Revenue is easy, profit is harder

https://www.edge.ceo/p/revenue-is-easy-profit-is-harder

by rwaliany • 3 years ago

301 168 3 years ago

“This forced other disciplined startups to loosen their ad spend to be competitive in the venture-market industry and created an era of capital-inefficient businesses. With time, this will re-adjust back to historical norms and the process will be painful.”

I thought this was a pertinent quote.

You’re going to see many companies deciding to become cash flow positive instead of growing. And if the business is stable, the quickest way to get there is to drastically cut operating costs…

bboygravity• 3 years ago

You’re going to see many companies deciding to become cash flow positive instead of growing. And if the business is stable, the quickest way to get there is to drastically cut operating costs…

Or or do a public stock offering at a relatively high stock price after a short squeeze.

wpietri11• 3 years ago

One of the interesting questions for me is how long this adaptation will take. I think there are a bunch of things that could make it pretty laggy. E.g., the fact that so many execs have spent so many years in an unsustainable capital environment. Or the amount of VC money still sloshing around waiting to be applied. Or the number of VCs who basically built their careers on these kinds of unsustainable businesses. How many will be able to admit that their special genius no longer applies, and was in fact the cause of a lot of problems in the long term?

coffeebeqn3• 3 years ago

Also many companies are probably just praying that one set of layoffs and improving inflation will get them to the next era of easy funding sometime in 2024

robertlagrant2• 3 years ago

As they say, revenue is vanity.

ghiculescu4• 3 years ago

I love payback period, it's a great metric. But it's easy to take it too literally. It's meant to be a tool to help you make prioritization decisions ("what if we do this instead of that"), but people often use it as a management report ("we did this; here's the verdict").

Here's a SaaS example: if it costs you $1000 to acquire a customer that pays you $100/month, the PBP is 10. That doesn't sound amazing. But you have options! If you give the customer a 20% discount to pay annually, they're now paying you ~$1000 upfront, for a PBP of 0. Tweak the numbers slightly and you can get a negative payback period. Suddenly your "capital inefficient" business has a big flywheel without the need for outside capital.

It's easy to think decreasing acquisition costs is what you need to do in the current market (and believe me, that's not a bad idea!), but that's the denominator. There's also a numerator - how much cash you bring in, and how quickly - that matters just as much. It's cash flow that matters, not profit.

ecpottinger• 3 years ago

My dad had great ideas for businesses. Yet each one he started failed for him. Why, because he has such unrealistic view on how long the payback period will be. He even founded with a partner what is now a national company, but at the time it did not make a big profit in the first year, so he sold his share of the business. He had "Get rich Quick" fever, and never saw that bussiness rarely become an overnight success.

birdyrooster• 3 years ago

Interesting to think that the company which he divested from may have made it because of his exit.

rrrrrrrrrrrryan3• 3 years ago

One of my finance professors mentioned that ~70% of business fail in their first two years, and ~90% of those failures are purely due to a lack of working capital, not due to any fundamental flaw in the business plan. If they kept doing the same thing and just had more money and time, things would have eventually worked out.

People start businesses for emotional reasons, not logical ones, and vastly, vastly underestimate the amount of money they'll need to get the thing off the ground. Entrepreneurial people are inherently optimistic, (and they have to be), but he said their estimates were typically off by ~5x. If you think you need a million dollars of runway, you probably need 5 million. If you think it'll take a year to achieve profitability, it'll probably take 5 years.

toss1• 3 years ago

Yup, just about every time I've read of an 'overnight success', it was indeed an a very rapid path to success . . . after a decade or two of slogging it out in the trenches of obscurity.

There are a lot of moving parts, a lot to learn, and timing/luck are also factors. Until they all hit at the same time, it looks like a flop. It takes time to find, learn, or assemble all the key bits.

Sorry your dad's impatience was so persistent. Sense of urgency is important, but impatience is deadly. Thanks for sharing such a clear example.

hgomersall2• 3 years ago

So far, my experience has been that business as a start-up is basically about surviving long enough to make a profit. Of course, some ideas are just bad, but I'm convinced loads of start-ups that failed could have been made to work given sufficient time. This doesn't work so well if you take a pile of capital, but if you go for organic growth it is more plausible to survive hand to mouth for a while.

exelib• 3 years ago

Great example! I think your example exactly points out why PBP of 0 is soo awesome in this case! You can invest $1000 immediately and get another customer in 0 months instead of 10. If they pay upfront again, so you can invest it again and so on.

throwaway292939• 3 years ago

If you give the customer a 20% discount to pay annually, they're now paying you ~$1000 upfront, for a PBP of 0

This sounds like a huge assumption being made here - as in, this is not as easy as it sounds.

ghiculescu4• 3 years ago

What’s the assumption?

We do this all the time so if I’m missing something I’m keen to hear it :)

sbierwagen• 3 years ago

Not every customer will take that option. The PBP is 0 for that customer, not the entire population.

ckdarby2• 3 years ago

Two good friends were running a sketchy Instagram business back in the day.

They had a massive churn issue around 3 months. They knew this was a cash cow that was printing money but someday it'd come to a end abruptly.

I suggested to them to offer 20% to their existing customers to switch to annual. They made ~$60k in a day and knew they'd have to refund if things went south before the annual contract ended. They were able to deploy the capital into marketing and explode.

In the end they had to shutdown but not before each founder had taken home +$250k and invested into legitimate means.

jschveibinz• 3 years ago

This is indeed an excellent strategy, and is perhaps the greatest advancement ever in business models. Nevertheless, there is still a cost-benefit snd cash flow analysis necessary for the amount of that discount. This works easily for software businesses because the gross margins are so high. But that 20% is still money left on the table…

whatever1• 3 years ago

As seen at Amazon.com

hef198989• 3 years ago

How so? Amazon didn't jave that many unprofitable quarters, even less years, during its history. That Amazon was never profitable because they prioritized growth is a meme made up buy various start-ups to explain their lack of profits and/or positive cash flow.

wpietri11• 3 years ago

Are we looking at the same numbers? I think Amazon was basically breakeven for 20 years, from 1997 to 2017: https://www.marketplacepulse.com/stats/amazon-net-income-112

And it looks like that recent profitability is more about AWS than their traditional core business: https://www.visualcapitalist.com/aws-powering-the-internet-a...

wpietri11• 3 years ago

Is this true?

I have observed that few people understand these nuances and the significant role they play

I've been out of the venture-backed world for a while, so it's an honest question. Few people understanding business basics would certainly explain a lot of recent behavior, but there are other possibilities too.

gizmo4• 3 years ago

Literally every founder is capable of figuring out the basic unit economics of their business. But when VC money is abundant the unit economics don't matter because growth is the only metric worth tracking.

wpietri11• 3 years ago

Oh, I believe they're capable of figuring these things out. My question is whether they did.

For example, I could imagine a founder who knew what a real business was, but just said, "In crazy times we'll do crazy things", took the VC money, and mainly shut up about the problems, while quietly trying to mitigate the risks.

Or I could imagine that the OP is literally correct here, that many never bothered to figure this stuff out because it did not matter for the short term, and in fact would interfere with them projecting an SBF-grade aura of extreme confidence.

I've certainly met people in both camps. I'm just wondering if the latter have truly become very common, or even possibly the majority in some circles.

gizmo4• 3 years ago

This isn't another 2000 crash. The internet is much, much larger today. And the prize you get for being #1 in any market is enormous. It's so large that it pays to gamble with questionable growth strategies in the short term.

Reasonable growth that balances LTV and CAC is nice and pragmatic but it's not a winning strategy when your competitors are putting the pedal to the metal.

ghiculescu4• 3 years ago

On the contrary, I think the internet being bigger means the prize for being #2, 3, etc is great too. Very few markets are actually winner takes all.

leetrout• 3 years ago

Yep! And the second / late mover advantage.

For any that are unfamiliar:

https://insight.kellogg.northwestern.edu/article/the_second_...

coffeebeqn3• 3 years ago

Also people thinking that Google and Meta won’t be looked at like Oracle and IBM in 10-20 years are probably way too confident in the status quo

kolbe• 3 years ago

"the prize you get for being #1 in any market is enormous"

I believe this for broad markets with network effects (though see how quickly tiktok obviated facebook), but for companies that send out text messages to your customers or host your application in the cloud, which are examples of the creme de la creme of 10s startup success, it matters a lot less. These companies have no moat, no future, and are purely designed to be vehicles that take money out of the pockets of pension funds and give it to financiers.

hinata08• 3 years ago

Almost unrelated, but I also learned what was capital efficiency and payback period after playing Monopoly for the first time in years.

Long story short, when the properties were eventually sold out, I burned my cash flow to buy more of them to other players, at a high price, when they needed money (it would also allow them to play longer)

My logic was that by owning the most properties and by building houses and hotels, I would have the most revenue on the long run. And had the game been endless, I would have won.

However, the chances of someone going on your property isn't even high in this game ! You can sometimes wait for several rounds before this happens.

Unluckily, I stumbled on a rent I couldn't pay, mortgaged some properties. It happened again, and other players would only buy my properties at a price to cover the rent.

And my empire (i had the most properties by far) was on the verge of collapse when I had to run to go to the station.

So yeah, consider the payback period, even in the simplest models of the economy. Monopoly is economy taught to children, yet we adults can overlook its lessons.

whitemary4• 3 years ago

Monopoly was literally invented to illustrate the deceptions of capitalism. Great game.

robertlagrant2• 3 years ago

It's the regulations that stop you building more places that are the issue : - )

8note• 3 years ago

It's also there to convince people to switch to a land tax, but it's really not successful at it. I think because there's no land owners separate from building developers

JohnFen3• 3 years ago

It's a great tool to teach about the evils of monopolies, but a terrible game.

smeej3• 3 years ago

There's one monopoly that matters in Monopoly: the houses themselves.

The game only has 32 houses. If you get two 3-property monopolies and build four houses on each one, forgoing hotels, you have 24 houses and everyone else is fighting over the remaining 8. If you get max out houses on two 3-property monopolies and a 2-property one, the game is yours regardless of what anyone else has.

kjkjadksj• 3 years ago

Wow I never knew the houses were finite! That really changes things

hinkley5• 3 years ago

That’s also part of the logic of locking down Baltic and Mediterranean. It’s cheaper to get the set, it’s cheaper to get the houses. You’re not going to make a ton of money off them but now at least 25% of the houses in the game are friendly.

I usually did better playing this strategy. Even though winning with houses on park Place is more fun, houses on Mediterranean ave are more certain.

codegeek• 3 years ago

I would nitpick the title a bit. Revenue is never easy. I think they should rephrase as "Revenue is relatively easier than profit especially if you have PMF". Once you hit PMF (which is where most startups fail), you can just pour money into growth and that's when revenue generation becomes relatively easier.

qup• 3 years ago

That's entirely more accurate, but a terrible title

spencerchubb• 3 years ago

If we're nitpicking, then it's redundant to say that revenue is relatively easier than profit. Profit is a subset of revenue

whiplash451• 3 years ago

Can you elaborate on why most startups fail when they hit PMF?

majani• 3 years ago

Usually bad unit economics. The whole "make losses now to jack up prices later" thing does not work in reality. Usually the whole market just gets poisoned and the only way out is to leave richer investors holding the bag

photochemsyn2• 3 years ago

Remaining profitable is likely even harder, as other people will rush in and start providing similar products or services at competitive prices. In a heavily financialized system, the common solution is monopolization (buying up startup competition using pools of capital) - leading to situations like TicketMaster, which gets away with providing low quality-of-service to artists and their fans because they have no alternative to turn to.

Unregulated markets in a finance-centric economy inevitably drift toward the controlled monopolistic model for this reason. Advocates for unregulated free-markets either don't understand this or are simply being deceptive and are really trying to maximize profits by promoting the growth of monopolies.

whitemary4• 3 years ago

Regulated markets in a capital-centric economy serve, in aggregate, the interests of those who control capital, and therefore also drift toward monopoly. Liberals either don't understand this or are simply being deceptive by promoting the continuation of capitalism.

photochemsyn2• 3 years ago

Even highly socialist countries like Cuba found that introducing regulated markets was healthy for their economies. Now if 'those who control capital' are themselves a small minority of the overall population who act in concert - well, that's a financial monopoly, and of course there are ways to break up a financial monopoly of this nature, such as re-introducing Glass-Steagall provisions that separated commercial and investment banking, eliminating offshore and similar capital tax shelters, etc.

Note that if it is a state body that controls all the capital and hence controls economic decisions like infrastructure development, this isn't so different in practice from having a small group of financiers controlling all the capital - in both cases you have a centrally-planned economy controlled by a small cabal that puts their own interests ahead of everyone else's.

kazinator• 3 years ago

Revenue is easy only if you ignore survivorship bias. Organizations without revenue perish. Organizations with revenue whose balance sheets don't show a profit don't necessarily perish.

mrweasel• 3 years ago

Sure, you need revenue to generate a profit, otherwise you'd be generating profits from nothing. You can also have organisations who are specifically "Not for profit", they balance sheets will frequently end up with a 0 dollars in profits each year, and that's as expected, but they too need revenue to do anything.

For certain types of companies, revenue is easy. I worked to a company that did mostly consulting, but would also sell you hardware or software licenses, so customers only need to interact with us, and no one else. Technically we could just have given away hardware, and we frequently did sell servers at a lose. That shows up as revenue. As long as you have money or credit to sell expensive stuff at a lose, then revenue is easy.

That's not the main point though. The point is measuring companies on revenue is pretty stupid, without also looking that profitability.

hinkley5• 3 years ago

Conversationally, though, you’ve got a bunch of founders sitting around over beers or at a convention, the ones who couldn’t make revenue aren’t there. Revenue is tables stakes for the conversation. You’ve already figured out the first part, but you haven’t figured out the hardest part.

jossclimb• 3 years ago

Pretty much.

I have seen so many startups over the past few years, with A rounds up to $25 even $50 million where the CEO has zero business experience, they are literally learning by the seat of their pants.. They have gone from some experience as a tech lead for a small team, to the next day to running a large company. Obviously, there will be the odd outlier Zuckerberg type, but many of them are going to be totally out of their depth when the burn rate and path to profit (or even revenue in some cases) start to close in.

2024 will be a bloodbath in the startup world.

jasmer• 3 years ago

Zuck had no idea what he was doing, and a lot of these guys don't learn some basic things until much later on, or never do.

When you have that kind of growth and that kind of money, frankly it's different anyhow - riding an explosionn is different than running a company, which is almost always 'operating'.

CEO's are captains of ships with moving parts, experts, probably already a navigator, engineer, maps, standard port-to-port model etc.. In a way CEO's of established companies are 'overseers'.

CEO's of compaanies blowing up is something different, it's not an optimization process it's usually a top-line process, and then maybe crude bottom line net-profit process while keeping enough wood in the fire.

disgruntledphd2• 3 years ago

To be fair, Zuckerberg hired lots and lots of experienced people early on, and listened to them. Honestly though, if he hadn't hired Sheryl Sandberg then Facebook would probably have failed as a business.

maCDzP2• 3 years ago

So I am a Silicon Valley outsider. I live in the northern EU and work with project management in the construction industry representing the owner. It’s mostly infrastructure, roads, water. Old industry, conservative, we basically hate new things. On my spare time I tinker with my computer, learn assembly or whatever. Hence HN.

I have recently started a course in corporate finance at my local uni because my new role requires me to understand accounting, making business decision and so on.

I haven’t finished my course, and I have to admit that I skimmed the article. So what I am about to say is probably wrong. It’s a feeling I have.

I have the feeling that a lot of theses articles are pretty basic corporate finance. What I mean is that if you study and try to understand basic CF, you will gain the insights that many of these articles talk about.

When I then read in the comments that there are cases where tech leads with no business experience get millions in funding and basically are learning by doing. Silicon Valley seems to be on another planet for me. It’s sounds surreal to me.

If I was an investor I would never give that person money since projects are so extremely difficult. The wicked problem is a real thing. Or maybe I am just poor and don’t get how people with large amounts of cash think. I get that it’s a numbers game and you have a portfolio of companies, but still.

Guys that are closer to SV, I would love to hear your thoughts on my thoughts.

polynox• 3 years ago

So you would refuse to fund Google (Larry and Sergei being PhD students at Stanford at the time) because they "[have] no business experience"?

kristianc• 3 years ago

Google’s initial VC funding round pre-IPO was something like $25m. Even allowing for inflation you see that kind of money tossed around on pre-revenue NFT startups based on a pitch deck today.

JumpCrisscross3• 3 years ago

a lot of theses articles are pretty basic corporate finance

One take: yes, and venture-backed companies often forget or ignore the basics of corporate finance.

Another take: orthodox corporate finance isn’t tailored for start-ups. If you’re developing a product, GAAP income is meaningless. So we bootstrap interim financial metrics, e.g. eyeballs and ARPUs and DAUs (oh my!).

In truth, the latter dominates at the early stage. But firms grow. Some founders and VCs (see: Andreessen) are late to recognise when nontraditional metrics do more harm than good. When that ignorance becomes a point of pride, the former gains explanatory power.

elefanten• 3 years ago

I'll add to this a quote that is (purportedly) native to gp's northern EU: "Do you not know, my son, with how very little wisdom the world is governed?"

notfromhere• 3 years ago

Difference is that corporate finance is focused on managing a company at its current size while startups are really focused on building a much larger company. Hence why the economics of it make no sense until it hits that mythical future size

threeseed4• 3 years ago

Actually the problem with startups is that they focus on corporate finance too much.

When in reality they should be acting like a small business e.g. florist.

Often these startups are failing because of basic cash-flow management.

scarface744• 3 years ago

That’s all nice in theory. Name one tech company that has gone public and been consistently profitable in the last decade?

AirBnB hasn’t had a long stretch of profitability. But I will give it the benefit of the doubt that it can maintain profitability.

renewiltord• 3 years ago

Think of it like this. If you're a big fund you want a portfolio diversified in industry and risk.

If the guys CalPERS allocated the 0.5% (a few billion) to (the VCs) decided to also not do the risky thing then you haven't got a diversified portfolio.

The point is to put a small amount of your phenomenal wealth into risky bets with outsize returns precisely because you want to capture some of that other risk diversity.

ivan_gammel2• 3 years ago

Let’s say you distribute X million € to X startups (each one gets 1M) and you know that on average one of them will yield 2X in 5 years and the rest will just burn the money and die. This seems to be a good investment, right? You only need to pick those startups carefully. It appears, the criteria of selection may be quite different from what you would look at if you were to provide those money as a loan. I’m not sure how VCs really make their decisions, but this is just a case of having a good risk model based on variables that matter the most.

kmonsen• 3 years ago

No the unicorn needs to do a lot better than 2x. I think you need an X and a Y there for it to make sense.

NegativeK2• 3 years ago

x > 2 means you've lost more than your investment in five years. You've going to need a startup to return X million dollars to break even.

You only need to pick those startups carefully.

This is the "draw the owl" moment. The top comment is saying that they wouldn't pick any startup that didn't have someone to understand basic corporate finance.

crenwick• 3 years ago

I think you’re right on most accounts.

Yes, articles like this seem rudimentary to folks with MBA/accounting backgrounds.

Yes, tech startups can get millions in seeds funding, even where the company doesn’t have a CFO (or anyone with an MBA).

However, at those super early stages for sw startups, it doesn’t really matter. The money is to finance a product, prove the product’s value, and build a team. And its that journey where that company may start looking for a CFO.

By the time that company is raising a series A, they should have these things worked out.

erenyeager• 3 years ago

My understanding as someone who worked in SV is that there’s a lot of buzz in the area around new technologies and people are always doing something interesting/revolutionary/whatever. There are investors who diversify their portfolio by investing in multiple high risk high reward investments like these startups. So even if you invest in 100 companies and 99 fail, the one that succeeds might be that unicorn that pays off.

Concurrently, there is a greater understanding that waterfall engineering is not the best for software. Instead, software is more agile, in that you build test prototypes and have a tightly integrated feedback loop instead of huge project plans that take months to even reach market.

The philosophy is more around testing market hypotheses quickly and iterating quickly.

Another factor is there is a lot of hype around SV that forms a positive feedback loop. Of course investors are not so easy to part with their money but it is inclining towards gambling in some fields flush with capital.

This is not true for all fields in SV though, for example in the biotech and medtech field, getting investment is much harder from my experience, as there are more regulatory factors, higher barrier to startup, longer time periods for outcomes, etc.

samcheng• 3 years ago

I live and work in Silicon Valley, and I agree that the concepts in the article are pretty elementary and critical to understand in any business, not just tech.

However: if your software product has struck gold, it will have “rocket ship” nearly-free growth and negligible incremental costs. In that regime, only the top line really matters. This is the kind of home run that many people are looking for in Silicon Valley, both founders and investors, which explains the relative “traditional” financial illiteracy in startups around here.

boulos• 3 years ago

At the beginning of a company, it's all hope anyway [1].

Investors are sophisticated enough to quickly reason about basic margin opportunity, and decide if the company could ever be profitable, even if the founders have no real business experience. The assumption is that by the second round or so, you can refine the estimate of "Could ever be profitable".

More importantly for venture capital, is that there are many profitable businesses in the world that have people with finance expertise. If you just wanted to invest in profitable companies, you wouldn't be doing venture capital. Instead, you're seeking companies that will have massive returns and become profitable some day.

If the founders still don't know how to do finance, but they're making a ton of money, you send them a CFO to tighten that up. Same way you send them names for VP of Sales, or whatever else they need.

Deciding to give up on a company that seems to be generating lots of money, and "just" needs to improve margins is hard. If you tighten too early, you've blunted growth. If you tighten too late, you've thrown away the money. For the last few years, the amount of money sloshing around meant you saw more of the latter. The firms "had" to keep investing their funds, so they were chasing more and more deals on hope. But $10M out of a $1B fund is still no big deal.

tl;dr: the rare thing is rocket ships, not financial sophistication.

[1] https://www.k9ventures.com/blog/2012/05/31/hope-and-numbers/

lchengify4• 3 years ago

When investing in different industries (construction vs tech), it's often useful to think about them in the context of asset classes.

Specifically, construction is more tied to either real estate, hospitality or government contracts. These often raise money via a bond (debt) offering or an equity with a very well-worn finance model. These projects require a lot of upfront capital (billions not unusual for roads) and have long time horizons, with log() or linear returns, and have a very well understood model for packaging as a risk asset. These risk assets attract a certain kind of investor, or a certain risk profile in a large fund's portfolio.

Venture capital as an asset class is a bit different. The expectation is that an idea can be proven out relatively cheaply, and the business will scale since the major leverage is intellectual property (vs physical assets). The expectation is also that most business will fail, with maybe a handful of successes capturing most of your return. VC's investing in startups with risk-appetite LPs, is very different than a real estate developer going to a large bank to build a housing project. The VC model is closer to investing in a TV show than a construction project.

Put simply: Investing in a moderately sized government construction project ($2b or so for a toll road in latin America) is a totally different finance product than a startup that leverages IP. The aggregation of risk is also different (VC vs say, REITs) and the devices are different (equity vs debt / leverage). Most investors either run a balanced fund at a large size, or specialize, since they are so different.

EDIT: Also important is relative size of each investment asset class. VC is hilariously small (222 billion in 2022) in comparison to something like energy (2.4 trillion in 2022). VC gets a lot of press but for most professional investors "real funds" start at about a billion table stakes.

dopeboy• 3 years ago

This is a helpful reply. Any further literature (blogs or books) that you'd recommend to learn about these concepts?

lumb632• 3 years ago

This doesn’t answer OPs question, IMO (or my interpretation of what OP was saying is wrong).

Sure, construction and high-growth tech startups are different investment opportunities. They have different risk profiles. As someone managing money, shouldn’t you be looking to mitigate risk to maximize returns? Why give money to the startup which has an idea and no experience running a business, managing capital, accounting, etc.? Wouldn’t money be much better spent on a startup that had all those things?

I have heard in the past that the majority of startups fail, and that successful startups are often founded by people who have founded (often unsuccessful) startups before. When looking for a company to invest in, shouldn’t these be top priority? I don’t buy that VC and high growth companies need to be as risky as they are. I suspect a lot of it is bad decisions and lack of due diligence.

gen220• 3 years ago

There's an angle to consider – why is it that people who are technically skilled and financially experienced do not take on venture funding and build billion dollar plus companies? [1]

Perhaps, they know (from business experience) that the VC treadmill is not in their best interests, when everything about that life is considered! :)

Perhaps investors actually benefit from the naïvete (read: not incompetence, just naïvete) of their portfolio companies?

It's a symbiotic relationship, but there's a reason that the road between founder and VC is generally a one-way street.

[1]: There are notable exceptions to this observations. They're worth understanding, too.

threeseed4• 3 years ago

You have an issue with VC not SV specifically.

a) Yes in some cases engineers with no business experience get funding. But in most cases there is significant due diligence being done on the capabilities of the team.

b) There is plenty of history that engineers with great product sensibilities can learn to run a business and become successfully by augmenting their weaknesses with members of the SLT who are stronger at them.

c) The whole point is for them to deploy their LPs money rather than just letting sit around waiting for the perfect idea/team/market etc combination to arrive on your lap. That simply doesn't happen.

ChuckMcM• 3 years ago

Okay, as someone who has lived in the "heart" of Silicon Valley for a few decades I'll take a shot at this.

To be fair, I didn't appreciate how unusual it looked until I helped a friend start their business in Illinois and saw what they dealt with at a bank.

You are correct in your assessment that articles like the one linked here are pretty standard business explainers. The interesting thing for me is that it really is just math and systems so it "should" be interesting but for a lot of folks they don't seem interested and just want to sell product.

So at least part of the venture community has convinced itself that it knows how to "productize" anything, if they just had something to work on. And along comes a person with an idea and hope. The venture capitalist (VC) thinks, "I'll provide the business sense, this person provides the creativity and the elbow work, and we'll split the profits." That can work out spectacularly well for the VC where they invest $X and get back 10 - 100 time $X in wealth. It doesn't always work out, but if it works out enough times, the VC can turn their money into more money faster that way than with say investing in government bonds.

In Silicon Valley this works because of two things, one there was a tradition of providing equity to employees which, when companies grew, put a lot of the wealth generated in the hands of individuals rather than companies. And secondly, California had some pretty good laws on the books about disallowing "non-compete" employment agreements so people who thought they could do the same thing their company was doing, only better, could go out and start a new company doing the same thing without too much risk of getting sued.

Having lived here I can tell you that 20 - 30 year old people are much more willing to invest in something risky than 50 - 60 year old people. So getting that wealth into younger hands adds to the risk tolerance.

To this point: Or maybe I am just poor and don’t get how people with large amounts of cash think. I expect it is a scale thing.

Imagine you have saved enough to pay for all your kids college education and you start your "retirement" fund. And you save money in that until the returns on that fund are actually enough to provide you with the same income, and in the US buy you the same medical coverage, you are currently experiencing working. Now you can "leave your job" and have a lot of free time. (It doesn't mean you can buy a yacht or an airplane and party all the time, just that you're new lifestyle looks like your old lifestyle with the single exception that you don't have to go into work every weekday). Now you end up with a few million $ more for this "third" account. What to do with that? Well a lot of people feel comfortable "gambling" some of that on new ventures because if they lose it, it won't change their life, and if they get a big winner, well it means more things they can try.

So to understand it, you have to imagine that you've got enough savings for all of the life expenses you expect to have going forward, and you have enough savings on top of that such that those savings are providing the equivalent to having a good job (pay and benefits), and now you have savings on top of that.

In the current batch, there are estimates of >100,000 former Google, Apple, Microsoft, and Facebook employees are in that position today. Money did a story on how the density of billionaires in San Francisco was the highest in the world [1] (post Crypto-crash I'm guessing this number went down :-)).

So why do young millionaires and billionaires invest in crazy ideas? Maybe because it is more exciting than having a few million dollars sitting in a bank account doing "nothing"?

[1] https://money.com/san-francisco-billionaire-density-income-i...

ghaff2• 3 years ago

I have a friend who retired somewhat early as CxO of a company with a (lowish 8 figure?) payday. Although, from a financial perspective he somewhat regretted spending about a decade doing a bunch of angel investing rather than just investing in big tech, I think it was also sort of a hobby and he still invests in a few companies he's particularly interested in. Along with also being involved in philanthropy with a large local institution.

So, yeah, there's a level where you know you don't have the money to routinely fly private or buy a super-yacht or buy properties around the world. But you have enough for any expenses you reasonably want/need and may not even want a bunch of the stuff that more money could buy. So you throw some money at interesting things.

dsugarman• 3 years ago

A lot goes into making a product that people love, if you can master the customer, market dynamics, pricing, pitch, product, service, etc to be growing really fast, you can probably learn basic corporate finance. That's what the VCs are betting on and they will even give you a board member and resources to help you out! if your product is only successful because your unit economics are upside down which is giving an unfair market advantage where you have none otherwise, well then that's reckless

fxtentacle• 3 years ago

In some cases, your goal as an investor is not to hold on to the investment until it becomes a viable company and IPOs. Instead, you just try to sell your shares to the next person as quick as possible.

If you're in the latter situation, then hype is way more important than actual fundamentals.

threeseed4• 3 years ago

This is a rare situation. Most VCs are not interested in a quick exit/entry with a 10x return.

They need the 100x/1000x outliers in order to return their fund and that means holding on to investments until IPO.

13415• 3 years ago

Most innovation of internet and computer-related business come from Silicon Valley, so it seems reasonably clear to me that investors there are doing the right thing. To be honest, I find it hard to name any highly successful EU companies whose main business is internet-based or software-related, at least not in the b2c sector. There are some, but the major players seem to come from the US and more recently also from China.

I've always considered the risk-averse investment culture and bureaucracy in Europe to be a major factor.

ivalm3• 3 years ago

Skype, Spotify. But both grew with SV venture. EU venture is not as good for early companies because they are much more conservative.

danenania• 3 years ago

You say it’s difficult, but you yourself will learn the key principles from a single course.

Learning to create a successful product is much harder and requires a much rarer set of skills. There’s no course you can take that will give you this ability. Knowing lots of details about accounting and business administration won’t help you unless you can make something that sells.

balderdash• 3 years ago

Your observation is not wrong, and it’s part of the reason why so many of these startups lose money. However the element I think you’re overlooking is the distribution of potential returns. If you invest $10m into a a startup, maybe you lose $10m or earn $250m, vs investing $1b into an infrastructure project and maybe making $200m or losing $200m…

hnfong• 3 years ago

As you may have realized, basic corporate finance is not that hard. It's totally doable for tech founders to learn by doing -- and savvy investors presumably give them sound advice and make sure they're on the right track. They'll also usually get somebody with business/finance experience to join if/once the product gains traction. The value founders provide is usually bearing the risk and effort in developing the "new product", while anyone with a MBA can deal with the business/finance side of things if needed, so the latter might be viewed more as a commodity.

But then, as we've seen in the FTX fiasco, some investors really just throw money around without any due diligence.

warren-williams• 3 years ago

I might be off, but why are you adding CAC back into Contribution Margin to determine LTV? This seems like more of a sunk cost that would imply 1x LTV/CAC than the 2x that you show?

Other than that, nice article!

hinkley5• 3 years ago

The number of times I’ve worked at a place where some sales asshole was trying to land $1 of revenue that was going to cost us $2.50 to achieve the deliverables… wtf are they teaching in business school?

One place I worked, their strategy was to chase the “whales” first and get them as customers so we could use them to get other customers. So many problems there that only because apparent to these idiots afterward. First, big companies aren’t idiots. If you have next to nothing to offer, they’ll give you next to nothing in return. And once you have an exploitative contract, good luck renegotiating it once your product has improved.

In this particular industry it was even worse, as we found out. The big companies felt like they were doing people a favor, the medium sized companies were just cheap. Only the little companies were hungry and humble enough to pay good money for good product, but now you have a product that’s been tilted toward the whims of much larger companies, which adds a lot of friction. Plus you’ve done all of your scalability work at the beginning when you are the least experienced with it.

They did end up selling the company at a profit, but they had hoped for early retirement and all they got was comfortable living. I’m not convinced the buyers got a good deal on the terms either.

simonswords82• 3 years ago

Often this happens when a sales commission structure is misaligned with company profitability.

The salesperson then cares more about commission and less about profit and generates revenue at any cost.

JohnFen3• 3 years ago

This reminds me of an exchange I had with someone who wanted to enter into a business deal with me. He bragged about how his company had X millions in revenue. Since revenue was a meaningless figure to me in this context, I asked what their profit margin was. After hemming and hawing about it, he admitted the company was not profitable, and it became clear it was unlikely to become profitable anytime soon.

hackernewds2• 3 years ago

You can just say you were talking to the founders of Lyft.

blobbers2• 3 years ago

GAAP accounting is for stable cash flows in well understood businesses.

Bootstrapping (funding growth with revenue) isn't the silicon valley way; the silicon valley method is as follows: 1. get funding

2. grow team/build product

3. raise more funding and find product market fit

4. seize control of market / make large top line moneys

5. repeat 3/4 a as necessary.

6. acquisition/IPO, shareholders payout.

hef198989• 3 years ago

As soon as a company IPOs, or uses a SPAC, it is either GAAP or IRSF accounting. And it doesn't matter what the comoany might think about that.

blobbers2• 3 years ago

No, they'll run GAAP statements but everything they report in their earnings calls will be non-GAAP.

tiffanyh• 3 years ago

I could generate huge revenues selling $100 gift cards for 80 bucks.

But I wouldn’t be generating much profit.

fatfox• 3 years ago

We’ve created a generation of leadership people who never learned how to make a profit. Until last year, if you were focusing on unit economics, you were laughed out of the room. Fast growth and market share at all cost…

lumb632• 3 years ago

I disagree wholly with the “revenue is easy, profit is harder” idea. I suppose it is tautologically true since profitable ventures are a subset of ones which generate revenue, so more businesses generate revenue than generate profits, thus it is is “easier”. However, that is only at the present instant. That statement does not factor in all the companies that generated only revenue and no profit and are now extinct. When considering these, it is vastly easier to be profitable than to have revenue.

Without infusions of external capital it is literally impossible to generate revenue without profit for any period longer than one can sustain their losses. Isn’t it way easier to focus on businesses that do this, that meet a demand people have, and are thus profitable? Instead, investments are made in areas where demand has to be induced via advertising spend, expenses have to be reduced by relying on the ability to “rapidly scale”, and the business has to sap round after round of investor capital at increasingly higher and increasingly more ridiculous valuations with the hopes that it can weather that storm.

When considering the above, it seems to me that we are systematically mis-allocating capital to bad investments. As the saying goes, a bird in the hand is worth two in the bush. You can see people behaving in accordance with this during high-risk periods, e.g. COVID, when capital shifted toward durable goods and physical assets (pre QE infinity). But for some reason, when the risk is not literally right in front of investors, they do not see it. That risk, the integral of which increases over larger periods of time, eats away at the growth rates of companies. I suspect risk would spoil the math that makes a lot of the high-growth companies worth anything, if it were properly accounted for. Not to mention, negative externalities are unknown and thus largely ignored in startups, and thus cannot be accounted for.

AlbertCory3• 3 years ago

This is an accounting method that's different from the traditional ones. That's not to say it's wrong. It's just interesting.

However, "customer acquisition cost" seems to imply that that customer is now "yours" and he'll keep buying without any more spending from you. That assumption is questionable. Maybe he's just on loan to you, and fickle as all hell. Did Uber "acquire" me just because I used them a few times?

Traditional accounting is "fixed cost" plus "variable cost." You build your factory (fixed cost), and then produce widgets (variable cost). For a long time, you're amortizing the fixed costs, and eventually the price of the widgets is all profit, assuming the factory still runs.

In that method, every customer is a random draw from a raffle, and you have no guarantees that the customer will keep buying. They may, but they may not. You have to keep getting new ones to even keep your base stable.

ZephyrBlu• 3 years ago

This is primarily a growth model/strategy not an accounting method, and these metrics have been very common in startupland for quite a few years.

Customer acquisition cost (CAC) is paired with lifetime value (LTV). The length of time you're on "loan" to the company doesn't really matter as long as LTV is higher than CAC.

This model is commonly used for subscription businesses, where assuming each purchase is independent is not really appropriate because they are recurring.

hinkley5• 3 years ago

However, "customer acquisition cost" seems to imply that that customer is now "yours"

I’ve confused a few people this ways in conversation lately and I’m not sure what the solution is, but it’s a case of saying, “even the most optimistic scenario is still very bad”.

Keeping someone’s attention is never going to be cheaper than getting it in the first place. The best you can do is spend a maintenance cost to retain them, in which case if enough time passes and enough repeat business happens then the profitability of that customer keeps going up. But you’re going to hit an asymptote that looks like Amdahl’s law, and dictated by those investments.

AlbertCory3• 3 years ago

Thanks. Subscriptions always seemed to me like they were for the business' benefit, not for mine. I'm sure it does make the growth models look really good; you've got this nice, regular stream of money coming in.

However, it does nothing for the customer. I refuse to subscribe to anything, as a rule. Deliver some value, and I'll pay for it when I need it. YMMV.

ckdarby2• 3 years ago

I am an amazing "2nd in command" employee. I struggle taking nothing to something and the dedication required to get market fit to build revenue.

On the other hand I find building profit one of the most enjoyable and fun things! I've now successfully more than 3 times in a row taken ~$100M revenue and grown it via new top/bottom around 10-15%.

I think it takes a different kind of person to optimize for income than just purely growing revenue.

Revenue is easy, profit is harder

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