Use of talent, proceeds and profits.

The rate limits to long-term growth come down to how a business answers these two questions: “What do you do with talent?” and “What do you do with money?” The ideal business can absorb unlimited talent and money, but no business achieves this ideal, because both questions contain paradoxes.

Success is as dangerous as failure. Whether you go up the ladder, or down it, your position is shaky. When you stand with your two feet on the ground, you will always keep your balance.

“What do you do with talent?”
When new talent joins a growing business, it expects to ascend the ranks. In the talent paradox, you have to decide between the young and the old. If you choose the old, the young will leave. If you choose the young, the old must go. This tradeoff exists at every level in the hierarchy. Your most talented VPs will leave if they cannot become Cs. Your most talented Directors will leave if they cannot become VPs. Your most talented Managers will leave if they cannot become Directors.

To some extent, this upward pressure can be mitigated by overall scale: if a Manager at Company A is responsible for more people and resources than a Director at Company B, then perhaps they will stay. Meritocracy helps, too: if every person in a hierarchy sincerely accepts their superiors as superiors — superior in talent, skill or experience. But a perfect meritocracy, like a perfectly efficient market, is an ideal that has never, and perhaps will never, exist in reality: especially since value judgements are subjective, and it is inevitable than the young will eventually want to try their luck in higher realms, and favor learning by doing, instead of just observing. Development helps: if everyone looks up to their manager as a coach and mentor, as someone they can learn from and grow underneath, they will stay longer. Compensation helps: increasing cash and equity can keep ambition at bay. But for the most ambitious mercenaries, there is always better pay elsewhere; and for the most ambitious missionaries, starting a company offers the tempting illusion of 100% equity. Title inflation probably doesn’t help: it is too easy to see through, although perhaps that underestimates our capacity for self-delusion. Mission helps: if you continue to believe that this, this, this is the most important problem in the world, and that you, you, you are absolutely necessary to solve it, that is persuasive and motivating.

But even all of these, taken together, are not enough to retain the best talent in the long-term. The only way to transcend the up-or-out paradox, in my view, is to create up-and-over opportunities, and I outlined what that might look like in my post on succession planning. To not let anyone stay in an operating role indefinitely, not even the CEO, and to start many businesses inside of one business, by turning VPs into mini-CEOs to run them: that is my answer to this question, and my proposal to transcend the talent paradox. This year we will be creating development plans for every partner, that help us each chart a path over the next 24 months.

The allure, if we get this right, is that we can increase the density of talent in the organization, and continue to attract Caesars. A question that has pre-occupied me since starting this company is this: “How do I build a company that I would want to join if I wasn’t the CEO?” From this question has sprung much of our ownership culture, including the maxim: “You’re the CEO until told otherwise.” If incentives, beliefs and values are aligned, if ambitions are channeled, a company with many CEOs will grow faster than a company with just one.

The problem is that Caesars, alphas, tend to kill each other. In one of my favorite books, T.H. White’s The Once and Future King, Merlin tells Arthur the history of the world in terms of this problem: the ambition of alphas — of the young overthrowing the old, of jealous brothers, of Cain and Abel, of jealous sons and fathers, of Kronos and Zeus — cannot be contained and must be expressed non-violently, otherwise war will break out. The ideal company would figure out a way to transcend the talent paradox and allow many alphas to work together to create more value than they could alone. Like ideal meritocracies and markets, ideal companies don’t exist, but even recognizing that nature has its limits, the more we wrestle this angels, and seek to overcome, certainly we will receive the blessing.

“What do you do with money?”
In the money paradox, you have to choose between financial discipline and growth.

If you choose financial discipline, you maintain profitability at all times. You don’t make investments that increase revenue and market share, if they make the company temporarily unprofitable. You’re even wary of temporarily giving up margin points. You don’t make investments that create structural dependencies which require never-ending investments. You like one-off investments that increase profits or margins, or increase revenue and market share, but don’t come at the cost of profits or margins. It is hard to convince you that one-off investments are truly one-offs, or that there are no trade-offs other than the investment itself. Your warchest, margins and profits are important to you because they give you independence, flexibility, and resilience.

If you choose growth, you trade margins and profits for revenue growth and market share. In the long-run, you calculate that this is a winner-take-all market, and once you have monopolized it, you will generate enormous profits and recoup your investment. Revenue growth and market share are important to you because if you’re growing faster than your competitors, you are more likely to attract more capital, which will allow you to invest even more to grow even faster, and so on, until you establish a monopoly.

To summarize, there is the conservative approach, and the aggressive approach. If you choose financial discipline, you invest conservatively, sit on capital and profits, and accumulate a large warchest: like a dragon sleeping on treasure. If you choose growth, you invest aggressively, deploy capital, become unprofitable, and require more, and larger, capital infusions as time goes on, but your revenue and market share grow fast: like an all-out-invasion.

Which approach is better? Is there a way to transcend these trade-offs, and resolve the paradox?

A company may be conceived of as a machine that creates value by taking inputs and turning them into more valuable outputs: taking a dollar and turning it into more than a dollar — generating a profit. Profit-generating machines require financial discipline to run efficiently: it is all too easy to take ten dollars and turn them into a dollar; chaos, gravity, inertia, and entropy are the norm in nature, what is abnormal is efficiency and order.

But in an ambitious world, there is competitive pressure to grow faster, and reserves of capital available to finance it. If you don’t tap into that capital, your competitors will, and unless your business is already defensible, you have to secure that capital before they do, accelerate faster than them, reach escape velocity, create unassailable network effects, and establish a monopoly. Even if you have a secret, and have watched well-financed competitors wipe out with badly designed models, you know that once you prove that your model actually works, the world will react to the news like a scientific discovery: in a networked and scaled economy, with winner-take-all markets, every profitable new model is a business explosion, a singularity, and a vicious gold rush follows.

Capital is destabilizing. When you raise $10M, you are expected to spend it to generate growth. Traditionally, capital was required to make resource investments. But today, most capital is spent on talent: and salaries are not one-off or variable costs. Once you’ve spent the $10M, you still have to pay the salaries, or you have to fire people, and if you fire people, you damage the morale and reputation of your organization. So, deploying capital creates dependencies. Even if you deploy the capital effectively, and generate growth, if your profits don’t accelerate more rapidly than your investments, you are forced to raise another round, and do it again. All the while, your dependencies are increasing, and if, for whatever reason, you cannot raise another round, or the market changes, or talent starts leaving: you may find that you’ve built a house of cards. Tragic value destruction follows: what could have been a profitable, high-growth company became unprofitable and went bankrupt in an attempt at hyper-growth.

Investors should care about the “What do you do with money?” question, because if you don’t know how to deploy capital efficiently to create value without destabilizing the financial discipline of your model, you have existential risk. “We’ll figure it out” is a fool’s promise to render and to accept.

Use of proceeds
In theory, if a company is profitable at T=1, then raises $10M at T=2, then spends $10M in capital investments at T=3, then is more profitable at T=4, capital is not destabilizing. If the increase in profits justifies the investment, then the company should keep deploying capital. This is the ideal.

In practice, the fact that most capital investments are not one-time or variable, but ongoing salary costs, makes capital destabilizing. And it also makes it hard to track underlying profitability, because the salaries are accounted for as costs, not R&D investments.

I propose that we recategorize all compensation to our technologies team, including not just engineers, but also product managers and creatives, as R&D investments, not as costs. Then, any capital we deploy to hire and pay tech talent should come out of a limited, transparent sub-fund, set aside for that purpose. To emphasize the dynamic of investment instead of costs, it would be better to make payments annually or quarterly instead of monthly: monthly feels like a salary and an entitlement, quarterly or annually feels like a bonus from a limited fund allocated to a specific purpose. As that sub-fund nears depletion, publishing it transparently should raise the alarm of all its dependents, and focus everyone on whether the investment has indeed increased the profitability of the underlying model. If a strong case can be made, then more capital can be raised or allocated to the technologies fund. This way, the social contract of the organization would be less jarred if a contraction was necessary. And if capital was not replenished, the mentality would be to run the operations of the company profitably without further investment in technology.

A similar fund could be established for sales and marketing costs. Any spending that increases CAC would change our unit economics and decrease our margins, so such “investments” should be forbidden. But hiring expensive sales teams can be justified, if these investments pay back within a 24 month period. This is a classic use of capital to overcome high upfront costs to build a machine that is profitable thereafter.

The concept may be extended towards other investment areas, such as organizing company off-sites, to bring our remote team together for temporary collaborations. A fund would exist. Once depleted, no more off-sites unless ROI can be proven.

The more predictable the business becomes, the more flexible you can be about deploying capital. If we know that, even in a conservative model we have very high confidence in, partner pay will reach $8K/m per partner by December 2020, then we can artificially bring partner pay to that level now, by calculating and financing the difference, which is a limited capital investment, as opposed to an entitlement. Using capital to supplement partner pay is better than digging deeper into gross margins, which is what we’re currently doing. 100% of gross margins go to partner pay today. I propose that only 50% of gross margins should go to partner pay, as per the original model, but that payouts should remain unchanged, and merely be supplemented by more capital. There would be no change for partners, but from an accounting point of view, this accelerates our profitability date and recategorizes costs as capital investments.

But this kind of investment is culturally dangerous: it has to be positioned correctly, both in terms of accounting and messaging. If an investment becomes normal, it becomes a dependency. Dependencies are risks, and enough dependencies can kill a business: against dependencies, we must be vigilant!

As soon as entitlement and capital dependence creep in, financial discipline is lost, and the company’s survival depends on further capital infusions. But if strong compartmentalization is maintained, the company can deploy large amounts of capital effectively, and demonstrate the effectiveness of these investments in the growth of the underlying profitability of the company.

Use of profits
I propose a dividend be established as soon as the company is profitable. However small the dividend, it is psychologically important. Profits exist not just to sit in a company’s warchest, but to be paid out to shareholders: that’s the whole idea. Unfortunately, that idea has been lost, as tech companies justify holding on to profits to finance growth. But this rhetoric falls flat warchests grow absurdly large, far larger than any acquisition or investment could conceivably require. Tech giants no longer have good answers to the question: “What do you do with money?” They sit on it.

Initially, our dividend can be small, as small as 1%. But by the end of the first decade of profitability, at the latest, it should be as high as 50%. I don’t think it should go higher than that, as long as the company has good answers to the money question.

I propose the company create sub-funds for every sensible investment we can conceive of. A taxonomy should be established. There may be sub-funds for every team, discretionary budgets at the disposal of each VP. There may be sub-funds for agent benefits and partner benefits, like healthcare. Sub-funds for off-sites, sub-funds for new equipment, sub-funds for business experiments, sub-funds for everything…

Each sub-fund would be assigned a certain number of percentage points. Every dollar in profit not allocated to dividends would be split into these sub-funds according to these points. That’s how money would go in every month. But for every dollar that goes in, the RP for that fund would only be able to withdraw, say, 60%. So each sub-fund would grow, forever: getting larger every month, without end. As profits grow, the warchest grows, but withdrawals also grow: the company maintains financial discipline, but grows increasingly aggressive.

“The plans of the diligent lead to profit
as surely as haste leads to poverty.”