The No Free Money Theorem and Entrepreneurship

There’s something of a folk theorem in economics that goes as follows: if you discover a $100 bill on the sidewalk, ignore it, because if it was real someone would have already picked it up. Formally, it’s really a reformulation of the Efficient Market Hypothesis, but when expressed in this form I like to think of it as the No Free Money theorem.

This clashes with a lot of people’s intuition (and lived experience – I’ve actually found a $100 bill on the sidewalk once, though I suppose it’s not impossible I’m just 1-in-a-billion lucky…), especially when applied to startups. The translation would be something like “Never build a startup, because if your idea could create value someone already would have done so.”

At the very least, this formulation of the No Free Money theorem is patently untrue. Startups are created – and succeed at producing tremendous value – far too often to be dismissed as lucky people succeeding at a bad bet. The expected value of a startup (at least one which meets a certain minimum bar of viability which can be checked in minutes) is definitely more than $0.

Why is this, though? Why don’t more people become entrepreneurs until all the good ideas are taken instantly? The answer basically comes down to the fact that the No Free Money theorem only holds if you’re a member of a vast population of people with similar exposure to the potential value (i.e. if thousands of people regularly traverse that sidewalk.) If you’re only one of a few people who actually could grab the $100 bill, unsurprisingly the odds go up.

Now, I could try to argue down the population of potential entrepreneurs by saying “they need skillset XYZ,” but that would be too dismissive – few entrepreneurs begin their work knowing how to run a company, instead having to grow alongside it. So instead, I’d like to break down the process of “picking up the $100 bill.” Because that process actually involves 4 separate steps, each of which whittle down the competitive population significantly enough that, when you get to the end, it’s not so surprising that you’re the first to get there.

Step 1: See the money

The first step is to recognize that the money is there. In the case of a hundred dollar bill, perhaps it’s simply outside your peripheral vision. For startups, this is of course also true – people have different focuses. If I spent all my time thinking about, say, the gaming industry, nobody would expect me to be the one to realize “hey, there’s a more efficient way to manufacture sinks!” There’s still plenty of people who could, but in this one step we’ve already gone from a few billion people to likely a few million at most.

Step 2: Believe the money

This might feel like a stupid step to call out, but it’s actually crucial. When you see value, you have to believe it’s not merely a figment of your imagination. Take, for instance, airport security lines. Every single time I’m in the airport, I see people filling up a single line while leaving the line next to them almost completely empty. Now, this is not due to a failure to see the emptier line – you can hear everyone grumbling about the difference. What’s happening is that the people in the long line are assuming that, if they were actually allowed to go to the other line, someone would have told them, or someone would have at least already moved. But since nobody has explicitly confirmed that it is 100% ok to change lines, people default towards the status quo. This cognitive failure also applies when thinking about startups – ideas which might work, but which won’t certainly work, are often dismissed by those who think of the idea.

By the way, it’s this step that really highlights why it’s ok to have some investors tell you your idea is bad. Remember, seeing the money is the first step, but investors’ whole jobs are to see as many things that might be money as possible. Meaning they’ve likely seen something like your idea before, so if it was easy to believe in, they would have already funded it. So don’t be discouraged if you have to do a bit of convincing before they believe you can pull it off! (Though – and this diverges into a different topic, so I’ll be brief – be careful to only spend this time with investors who are trying to believe.)

Step 3: Have access to the money

OK, so we’ve maybe gone from a few billion people to maybe ten thousand people at most who both see and believe in the money being there. The next step is to have access. That money on the sidewalk does you no good if you’re stuck in a classroom and are merely staring at it out the window. Similarly, even if you believe that a startup idea could be successful, that doesn’t mean you have the opportunity to capitalize on it. Building a startup requires connections, it requires backing, it requires knowledge of the industry, and it requires you to be able to put your whole soul into the business – all of which rule out people with other obligations, with lower capacity for risk-taking, or with less privilege than you. (It’s worth noting that societally, if we want maximum innovation – or, perhaps more powerfully, equal opportunity when it comes to innovation – then these limitations are bad things. Personally, I’d vastly prefer to live in the alternate world where more people had the opportunity to be entrepreneurs, even if it meant more competition for me. And indeed, some people would even argue that those who have this capacity have a moral obligation to pursue the idea, because the creation of the startup would benefit society, and it’s not fair for them to decline when there are others who don’t even get the chance to try – which is yet another topic that deserves a whole separate post of its own. But ultimately, none of this changes the fact that, in the current world, there are far fewer people who have the freedom to execute than those who see the potential.)

As an interesting aside, in something like the stock market, all these forces we’re discussing are counterbalanced by equal opportunities to identify, and bet against, negative value (losses) as well as positive value. But this isn’t true for startups – while there’s a decently large population of people who have access to tap into startup value (i.e. investors, founders), there’s basically no population who have the option to short-sell private stock. This results in startups, generally speaking, always being overvalued when they’re far from going public – because so long as you find one person who believes the value is X, none of the people who disagree actually have a lever to bring the valuation back down. This should be taken as one of the many reasons not to put too much focus on startup valuations, especially those determined through rounds of funding.

Step 4: Execute on taking the money

OK, so we’re down to maybe a few hundred people who have the capacity, awareness, and belief to go after the money. Now they need to execute. They need to get the money first – which importantly is different from going for it first! Being first to an idea can help (say, you get all the investors who are hyped about it, and now your competitors have a harder time raising money), but ultimately the only thing that matters is who actually picks up the money off the street. This is (finally) where operating skill comes in to play – even if you have access to the key partners you need to charm, you still actually have to go out and do it! Not to mention that even if you see the money, believe in it, and have it within your reach, most people still won’t actually go pick up the money because their mental assessment of the cost of executing is greater than the value of the money. This is sometimes true – building startups is costly work! – but our brains also often massively overweight the costs of any work to execute on an idea simply due to inertia.

As an example of this inertial force, I sometimes make notes of stocks I expect to shoot up within a given time frame, and have thus far been right about 80% of the time (though this is largely due to the fact that I register no bets on anything unless I deeply know the industry, and never record my “I’m sure it won’t do anything” guesses which are surely often wrong.) Yet it still took me until earlier this year – about five years after I first started doing this! – to finally set myself up on a simple stock-picking tool. And that was largely driven by my annoyance with the hypocrisy of being proactive as a startup founder, yet having failed to muster the willpower to do this in my personal life. There’s lots of ways I can ultimately rationalize this kind of behavior, but the point I really wanted to make was simply that it’s easy for people to not go do something.

So, what percentile would you rank successful entrepreneurs on the scale of ability-to-go-execute? If you’d rank them as the top 5%, then we’re talking about 10 or so people in the world who might have actually been in competition for that $100 bill on the sidewalk.

Are you really willing to say that there’s no way you could get there first?

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