How to avoid building a company that you’ll hate
How do you know if the business you’re running will enable you to live the life you want to live? This was a major question we grappled with during our year-long search for our next business venture, a process we imaginatively termed “Project Next Biz”.
This is the first in a three-part series. In this post, we’ll talk about how we defined success for “Project Next Biz”. We’ll also share the framework and exercise we used to figure that out.
Part two is about how we evaluated the different paths we could take to maximize our chances of success. We’ll share the framework we used to choose an opportunity to work on for the 7–10 years it takes for a SaaS business to hit its stride. We’ll also talk about how we arrived at our ideal financing approach. Hint: venture-backed isn’t the only road.
- how we ended up at the purchase price
- our psychology during the negotiation
- the risks of buying Codetree
- and a whole lot more
A little about us
A little about us before we jump in. We’re three business-minded software devs with 45 combined years of professional experience building software. We’ve started, run, folded and sold several SaaS businesses. We’ve done venture backed and bootstrapped startups. We’ve worked at companies like Microsoft, ESPN, and MySpace. We’ve worked together before and we wanted to work together again.
“It is remarkable how much long-term advantage people like [Warren Buffett and myself] have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” — Charlie Munger
We’re big fans of Warren Buffett’s business partner Charlie Munger. Charlie is big on avoiding mistakes and our past ventures had given us a long list of mistakes to avoid. One mistake we’d made is that we’d never defined success when starting previous companies. We’d skipped this step and headed right to the problem/solution and financing approach.
With Next Biz, we didn’t want to make that mistake again.
Munger talks about the concept of “inverting”. He borrowed the idea from German algebraist Carl Gustav Jacob Jacobi, who said “Invert, always invert.” In a 1986 speech Munger said: “It is in the nature of things, as Jacobi knew, that many hard problems are best solved only when they are addressed backwards.”
In other words, begin with the end in mind. If you don’t know where you’re going, you’ll end up in the wrong place by definition.
A useful exercise
One exercise we did to figure out where we wanted to be was to write down what a day in our lives looked like when Next Biz was successful. We answered things like:
- Who were we working with?
- What kinds of things were we doing? In what parts of the business?
- What kinds of customers were we serving?
- What kinds of problems were we working on?
- How much were we making?
- What was the culture like?
- What kind of office did we have?
- Who did we talk to regularly?
- How many reports did we have?
Each of us did this independently and talked through our answers with each other. We drew on our own previous founder experiences, conversations with other founders, and things we’d read to paint a picture of what an ideal day looked like.
We all had similar ideas about what we wanted our world to look like. There were also factors that one of us raised that the others hadn’t thought of and agreed on. We’ll cover those below.
This was a helpful exercise to realize that we didn’t care about being on TechCrunch, or managing a board of directors, or ringing the bell on the NYSE, or having a company with 500 employees.
After doing this exercise, it turned out that the things we talked about fell into two buckets: the non-financial success bucket, and the financial success bucket.
We admire companies that focus on making customers happy, charge for it, and do it on their own terms. Their owners can control how they spend their scarcest resources: time, attention, and energy.
Every business has criteria that determine whether your day will be painless or painful. Will you jump out of bed, excited to face the day at the office? Or will every minute at the office be soul-crushingly painful?
Here are the criteria we used to determine whether we’d enjoy working on the business or not:
- Sales Model
- Operational Complexity
- Company Size
- Nature of the work
Of course, your criteria may be different. There isn’t a right and wrong here, just better and worse for you (and for us). Our goal here was to identify what would constitute non-financial success for us.
Let’s unpack the criteria.
1. Sales Model
Do you rub your hands in glee at the thought of coming into the office and talking to prospects all day? If so, you’re probably better off selling to customers with a high Annual Contract Value (ACV).
Perhaps unintuitively, ACV drives a lot of the mechanics of your business. Nick Mehta from Gainsight says “ACV is everything”. What he means is that when you have customers with a high ACV:
- You’re probably selling to Enterprise customers
- You have longer sales cycles
- You have contract negotiations, and they’re often painful
- The buyer isn’t the user. This means sales skills are often more important than building a great product
- Churn is probably lower
- You can get to scale quicker
When you’re selling to customers with a lower ACV:
- A great product is important because the buyer is often the user
- It’s harder to get to scale
- Churn is often higher
- A self-service sales model is possible
- Marketing is important to drive traffic and potential customers to your site
Christoph Janz says you can build a $100M company by selling to one of five sizes of customers. He calls them Elephants, Deer, Rabbits, Mice, and Flies. Elephants are the biggest customers that pay the most; Flies are the smallest and pay the least.
The way to sell to these customers differs. On one end of the spectrum, Elephants require in-person sales people. On the other, Flies either have a high viral component, or user-generated-content component that fuels huge SEO traffic.
We know that while we love talking to customers, hand-selling doesn’t give us energy.
There’s a lot of good that comes with selling to customers at a higher ACV. But we knew we’d be happier making a great product and focusing on marketing. So we decided to start with smaller customers. Janz calls the approach we’re taking “hunting rabbits”. We wanted to start off “hunting rabbits”, knowing that we might grow to “hunting deer”, and that we don’t want to “hunt elephants”.
2. Operational complexity
Operational complexity can dramatically impact quality of life. We’ve run operationally complicated businesses. One business has hundreds of software scrapers that often break. Another was a web app that relied on people to do a lot of data entry. Those were more painful than the straight software businesses we’d run.
We’d much prefer to run an operationally simpler, straight-software business.
This was a factor that one of us raised as being important to him that the others hadn’t thought of. After contemplation and discussion, we agreed that it impacted happiness enough to weigh it heavily when considering non-financial success.
We wanted the people we work with and our customers to hold us accountable, not investors.
4. Company size
None of us want to run a huge company. 100 people would be pushing it. We’d prefer to work on the business than manage people and deal with the inevitable politics and bureaucracy that comes with that. So having a small, excellent team was better than a large one.
6. Nature of the work
In every business there are going to be some tasks that you really don’t want to do but that you’ll have to do anyway. But to the extent possible we’d prefer the business we’re working on to reward us for focusing on the tasks that we actually enjoy doing. For us, those tasks are:
- talking to customers to understand their problems
- using that knowledge to make the product better
- and marketing the product
Non-Financial Success: where we ended up
Here’s what we netted out:
- Initially, a low-touch sales model that plays to our strengths: building and marketing a great product
- A business that’s operationally simple
- Being accountable to our customers, each other, and our team
- Having a small company of well paid, professional co-workers
- Enjoying the nature of the work
Seeing these written down may seem obvious. But optimizing for these doesn’t happen by accident. We determined that these criteria were important because we’d run businesses that operated under different, less pleasant circumstances. And we ended up running those businesses because we hadn’t taken the time to ask ourselves — before we started — what success looked like.
It’s difficult to isolate success in financial terms because it’s tied up in non-financial success. For example, if you’re aiming to be a billion dollar company, you probably need to raise money. This means you’ll have investors and a board that you need to manage (and that can fire you). Below, we share how we tried to tease out what financial success looked like to us.
Venture backed tech companies are built to get huge or die. Like a lottery ticket, you either win big or lose. But outside of tech, it’s common to run a business to generate free cash flow for its owners.
Interestingly, huge markets where subscription SaaS is the dominant business model aren’t winner-take-all. Look at the CRM market. There are many billion dollar companies (Salesforce, Veeva, Oracle, MS Dynamics, etc). But there are also many companies making $1M — 10M in ARR whose owners can choose how to spend their time. You can find similar examples in huge markets like project management (Basecamp), help desk (Groove), time tracking (HubStaff), marketing automation (ConvertKit), etc.
Jason Cohen’s Rich vs. King post is helpful here. Essentially, the choice is between having a lottery ticket (“Rich”), or having control of your destiny and earning a good income while building an asset (“King”).
Company founders are either in it for the money (“Rich”) or in it to build a lifestyle and personal identity (“King”). FogCreek and 37signals are built to be “King;” all venture-funded companies are built to be “Rich.”
At his last company, Smart Bear Software, Jason became both Rich and King by initially focusing on being King. He retained control and focused on profitability. He didn’t raise a boatload of VC money and hope his company would be acquired. His company’s profits enabled him to build the kind of company he wanted.
Ironically, Jason discovered that Rich vs. King is a false choice. Jason focused on being King and building a great, profitable company. Because he did, he ended up becoming Rich when his company was acquired for life-changing money. Jason ends his post with this:
I can stay home with my wife and new baby girl for as long as I want, having all the precious time and experiences and memories that they say money can’t buy.
We asked ourselves two questions to figure out whether we wanted to be “Rich” or “King”:
- How important is controlling our own destiny?
- Do we want to optimize for steady cash flow, or for a billion dollar company?
We had already figured out that controlling our destiny was important to us.
To answer the second question, we looked at the chances of achieving steady cash flow versus becoming a billion dollar company.
Steady cash flow
We’d already started four cash-flow generating companies. We’d made upside-limiting mistakes with previous businesses, so none of them got as big as we would have liked. (We’ll cover these mistakes in part two.)
But building a company than generated substantial cash flow seemed achievable. Especially if we did it in a large market with a must-have solution to a painful problem.
Billion Dollar Company
There’s nothing wrong with wanting to build a billion dollar company. We need people that want to do this. But before you go down this road though you should make sure you really are one of those people. You want to make sure you’re doing it for well thought-out reasons and that you have a firm grasp on the math. Don’t be fooled by survivorship bias or breathless media sensationalism about the latest rags-to-riches entrepreneur — those are the exceptions, not the rule.
To build a billion dollar company you need to:
- Pick the right problem and solution
- Get lucky
- Catch lightning in a bottle
- Have your investors’ agendas stay similar to your own
Let’s drill down on each of these.
1. Picking the right problem and solution
If you don’t offer a must-have solution to a hair-on-fire problem in a huge market, the odds of joining the “tres commas” club are zero. Picking the right problem and market aren’t hard if you’re resegmenting an existing market. You pick a big, existing market and serve a smaller slice of it better than the incumbents. But finding the right solution for that slice of customers is tricky and time consuming. Plus the slice needs to be big enough to eventually become a $1B company.
2. You get lucky
You have to get lucky to cash out. What if Yahoo decided to take Larry and Sergei up on their offer to buy Google for $1M? Or if Mark Zuckerberg sold Facebook for any of the offers he had before the company became a beast?
Founders who build billion dollar companies get thousands of lucky bounces. Did we want luck to be a necessary component of a successful financial outcome? Remember Charlie Munger, who has gained “long term advantage… by trying to be consistently not stupid”? We didn’t want luck to be a necessary component of Next Biz to be successful. Though if the gods smiled down on us every so often we’d be ok with that.
3. Catching lightning in a bottle
Most massive companies timed the market. They provided what became an excellent solution to a latent, unmet need. AirBNB stumbled into becoming VRBO 2.0 just as the sharing economy was taking off. Dropbox built an excellent file syncing product as smartphone and tablet growth exploded. Files needed to be on many devices and Dropbox solved that problem. Palantir exploded because defense spending increased to analyze the terabytes of internet data to combat the rising threat of non-state actors.
Did we want to have success hinge on a rare event of being right at the right moment in history?
4. Your agenda stays aligned with your investors’
VCs need massive exits to generate the necessary returns for their Limited Partners.
Mark Suster has a phenomenal presentation on this. You must read it if you’re considering raising money. Slides 24–33 are key:
Here are the highlights:
- In Suster’s example, assume a 300M fund size where the VCs need to return 1.2B to their investors
- An $80M exit where the VC owns 20% of the company yields $16M back to the VC’s LPs. This $16M makes up 1.33% of the $1.2B that the VCs need to return. In other words, an $80M exit which most entrepreneurs would be proud of is inconsequential to a VC.
- A $3B exit (assuming 15% VC ownership) yields $450M to LPs. This is a little over 33% of what the VC needs to return to his investors
Suster says that “Venture is truly only aligned with enormous outcomes.” A VC’s incentive is to figure out whether you’re going to be a $3B company as quickly as possible. And if you’re not, it’s to spend as little time as possible with you. Is that the agenda you want in a partner and board member?
VC Heidi Roizen describes how investors become misaligned with founders in this “grim fairy tale about a mythical company and its mythical founder”.
Here’s what she says about alignment:
You are betting usually 10 years of your life and all your available assets on your startup. Your investor is likely investing out of a fund where he or she will have 20–30 other positions. So in the simplest of terms, the outcome matters more to you than it does to them.
If you’ve never raised VC before, this is a worthwhile read with some great recommendations. Here’s what Roizen closes with:
Understand your own motivation… your own goals will dictate whether you should even raise venture at all, how much to raise, and what to spend it on. If you raise $5 million and sell your company for $30 million, it will likely be a life-changing return for you. If you raise $30 million and then sell your company for $30 million, you’ll end up [with nothing].
So: were we confident that our agenda would stay aligned with potential investors’? An investor’s agenda could change because of many variables that we couldn’t control. Answering this question boiled down to how much we wanted to control our own destiny.
Financial Success: where we ended up
Heads I win, tails I don’t lose that much.
— Monish Pabrai, author of The Dhando Investor
Another way to figure out the Rich Vs. King question is to ask yourself which of these two scenarios is more appealing to you:
- You’re diluted down to 1% ownership. You go public. Your name is in the press. You ring the bell on the NASDAQ. Your company is worth $1B, and your stake is worth $10M.
- You’re a founder of a closely held company. You own 33%. You’re only known in your own niche. Your name’s not in lights and no press writes about you. Your company is worth $30M. Your stake is worth $10M.
We decided that a business that could reasonably grow to $10M in ARR would be a success. Much more so than a “big swing” business with a bimodal distribution of outcomes. Especially since it’s easier to build a $30M company than a $1B company.
Our combined definition of success
After walking through this process, here’s how we defined success for ourselves:
- The business can conceivably grow to $10M ARR. It’s growing at a natural pace and isn’t a grow-at-any-cost rocket ship.
- We’re working with a small number of well-paid, well-treated smart co-workers who work at a steady pace.
- We get to enjoy the day-to-day work of making and marketing software.
- We’re in control of the company, not investors.
This may seem like a no-brainer when laid out like this, however we think it was a worthwhile exercise. It’s too easy to end up working on a business whose characteristics you don’t like, or working towards an outcome that is ill-defined and perhaps not what you actually want.
Part two is about how we evaluated the many paths we could take to maximize our chances of success. We’ll share the framework we used to determine the problem that we chose to solve. We’ll also talk about how we arrived at our ideal financing approach.
To get notified when part post drops, join the mailing list on the Codetree blog.
This article was originally posted on the Codetree blog.
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