful.
In this way, volatility and optionality is your friend, not your enemy. Standard portfolios seek to limit volatility, but volatility means you can get very large returns. Startups do have more downside risk (they can fail!) but if you are resilient, and you take enough smart shots on goal, you will eventually be successful. Volatility can bring downside, but it can also bring massive upside, as long as you get enough attempts.
Another part of the consulting/finance/MBA trap is the trope that you’ll learn skills and gain brand recognition that’ll transfer over to startups. Sure you learn valuable skills at a firm like Bain or McKinsey, but the opportunity cost is high if you do them for anything more than a couple years. If your goal is to start or join startups, you won’t learn as much as you would working at startups, nor will those brands matter as much as working at good startup brands. Indeed, the consulting/finance/MBA brands have diminishing returns after doing just one of them. Once you’ve done one of them, you’ve proven you can play that game. In fact, they have diminishing returns even after getting accepted, which is why Naval recommends getting in and dropping out.
There is also such a thing as acquiring too much optionality for it to be useful. There is no point in building optionality to simultaneously be, say, a doctor, a lawyer, and a financial advisor, because there are barely any combinations amongst the three that creates a reducible set of skills that you can actually go after. Which is why it makes sense to take bigger swings in your career, especially early. Because that’s what gives you the skills and knowledge to realize what you’re good at and what you want to do.
If you’re going to pursue optionality, pursue the right kind of optionality. The kind with asymmetric upside, and limited downside. The kind that will get you skills, a network, and a reputation. And the kind that shows you what you might want to do, rather than confirms what you don’t want to do.
In summary, starting or joining startups isn’t nearly as risky as you think. Instead of accumulating optionality by getting more prestigious line items on your resume, accumulate optionality through the skills you gain, the knowledge you acquire, and the unique experiences you undergo. This helps you avoid competitive pressure. The more competition there is in a market, the closer that market is to perfect competition, and all of the profits get competed away, since it’s hard to make money doing what everyone else is doing.
Instead of pursuing options that cap downside while also capping upside, make bets that have asymmetric pay-offs: If you win, you win big. If not, you’ve gained valuable skills, relationships, and reputational benefits that will carry you over to your next asymmetric bet. As Peter Thiel says, “you are not a lottery ticket”. Act accordingly.
Thanks to Molly Mielke, Will Jarvis, and Paul Gu
The optionality trap is not talked about often enough! Thank you for articulating something I felt from the first day I walked through the doors at Bain so eloquently (and validating my decision to take a risk before my fixed expense base got too high)
This is a fantastic post, thank you. Considering there are 1,000 unicorns in the world though, the odds of success are far tinier than I think you imply. Another thing worth considering is compound interest and savings - if someone works at a highly paid tech job they can put money aside early in their career, which will have a much larger return than if they only invest later in their lives. If someone’s objective is to become financially independent, it may be rational to hedge bets early in their career, and only pursue riskier options later on.