Category Archives: Business

The Myth of “SaaS”

The Founder’s Schedule

There has been a lot written about how to effectively manage your time as a leader when building a new company. Paul Graham has a famous essay where he divides the needs of the engineer from the needs of the manager through the Maker’s Schedule and Manager’s Schedule. More recently, Danielle Morrill of Mattermark wrote about the transition from the Maker’s Schedule to the Manager’s Schedule as her company grows.

I have found significantly less written about how to effectively manage your time in the very early days of founding a company. In those early days, you cannot have a Maker’s Schedule since you cannot be sure exactly what you should make. However, you cannot have a Manager’s Schedule since you have to work on making something or else you will never get started. Then, what is the ideal Founder’s Schedule?

For me, the ideal Founder’s Schedule makes time for both making and meeting, since one without the other means you are not effectively narrowing in on your business. At the same time, it needs to make sure that you don’t constantly switch from one to another as you would then run the risk of context switching cost slashing all of your productivity.

Now that I’m a founder again myself, I have settled on the following schedule which I think is a great template for a Founder’s Schedule:

While it seems like all of your time is blocked off, in reality it leaves a lot of flexibility on how you spend your time. All of your time is divided up by purpose:

Make: This is time when you are making. This does not mean always coding or building, it might mean writing, brainstorming or designing.
Meet: This is time when you meet with people who might help you. That includes potential customers, investors, advisors and friends.
Plan: This is when you plan what you’ll do tomorrow. Productivity studies show that you are more productive if you decide what you are going to do the night before, so we set that time aside at night. Likewise, we leave an hour or two on Friday to decide on the tasks for the following week.
Research: This is time when you work on crazy ideas. While it might seem like a waste of time, it is important to think outside of the box and make sure you don’t get into ruts of ideas. The easiest way to break out of that is working on something that sounds crazy.
Off: This is time when you aren’t working. You NEED this time to avoid burnout and keep the creative juices going. I guarantee you that you will be more productive all week if you take weekends to enjoy yourself. Bonus points if you exercise.

These purposes are then divided throughout the day to make the most of them.

Make in the morning. Studies have shown that your most productive hours are in the morning (usually from 10am-noon), and so these are the hours when you should focus on the hardest mental tasks of making. Ideally, you would not even check your email until this time is over, lest you find yourself wasting this precious time on communications. (See Going the Distance).
Meet in the afternoon. Lunch is an inherently social experience in our culture and you should take advantage of it, and the time after it, to meet and gather feedback. This will help you overcome the afternoon lull that would hit you sitting (or standing) at your desk trying to make.
Make in the evening. Everyone gets a second wind, and it’s a great time to get more things done. Hopefully, you were inspired by some of your meetings or were able to figure out a problem from the morning by stepping away and now you can make the most of that creative boost.

I know there will be many people who decry this as a bad schedule, since it does not fit the typical model of how founders should spend their time. When you imagine a founder building a new company, you likely envision them in a dark room all day working in front of a computer screen, or spending every waking hour on the road interviewing customers. Doing both at once seems, at first, like it is the worst of both worlds.

However, I can tell you from experience that it has made me more productive. I no longer spend time making things that customers do not want since I have reality checks everyday. At the same time, I never spend time waiting to work on a idea since that time is reserved everyday.

If you are a new founder working to get your company get started, I hope you give this a try. If you do, let me know how it goes. But only in the afternoon, in the morning I’ll be making.

Unbroken Markets

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Many startup pitches start off with the simple claim that something is broken. “Email is broken.” “Messaging is broken.” “Advertising is broken.” If you hear too many pitches, you might start wondering how anything at all gets done since everything around us is so broken.

It’s a common refrain which you expect from aggressive founders who are eager to change the world. When your vision of the future is powerful and truly innovative, the current state of the world can seem very broken in comparison. However, such powerful vision and dismissal of the status quo overlooks the fact that the status quo exists for a reason.

If something is broken, why are people using it everday?

Activation Energy

In chemistry, changes come through chemical reactions. Reactions don’t just happen on their own, they require some minimum amount of energy to get started. That energy is known as the activation energy of the reaction.

Innovations are similar to chemical reactions. Where chemical reactions transform materials, innovations transform markets. What, then, is the activation energy of innovation? In business, activation energy takes the form of the amount of effort you need to displace existing tools and services with new innovations. That effort is a combination of how radical the innovation is and how much you need to invest to get that innovation adopted in your market.

Depending on the characteristics of a market the activation energy required for innovation can differ greatly. For example, a highly mature and slow moving market with large, entrenched competition such as the taxi industry requires a massive innovation and investment in the form of Uber/Lyft. A young but fast moving market like online messaging requires less innovation and investment in the form of WhatsApp/Snapchat to transform the market.

Your activation energy is not only overcoming the existing market competitors, but the ingrained habits of your customers. Customers who have a regular habit of using a product, even if that product is bad, will resist changing out of sheer momentum. In these cases you need even more activation energy to transform the market.

Unbroken Markets

So, how does chemistry help you start a company? By helping us make good assumptions.

It is dangerous to assume that the activation energy for your market is low, but that is exactly what you are doing when you assert it is “broken.” Instead, assume your market is stable and healthy, so that your innovation needs to be radical to succeed. Also assume that the effort to bring that innovation to market will be significant as well, so you will plan accordingly. Any other assumption will allow you to become complacent.

Your market may, in fact, be broken. Assuming otherwise will ensure that you do not underestimate your challenges.

Image By Jef Poskanzer (originally posted to Flickr as smash) [CC-BY-2.0 (http://creativecommons.org/licenses/by/2.0)%5D, via Wikimedia Commons

Why You Don’t Want to Be Acquired

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All founders dream of building everlasting public companies that will live on long after they are gone. However, after a few years of struggling and working for free the idea of being acquired for a nice payday can seem very attractive. In fact, if you read TechCrunch too much, you might believe that an easy way to get rich is to start a company and sell it for $100M in two years.

While getting acquired is a great exit for any company, planning for it is a very bad idea. Even worse, starting a company with the goal of being acquired will set you up for failure before you even begin. To understand why, let’s think about how potential acquiring companies look at acquisition targets.

Goals for Acquisitions

Large companies acquire smaller companies to gain assets they don’t have access to any cheaper way. Acquisitions, even small ones, are expensive ways to gain assets so acquirers are highly motivated by what is necessary to improve their own business.

While you might think about your company as a living, growing organism with many dimensions and nuances, acquiring companies will look at it like a butcher looks at a cow. Your company is made up of one or more assets and those are what they consider acquiring. Those assets may include:

People. All of the employees, including the founders, and the expertise they have developed working at your company. If everyone works together extremely well, that teamwork chemistry can also be considered an asset by acquirers looking for productive teams.
Product. The product(s) you have built, whether or not they have been released to customers yet or not.
Technology. Any unique algorithms, mathematical models or processes you have developed even if they aren’t patented.
Customers. Everyone using your products, whether or not they are paying you for them or not. In some cases, you may only have one customer but that customer is a very large customer who pays you a lot of money over a long term.
Profit. If your business is profitable, that positive cash flow is a huge asset since it produces a return for whoever owns the business. The same can be true of having a lot of liquid assets as the result of being profitable.

Not all of the assets are created equal. Below is an illustrative example of the comparative values of assets based on the acquisitions I have been involved with (both as the acquirer and the acquired companies).

Example of how corporate assets compare in terms of value to acquirer. Technology is 10 times more valuable than people or products, while customers are 100 times more valuable. Profit can be infinitely more valuable, depending on how much of it you have. Note that these are just illustrative.

Why are assets valued so differently? For the simple reason that the value of your assets are entirely dependent on how they apply to the acquirer’s business. For example, the value an acquirer assigns to your technology is not the value they would get from selling it themselves on the open market, but how much value it will add to their business. It is not enough that your technology is new and ground breaking, it needs to help the acquiring company make money.

It’s not a coincidence that the assets that have the highest value are developed later in the life of a company (customers, profit, etc.). Those assets are the hardest to build and therefor will carry the most value. That is one of the many reasons that companies become more valuable the longer they exist and why it’s so rare to see a big acquisition of a young company.

The Exception Proves the Rule

It is almost impossible to make generalizations about acquisitions because each acquisition depends so much on the companies involved. One acquirer may value your company at $5M while another values it at $20M, because the second company believes they can use your assets to increase their own profits by $40M. So, remember that the previous example is only illustrative.

But that is exactly the reason you should never focus on being acquired! You have no way to control how potential acquirers will value the assets you are creating. Successful acquisitions require the right acquirer to value your company at the right price, at a point where you would consider selling. That combination of factors is rare and definitely not something you can plan.

So what does that mean? The best strategy, in fact your only strategy, is to focus on building a successful and highly profitable business. As long as you do that, you will control your own destiny and decide if and when you get acquired on terms you decide.

Or, maybe you’ll go public! Then you can buy some companies yourself.

Closing the Loop

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Today, I am currently an advisor/mentor/investor in 10 early stage start up companies, 3 accelerators and 1 venture fund. I pride myself on spending a lot of time with each company and getting as involved as possible, in many cases having projects assigned to me. Regardless, I am regularly shocked by a simple fact:

Only one of these companies sends me a regular update.

I know I shouldn’t be shocked, as the early days of building a company are hectic and busy so updating advisors and investors is never a high priority. There is also a natural fear of bad news, so if things are not going extremely well it is easier to say nothing than admit things are hard.

Unfortunately, the side effect of a lack of updates is that I’m not as engaged as I could be. As a founder you live through a hundred battles everyday, but if I never see them then I can’t understand. For all the time I spend with a company, not knowing about the struggles, the victories and the defeats means that when I do help it is with only a limited perspective. Even worse, I have no idea if the advice that I provided proved useful as I rarely get told the end results of any given decision.

But it’s not the fault of these companies. Almost all entrepreneurs are really bad at closing the loop.

Closing the Loop

One of the fundamental components of continuous improvement is feedback. If you don’t know how you are doing today, you can’t get better tomorrow. Modern engineering processes such as Scrum or Kanban encompass feedback as a core part of the process through the use of retrospectives. This is why the engineering teams at many startups are the best run teams, since they have a clear and well understood process to follow. So what of the rest of the company?

The best way to make sure your company is focused on continuous improvement is to make sure you always close the loop. For every decision that’s made, for every goal that is set you check back on it in the future to see whether it worked. Did that strategic partnership pay off? Did you meet your goal of 10% weekly growth? Make it part of your company culture to always review decisions and goals in the future, and learn from them.

All companies make decisions and set goals, but surprisingly few will review them on a regular basis. Many start up board meetings involve a review of key metrics, but not a review of key decisions and how they worked out. If you don’t review the decisions you made and the results of those decisions, what do the key metrics matter?

It can be scary to review past decisions since many of them will not work out well. However, fear of bad news will slowly paralyze your decision making because it will evolve into fear of failure. If you develop a habit of sharing news, both good and bad, you will feel a weight lifted from your shoulders – the weight of that fear.

Communication as a Core Competency

Making sure your team closes the loop is easy if you’ve set communication as a core competency of your team. If you have done that, then you already have plenty of tools and structures for communicating, you just have to make sure you communicate retrospectively.

Some examples of how you can close the loop:

Regular Updates. Send regular updates to your team, investors and advisors on your progress that review the results of key decisions (Leo has a great template for these kinds of updates that is short and easy). These serve not only to update the team around you but force you to put in writing what has worked and not worked on a regular basis.
OKR Reviews. Many companies use OKRs, but not many have regular public OKR reviews. Such a public review of individual OKRs should not serve as a punishment or a reward, but instead a chance for everyone to learn from what worked and what did not.
Waterfall Financials. When projecting your company’s financials, the only guarantee is that those projections will change (a lot). Keeping track of changes in your projections will help you understand the flaws in your forecasting models and waterfall financial reporting is a great way to do that.

The best way to make sure you are closing the loop is to make it part of your corporate culture. Any decision that gets made comes with a report on how it faired later. Remember, the goal of closing the loop is not to punish failure but to learn from your mistakes.

We all make plenty of mistakes, why not turn them into assets?

Image made available via Creative Commons by Coasterman1234.

The Snowball Effect

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I spend a lot of my time advising and mentoring entrepreneurs, including coaching at three awesome accelerators. Since almost all the companies I work with are at the pre-Seed stage (translation: very very early), I end up hearing the same questions quite a lot. They are, in order of frequency:

How do I convince my co-founder to quit their job and join full time?
How do I close my first customer?
How do I raise my first seed financing?

These are very fundamental questions for building your business, so it’s no surprise they come up so often. The good news is that the first step towards answering any of them is exactly the same: build up your snowball effect.

The Fear of Being First

If you turn around each of those questions, you realize that the person on the other end represents a first for your company. You are trying to convince the first employee, the first customer or the first investor to believe in you. Being first, while exciting, brings with it the most risk since you clearly have not proven your business if they are the first. Most people have a very justifiable fear of being first which makes it hard to convince them to take that first step.

However, you need to have a first because if you don’t then you will never have a second, a third and so on. So how do you overcome that fear?

The Power of Momentum

One of the best ways to overcome the fear of being first is to use an even more powerful force: the fear of missing out. The more momentum you build up for your company and the more progress you make before asking someone to be the first, the more likely that they won’t want to miss the opportunity. You want to make your company move as far as you can as fast as you can to make it an attractive bandwagon for people to jump on.

Having a brilliant idea is not enough. If you have a brilliant idea and nothing else, nothing separates you from the hordes of other dreamers whose dreams will never see reality. An idea has little value itself, you need to turn it into reality or at least as real as you can make it.

So, how do you get that momentum going in the early days? You don’t need to build a finished product (although that works well), there are many ways to build momentum without a product:

Invest In Yourself. You should be investing in your own company, using your own money. The more you invest, the more you will show commitment to your vision and building your business. You cannot ask others to invest or believe in you if you cannot demonstrate that you believe in yourself. It only costs a few hundred dollars to form a legal corporation – how much more than that do you believe in yourself?
Prove Demand. One of the most important things you can do in the early days of your company is prove that your idea has customer demand. Building a product can come later, but you can start by talking to prospective customers, industry experts and investors about a product and how much demand exists. The more you can quantify and prove there is demand, the more likely you are to convince others that your idea has value. Along the way, you’ve also lined up a list of prospective customers that make your company seem a little less risky for employees and investors.
Sell Your Friends. There is no rule that says your first customer(s) need to be strangers that you cold call. In fact, almost all successful companies start out by selling to friendly customers whom they knew well before they got started. YCombinator, one of the best accelerators, goes to great lengths to get their companies to become customers of each other to overcome the first customer problem. This strategy won’t scale, but it will get you started.
Spread Your Message. While your idea might not have value, communicating about the problem you are solving and building a voice in the community does. Set up a blog, join Twitter and start a mailing list to talk about the industry, market or problem. The more you participate in the discussion the more you can start to build your company’s brand even before you get started.

Most of all, be creative. I know non-technical founders that hired people to stand in front of conferences wearing sandwich boards to raise awareness of their company which had no product. I’ve seen founders hire armies of people on oDesk to gather hard to find data on the web to create valuable industry blogs. Even Mattermark, a great market data start up, got started from a blog post.

Accelerators are in the business of helping you build this momentum, at the cost of a small amount of equity. Many accelerators require that you have a working prototype, but if you do have a prototype they can give you a big boost of momentum and help you get past a lot of these early hurdles.

The Snowball Effect

So, what is the snowball effect? The great thing about building up your momentum is that it becomes a virtuous cycle if you can maintain it. You are more likely to raise your first investment if you can close your first employee, which in turn makes it more likely to close that first customer. Then it becomes easier to hire that second employee, close the second customer and so on. Eventually, making progress on all fronts makes it easier to make more progress on all fronts.

That is the snowball effect. Just like a snowball rolling down a hill, the more momentum you have the larger you can get and the more momentum you will get.

All you need to do is start the ball rolling.

Image made available via Creative Commons by redjar.

The Profitability Challenge

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Here’s a fun weekend experiment for you, something I call the $20 Weekend Challenge: Take a $20 bill out of your wallet on Friday. You task for the weekend is to turn that $20 into $40 by Monday, doubling your money. You are welcome to use any legal means at your disposal, but heading into a casino or buying lottery tickets doesn’t count. You have to turn that $20 into $40 without gambling. It sounds hard, but it is worth it, I promise.

So, what does this have to do with building a business?

Cash and Business

A common refrain in business is that “cash is king”. Most people say that to mean your company does not exist if you don’t have enough cash to pay your bills, but it is also true that your business is designed to take in some cash and output more cash. You are trying to build something impossible in the world of physics: something that produces more than it consumes.

This is much harder than it sounds, as you likely know if you tried the $20 Weekend Challenge. If you are accustomed to working for a salary, you are used to exchanging your time for money which is very different from building a business. Having a job requires little thought on your part since your salary is (usually) guaranteed and your time has flexible value. Building a business, however, requires a lot of thought.

Let’s do a simple thought experiment to prove that point. Your typical employee at a high tech start up company costs between $100,000 and $150,000 depending on your location so let us assume $125,000. No, that’s not all salary, it includes benefits, payroll taxes, accounting costs, etc. (as a business, the salary can be only half the cost of an employee).

Depending on your business model, let’s see how many customers you would need to pay for that employee.

Business Model: Advertising

In advertising you are paid per every 1,000 ad impressions you show (CPM). CPMs vary wildly so let’s assume you make a $2 CPM (which is not bad). Assuming that 20% of your users are active on any given day and those active users generate 2 ad impressions, you would need 286,200 active users every day to support the cost of one employee.

Business Model: Subscription

In a subscription model, you make money through the monthly fee you can charge active customers. Let’s assume, your product costs $50/month to maintain a subscription. That means you need 210 paying customers every month to support the cost of one employee.

Business Model: Selling Products

When you are selling products, you get a one-time fee for the cost of the product. Let’s assume you sell your product for $100 and it costs you $90 to make it, leaving $10 in net profit per sale. You would need to sell 240 units every week to support the cost of one employee.

And remember, all of that only covers one employee.

The $20 Weekend Challenge

When thinking in these terms, I hope the value of the $20 Weekend Challenge becomes clear. In order to pay for a single employee, you have to have a lot of customers. To pay for your entire team, you need a large number of customers. To pay for your team, your offices, your lawyers and eventually make a profit? You need to have all the customers.

You need to take your money and almost double it to simply pay your bills.

Building a profitable business is hard because the cost structure that goes along with companies is high. Some companies claim they are profitable when they achieve Ramen Profitability, but that is really a false milestone. If you can’t afford to pay yourself a living wage, you are not really profitable.

If this makes starting a business intimidating, good. It should be intimidating. It should seem almost impossible. However, I bet when you first started thinking about the $20 Weekend Challenge it seemed pretty hard too. The only way to see if you can do it is to give it a try.

Financing: A Tale of Three Companies

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Image licensed under creative commons by Fornax, 2010.

If you want to start a company you might wonder where you will get the money your new business requires. The good news is that you have many options, as long as your business plan is sound and the market opportunity is big.

But, before we get to that, don’t confuse the money your business requires with the money you require to maintain your lifestyle – investors will not invest in you so you can pay your mortgage or make your car payments. Investors invest in your company to get a return so if you want to raise some capital you need to present them with a good investment opportunity that is likely to provide a return. It’s up to you to figure out how to cover your lifestyle expenses until you can pay yourself a decent salary, either through your savings or secondary income.

Assuming you have your personal expenses covered, a good business plan and your investment has a potential of return, there are many ways to raise capital for a business and we will cover three of them here. For these examples, let’s assume that you think that the market for umbrellas is going to expand quickly over the next few years due to global warming. Here, then, are the tales of three businesses started to take advantage of the upcoming umbrella explosion and how they might finance themselves:

1. Cash Flow Financing: The Umbrella Store

You decide to start an umbrella store, where people can choose from dozens of different models of umbrellas (either a physical store or online or both). The start up costs only include purchasing some initial inventory and setting up your store, but you are confident that sales can cover that cost. If you do well you might open up other stores, but you will wait for the market to demonstrate demand.

The best option is to finance the company yourself via cash generated from sales at your store. You will put up the initial money from your savings and the more umbrellas you sell, the more you will buy to increase your inventory. It might take a while but you think you can build up a healthy store that can support you and potentially a few employees.

Quick summary of your umbrella store:
Start up costs: $10,000
Estimated Annual Revenue: $150,000
Investors: You

In general, cash flow financing is a good idea if:

Your business will start generating revenue on day one.
Your start up costs are low.
You want to maintain complete control of your business.
You are not sure what form your business will take.

Cash flow financing is a bad idea if:

You can’t afford to provide the initial capital for the company yourself.
Your business needs to grow quickly to take advantage of a market opportunity.

Examples of the kinds of businesses funded via cash flows are consulting businesses, services businesses and small stores.

2. Crowd-sourced Financing: Umbrella 2.0

You design a new kind of umbrella, something the world has never seen before but is definitely better than all of the other umbrellas on the market. The cost of manufacturing the first batch will be significant because of the cost of setting up manufacturing, but after that you can easily grow the business based on sales revenue.

The best option is to crowd-fund your company by raising a little money from a large number of people. Using platforms like Kickstarter or AngelList, you can quickly find a large number of people who believe in your vision for a new umbrella and are willing to back you. In some cases, like with Kickstarter, you are pre-selling the product while in other cases, like with AngelList, you are giving them a small ownership in your company. If your start up costs are not very large, you can just raise funding from just your friends and family without needing to recruit investors that you don’t know.

Quick summary of your new umbrella product business:
Start up costs: $100,000
Estimated Annual Revenue: $1,500,000
Investors: Friends, family and/or strangers on crowd funding platforms

In general, crowd funding is a good idea if:

You require a large amount of startup cash but will be cash flow positive afterwards.
Your product will appeal to a wide range of people.
Your business will grow slowly.

Crowd funding is a bad idea if:

The amount of start up cash you need is very small or very, very large.
Your product is complex and will take many years to create.
Your business needs to grow very fast to take advantage of a market opportunity.

Examples of the kinds of businesses funded via crowd funding are new consumer products and non-profits (charities).

3. Venture Capital Financing: Build Your Own Umbrella

You want to build an online marketplace for people to design their own umbrellas and then have manufacturers build them on their behalf. The potential of the business is huge, but it will take a few years to grow the marketplace to break even and you don’t have a large window of opportunity so you need to move fast.

The best option is to raise venture financing. Venture capitalists and angel investors invest large amounts of money in high-growth companies with the expectation of a 10x return in under 10 years. The risk is high since your company needs to be extremely successful, but the reward is very high as well.

Quick summary of your umbrella marketplace business:
Start up costs: $1,000,000
Estimated Annual Revenue: $150,000,000
Investors: Venture capitalists and Angel investors

In general, venture capital financing is a good idea if:

You require a large amount of time and cash to build your business.
You expect your business to grow very fast (double every 3 months).
You need to spend ahead of revenue to fund your growth.
Your market opportunity is vast.

Venture capital financing is a bad idea if:

Your business will grow slowly.
Your market is small.
Your capital needs are small.

Examples of the kinds of businesses funded via venture capital are software-as-a-service companies, new drug manufacturers and new chip design companies.

So, what’s your best option?

Hopefully it is clear at this point that the best option for your business depends a lot on what your business is, how fast it will grow and how big it might become. Choosing the right option can be critical to your success or instrumental in your failure. Trying to fund a high-growth company on cash flows can starve your business since you will move too slowly and miss the market opportunity, but raising venture capital for a slow growth company can lead to unhappy investors and poor results for founders.

In many cases companies will combine strategies for the best outcome. For example, you might crowd fund your company to get started only to later raise venture capital financing when you start growing quickly. Or, you might grow using cash flow until you have a big opportunity for expansion and use crowd funding to take advantage of that opportunity.

There are, of course, other options than those listed here, including bank loans, and depending on where you are based those options may be most accessible. Network within your local community to understand the most common options.

Think about your business and what makes the most sense for financing options. But remember that investors are investing in your business, not your mortgage, so be sure to show them why their money will result in a big return.

The Entrepreneur’s Creed

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“My product is great. My vision is sound. My team is amazing.”
– The Entrepreneur’s Creed

Reality is a harsh place. Almost everything that is worthwhile doing is very hard and, despite what you might learn in school, there is no credit for hard work. There is very little recognition for your success and plenty of recognition for your failures. To be frank, the world is out to get you.

The good news is that there are no rules. You can do whatever it is you like, pursue whatever goals you desire and set your own definition of success. Other people will try to do this for you but there is nothing forcing you to listen to them. You set your own rules and choose your own path.

Starting a business is a great case study of these two characteristics of life. Anyone can start any kind of business whenever they want, setting whatever goal they desire. Unfortunately, most people who start a business run out of money, fail to acquire customers or simply not be able to get started in the first place. Reality kicks in and shows you that starting is easier than finishing and money does not come as easily as your dreams. Being an entrepreneur is a lonely pursuit because, in many ways, it is you against the world.

When you are starting a business you will inevitably talk to other people, most of whom will tell you that you will not succeed. They are almost always correct because it is very unlikely you will succeed. However, success cannot be impossible or else there would be no companies in business today. So the question is not if you can succeed, but will you succeed or will it be the next person. Everyone will tell you it’s the next person.

The best defense against the harshness of reality is perseverance. Since the world is telling you that you will not succeed, you have to believe in your heart that you will. This is not denial because the belief in your heart is based in facts. You don’t just believe, you know. You have done your homework and designed a great product. You have studied your market and have a clear vision for the future. You have surrounded yourself with a great team that works well together.

Does that guarantee success? Of course not, but it ensures that you play the game as best you can. Even the best baseball players will only get a hit at 1 out of every 3 at bats but they approach the plate every time convinced that they can get a hit. That inner strength, born from perseverance and knowledge, is what gives you a chance to succeed. That chance is the most life will offer, so take it and use it as best you can.

So every morning, with complete conviction, repeat after me:

My product is great. My vision is sound. My team is amazing.

———–

Note: This post was originally on my personal blog.

The Most Important Equation For Your Business

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Business is a very human activity. Despite the existence of high frequency trading, supply chain optimization and manufacturing automation all business boils down to one person selling something to another person. A product is worth what someone else is willing to pay for it, and business is the act of making that transaction happen. So, you would assume that you cannot describe business using mathematics.

But you can, and the formula that does is as follows:

LTV – CAC > 0

This equation describes the viability of your business. LTV (Lifetime Value) is the total amount of money you can expect to make from a customer over the entire period of time they are your customer. CAC (Customer acquisition cost) is how much it costs to acquire the customers that will then make you money. If the lifetime value of your customers is higher than your customer acquisition cost, then you have a profitable business because you make more from customers than it costs you to find them. If not, then it costs more to operate your company than it makes and the business will fail.

This equation maps into every kind of business precisely because all business is the act of one party selling something to another party. Below are some examples of how this equation applies to various types of business:

1. Physical Product

When you build and sell a physical product, both your LTV and CAC have many factors. Your LTV is not just the sale price of the product, as you have to remove the cost of producing the product in the first place. The CAC is a combination of both your marketing spend as well as the sales commissions you pay to either your sales people or the retail stores that sell your product. Hence, your equation looks like the following:

(Sales price - Cost of good) - (Marketing Spend + Sales Commissions) / Units sold > 0

As you can see, you calculate the net profit for the sale of a given item (Sales price – Cost of producing it) and remove the amount of marketing and sales commission that went into that item. In some cases, simply dividing the overall marketing and sales commissions by the unit price is misleading since different distribution channels have different costs. In those cases you would measure the viability of each channel independently and use the actual per item marketing and sales commission numbers.

2. Software as a Service

Most software as a service businesses are based on monthly subscriptions. Here, the LTV is the amount of the monthly subscription (often called the Monthly Recurring Revenue or MRR) times the average number of months a customer is active (paying for your service). The CAC depends a lot on your user acquisition strategy but is typically either sales commission based or performance marketing.

(MRR * Avg Months  Active) - (Marketing + Sales) / Number of customers > 0

The most challenging factor here is estimating the average active months for a customer, especially for new services which might not have a long history of data to use. Because of that difficulty, it is often easier to measure monthly churn rates which are simply the percentage of customers you lose every month. You can then use the MRR and monthly churn to estimate the LTV and use the following equation:

(MRR / Monthly Churn Rate) - (Marketing + Sales) / Number of customers > 0

By dividing the MRR by the monthly churn rate you are calculating retained revenue (the value of customers that stuck around). By subtracting out the cost of marketing and sales you are measuring how much it costs you to retain that revenue. You can see that if your churn rate is high (and hence your average active months per customer is low) then your business is not viable unless your marketing and sales costs are extremely low.

If you measure your MRR in aggregate instead of per customer, you do not need to divide the cost by the number of customers as you are calculating everything in aggregate.

3. Consulting

In consulting, both your revenue and costs are measured in time. Every hour you spend working for a customer is revenue and every hour you spend recruiting new customers is the cost of acquiring those users. Assuming your hourly rate is fairly consistent then you can measure your viability the following way:

Average # hours per contract - Average # hours recruiting contract > 0

The great thing here is that you don’t need to estimate your CAC cost per unit since you are measuring your business in a universal unit of time (instead of money). This works even for large consulting firms who have many employees, assuming a fairly even hourly billing rate. If it is difficult to track the recruiting hours specific to each contract, you can generalize this and just use the total billable hours and the total recruiting hours across all contracts.

Note that this requires you to track your business development time in the same way you track your customer billable time, which I always recommend anyway. It is common for consultants to consider only the time that they bill in determining their cost structure, which is a mistake.

Viability vs Profitability

Most companies have a goal of being profitable, not just being viable. In those cases, the fact that your LTV is greater than your CAC is not as important as how much greater. One rule of thumb for high growth companies is for your LTV to be 3 times your CAC because that gives you room to make mistakes and still be profitable. Keep in mind that the cost of your operations is likely not zero so your ratio needs to cover that cost as well. The best person to judge the right ratio for your business will always be you.

If you don’t already watch this viability equation as one of the key metrics of your business, you should start. It will provide a simple way to understand the fundamentals of your business.

Sean on Startups

Thoughts on startups, products and venture investing in Silicon Valley.

Category Archives: Business

The Myth of “SaaS”

The Founder’s Schedule

Unbroken Markets

Why You Don’t Want to Be Acquired

Closing the Loop

The Snowball Effect

The Profitability Challenge

Financing: A Tale of Three Companies

The Entrepreneur’s Creed

The Most Important Equation For Your Business

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