Expenses are like spending equity

http://david.weebly.com/1/post/2011/02/expenses-are-like-spending-equity.html

by drusenko • 15 years ago

50 21 15 years ago

david.weebly.com

drusenko3• 15 years ago

I need to give credit to my co-founder Dan for coming up with this analogy. I think it's especially potent because while entrepreneurs can lose touch with the value of money (eventually, it all just becomes "numbers"), equity always seems to stay near and dear to an entrepreneur's heart.

dannyv• 15 years ago

Hah, thanks. I think I mentioned this years ago.

I believe the analogy is most appropriate when a company hasn't yet discovered a solid, profitable business model. When you're in the early, exploratory days of your business, spending cash on non-critical items is literally like spending equity because non-critical purchases (especially extravagant ones) cut down your runway and do not raise the valuation.

rdl2• 15 years ago

The thing this needs to take into account is the time value of money and of risk in a startup.

$10k/mo for the next 5 years is a lot less painful for a seed stage startup than $200k up-front, if you're going to be increasing in valuation as fast as a successful venture-funded startup.

Reducing risk also needs to be part of the psychological model; sometimes it is worth spending 5% to get to a milestone with less risk, because owning 10% of a $50mm exit is a lot more valuable than 15% of $10mm.

The biggest trick I've found with startups is to just delay and defer anything not on the path; it's a lot easier to say "we'll buy a nicer couch later" vs. "no, a nice couch isn't a reasonable thing to spend money on". The other thing is to find people with a much better time value of money than you, and use their money to pay for things -- landlords doing upgrades for you (cash upfront) in exchange for higher rent, deferring getting an office entirely, etc. Basically, converting potential capex into opex.

drusenko3• 15 years ago

Absolutely. I'm certainly not trying to advocate being a penny-pincher. Growing a company requires spending money, intelligently.

This is just a quick brain hack that helps us place value on what seems like a small expense once it all becomes "numbers".

neworbit3• 15 years ago

A decent rule of thumb is usually "would you spend it if it was your own money" - most people aren't going to go buy $20,000 couches for the office, but they might buy an $800 couch or a $150 Craigslist special. Feel free to ignore this if you are Larry Ellison :)

rdl2• 15 years ago

Actually, there have been a lot of times where I'd spend more of my own money (and have) than I would startup money -- e.g. I'll bring in my personal game systems but wouldn't pay for them with company money, let people use my personal car, etc. That's a rational decision for a founder, especially since behaving that way might encourage others to be cost-conscious (you wouldn't expect employees to do the same thing, but they might be willing to try a software load balancer instead of a $50k F5 if you have the right culture, or at the very least to get the best pricing and terms possible from vendors)

neworbit3• 15 years ago

as one of my good buddies said "Who buys a $20,000 couch? Do you know how many servers you could get for that price?"

MrFlibble• 15 years ago

Exactly. Break it down into something useful & tangible.

This is the startup equivalent of reminding a 2 pack a day smoker that their habit could pay 1/3 of their rent or buy dinner for a month.

pge2• 15 years ago

I've always looked at this a little differently - There are only two sources of cash for a startup, customers and investors. Every dollar you spend has to come from one or the other. The more of your dollars that come from customers, the less of your company you have to sell off to investors. So, use the hard won dollars from your customers wisely, so you can minimize how much you have to take from investors (zero in the best case).

JacobIrwin2• 15 years ago

Don't retained earnings become a part of owner's equity after dividends?

To me, a buck is a buck. Spend it all "wisely."

pge2• 15 years ago

yes and no - different bucks have different costs. Every dollar you spend is an investment, so you should be asking what return you're going to get for it. For example, if I add another developer, how much value will be created by the extra expense? If I buy a new sofa, how much value? So, on the one hand, I agree with you that every dollar should be invested for maximum return, and it doesnt matter where it came from, but on the other hand, there are decisions to be made about going out and getting more capital above and beyond your retained earnings (i.e. debt or equity financing). That money comes at a much higher price, so the return on it has to justify the cost.

To put it in terms of an individual rather than a company, the decision to take out a mortgage to buy a house is connected but somewhat different than the decision of where to spend or invest your salary dollars. The mortgage is a loan that comes at a cost (the annual interest), yet it enables you to do something (buy a house)that you could not have done out of your earnings. So, many people choose that the return on owning a home (whether financial or otherwise) justifies the decision to seek out a source of capital beyond their earnings, even though that capital comes at a cost.

diego• 15 years ago

At the risk of sounding obvious, you have different sources of energy to spend: your own time/effort, cash, equity. Figuring out when to use which is the trick. You can't optimize everything, so you have to think about it and give it your best guess.

amalcon• 15 years ago

I like it. Sort of the business version of "Just because I have money doesn't mean I need to spend it."

far33d• 15 years ago

When you put it that way, a $20k couch costs you the same amount of equity as you would give a senior engineer in a post-series-A company.

corin_• 15 years ago

I wasn't the one to downvote you, but: that's not really comparable. You could say that a $1k computer in a company valued at $5m is the same as FaceBook spending $10m at their valuation... but it makes absolutely no difference.

j_baker• 15 years ago

If I had a startup, I'd probably rather have the senior engineer than the couch.

onan_barbarian• 15 years ago

Who buys a $20K couch at a startup?

Besides, this analogy is pointless. Saying a $20K couch - or a $20K breakroom/kitchen refit (more realistic) is 'equivalent' to 0.2% is meaningless. If you just turned profitable then you can afford it and you have to decide if the $20K is worth spending (vs. saving, or handing out as cash to the employees, or buying something else). If not, you have to decide whether $20K is worth shortening your run-way by however many days/weeks it will shorten your runway.

Knowing that it was 0.2% of a historical figure (amount of money you raised) doesn't tell you anything. If you've made $10M of revenue since, you'd look at a $20K expenditure quite differently than if you've made $0.

This might all make more sense if you're building a company to make noise on Hacker News for a while, then exit (perhaps a 'talent acquisition'), without any real plans to make revenue in the meantime.

drusenko3• 15 years ago

> Who buys a $20K couch at a startup?

Apparently, some people do. But it's more of a symbol for frivolous expenses than anything else.

This thought was meant for the "we just raised money" phase of a startup. It's certainly very applicable to the money you just raised, since by definition it was a trade of equity-for-money.

It's not just about being able to "afford it" (which is obviously better than not being able to afford it). Even if you are generating a ton of revenue, blowing it all in non-helpful ways is still not justified.

We've built a company that generates very significant revenue, and it remains even more important to have anchors to keep the value of money in perspective.

JacobIrwin2• 15 years ago

I agree with the article. But mostly with what is mentioned at the end. "Many times over."

If you look at your expenses like capital investments and you employ a good strategy of weighing alternatives against alternatives then that .1% may dilute to .001% with a future higher valuation.

The investors money is in place to cover the expenses that allow you to build the startup company's infrastructure. Try not to look at it so painstakingly.

ahrens• 15 years ago

A dollar saved is always easier to come by than a dollar earned. Very many companies start to spend their hard earned money foolishely once they become big or get funded. You should always treat the companys money as your own, or you shouldn't be allowed to make monetary decisions.

I always look to IKEAs founder Ingvar Kamprad for inspiration in these matters. He still buys schampoo in discount stores even though he is one of the richest people in the world (he doesn't show up in a lot of lists since his wealth is in funds and not in his name).

Expenses are like spending equity

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