After selling our last company I was surprised that the acquirer went on an even bigger spending spree just months after acquiring us. As a bootstrapper this blew my mind.
This article helps shine a light on how they pulled it off. They acquired us for the free cashflow the company threw off (uncommon in our industry) and the leveraged that to further their expansion.
I've always looked at accounting as "backwards facing" (meaning it looks at what has happened vs where a company is going) but this article has changed my perspective dramatically.
Agreed.
I didn't really care about the should you / shouldn't you raise money part and the whole first principles thing, but the middle half of the article gave me a lot of things to think about and I am guessing I will be checking out the other content on this site for the next while.
I believe The Goal is where I first read about this idea about cash flow being more important than revenue, in a way that can be easily explained to anybody: you have bills, you have a certain amount in the bank, and then you have in accounting a set of invoices that you have sent out to customers but they have not yet been paid. So that money is “as good as earned” on paper but it’s not yet in the bank. And the problem is not revenue, the problem is cash flow. If you don’t have enough in that bank account, then after paying for your materials and rent for your building and whatever else, you suddenly come up short on payroll. “Please forgive me,” you tell your employees, “we have the money and your paychecks will just be a week late, we are so sorry, this never happens normally.” Good way to lose a lot of your best minds that really make your money—your best salespeople, your best engineers, your hardest workers. They got rent to pay. In The Goal I believe the book points out that most companies that go under don’t have a revenue problem but a cash flow problem, the money isn’t coming in fast enough to pay to keep the company running even though it is coming in eventually.
there are a couple of other ways to look at it that may be helpful to the broader community, one of them is that your interest rate on debt actually sets a time scale for your “indefinite future.” If you have credit card debt at 36%/year compounded monthly that’s 3%/month, flip that to (1 month)/(.03) = 33 months. Now if I ask you “hey, how much is that $20 per month subscription worth to you in terms of present value?” you can answer: that subscription runs out into the indefinite future so it gets multiplied by this time scale and it is worth $660 to me right now. Which is another way to say equivalently that if I bought something right now for $660 I would pay $20/month for the indefinite future. Lots of people don’t realize how much present value they can unlock by just canceling out old subscriptions like that, because the cash flow is not there immediately, but it’s true.
Similarly, I ran into cash flow issues at the beginning of this year in my personal finances. With COVID-19 hitting at around the same time my auto loan asked me if I wanted several months deferral. Are you shitting me right now? Yes, the added productivity and lack of stress from having a floating several hundred dollars in the bank and therefore being able to set up auto-pay (and not incurring late fees on all my accounts) pays for itself and then some. Thank you so much! (Of course the bank is a bank, this is cold hard calculus to them, so I don't feel too bad. Imagine that, too, though! Imagine that if you are in a good cash flow position, as the bank is as covid starts, your reaction might actually be to turn away cash flow: you are a sort of landlord collecting rents and you need to mitigate the risk that all your tenants go broke, they need to be able to keep their jobs for your wellbeing. And then you think of the actual landlords and you realize that the system must have left them relatively strapped for cash if they’re not similarly absorbing some of the shock. And that launches into interesting questions about feedback mechanisms in complex systems and their modes of resilience.)
You can hold your breath only for so long before falling unconscious.
Making a profit requires cash flow management, but managing cash flow does not require making a profit. This article does talk about managing cash flows in a way that involves never making a profit.
First, and tangentially, it's interesting that real estate developers do this all the time.
Second, it's interesting that this article shows not only why cable companies regional monopolies are extant, but also that their continued existence relies on the preservation of those monopolies.
These and other companies that rely on a strategy of unfettered subscriber growth, in this case leveraged as a marketing tool to creditors to acquire additional debt, is no different than a Ponzi scheme. It makes the fatal assumption that subscriber growth can continue ad infinitum.
But, similar to the amount of free energy in a system, the number of potential subscribers remaining is finite. Eventually, cash flows will fail to meet the projections sold to creditors and established as assumptions in their financial models.
Thus arises a situation that remains tenable only as long as subscribers remain subscribed for as long as is required to service the debt outstanding at the time the growth stopped. Because the debt didn't go anywhere. It hasn't disappeared. Today that debt is sitting on the balance sheet of every one of America's cable providers: the direct result of a flawed line of thinking promoted by the author.
Consider the implications. To remove the regional monopolies of the cable companies is to not only destroy their subscriber base, and thus their cash flows, but also the cash flows promised to their legion creditors. Every one of these creditors now has a vested interest in the preservation of those monopolies, having themselves extended and received credit based on said promises of payment.
I propose that, contrary to the statements of the author, the proof presented by their friend is not "framed incorrectly". Rather, it shows something the author doesn't wish to see.
To paraphrase heavily, he's delving into the fact that these are simply different things. Profit, free cash, EBITDA, etc. These have different implications. Particularly, they translate into capital very differently. Ability to borrow. Ability to raise equity. Pay dividends. This translates into radically different trajectories and outcomes.
In 2020 terms, you might also include growth rate, MAUs or the current trendiness of the startup. This also, essentially, translates into real world effects. Big ones.
Most people, including many "business people" don't quite realize the implications of a positive or negative float. The difference between a -20 day float to a +20. With a positive float, growing itself is cash generative. With a negative float, growing is cash consuming. A business might grow, produce less profit but more cash.
Outside of accounting, there's a tendency to dismiss this nuance as trivial and convergent in the long term. In reality, the future never comes. It's always the present.
So long as you're running a profitable business, cash flow management does seem to be a pretty trivial problem. The difference between positive and negative float is just a loan. And, if you can show a bank that cash is guaranteed to come in at a future date, you will have no problem bridging the gap with a loan or line of credit.
> why cable companies regional monopolies are extant, but also that their continued existence relies on the preservation of those monopolies.
it's a moral judgement about monopoly that you imply (it being bad). But the article makes no such judgements at all, and that by bringing in this you direct the argument towards one of ethical behaviour, rather than logical deduction and application of such for businesses.
> no different than a Ponzi scheme. It makes the fatal assumption that subscriber growth can continue ad infinitum.
That's not the defining feature of a ponzi scheme - which is that it is using the investment of new investors to pay out existing investors (and only doing so, rather than undertake a business). The cable companies _do_ produce something, that of cable provision, maintenance and services. Even if they assume infinitely growing subscriber base, it is not a ponzi scheme.
And growth doesn't have to be ad infinitum - just large enough to last long enough until the next disruption (e.g., starlink might disrupt cable companies). There's nothing wrong with a company dying - the bag holders and creditors who hold them last will lose out when they are disrupted, and this is a good outcome. Investment has risks, credits has risks.
I'd love to read something more about this line of thinking from someone more knowledgeable in the area.
[1] I think, but maybe not! It would be interesting to trace the "capital lineage" (made-up term) of various successful businesses from the late 1800s through today, for example.
Isn't the exact opposite true?
I work with businesses which import goods and sell them. The vast majority of these make a steady profit without any thought to cash flow management. Accounts receivable are a mess, payment terms are long and they have a lot of cash tied up in working capital - but they are making enough of a profit to make up for this.
In contrast, you can stay in business making a loss with clever cash-flow management, but not forever. Equity will decrease year over year, and new sources of cash (lending, selling shares) need to be found to finance the continued operation of the business.
I disagree with the framing of both articles somewhat. The question should be "What is limiting your growth?" Is raising money going to distract you from making a product customers need and love? Then skip it. If being too small for enterprises to take you seriously is a blocker then you'll need to raise money.
Edit: /s
edit: woosh
There were some old ideas about how an interplanetary civilization would work, and in particular shipping, and now I understand better why we are still stuck on the ground. We are a long way from having ships so cheap that we can have them just floating around on ballistic orbits.
"Malone’s entire strategy was built around a single fact: that you have to pay up front for cable systems, but then earn back your money via a stable stream of cash for years and years afterwards. Notice how this extreme demand for capital drove Malone to embrace debt, over other sources of capital. Now notice how closely this resembles the Software as a Service (SaaS) business model, which is the primary business model in today’s startup world."
Gotta spend money to make money. But I wish he had commented further on businesses that do this incorrectly, based on wishful thinking. He talks about the strengths of TCI, with an engineered "loss" that saves them money on taxes, or Amazon, whose decades of "unprofitability" helped them to build a long-term-profitable empire.
But what about Uber or DoorDash? Burning investor cash, chasing long-term revenue that will never come? How on Earth are they keeping this scam going? Why do people believe in it?
Another factor is your vendors. The cable business expanded (and expanded into) an existing ecosystem: tv mfrs, film studios etc. The restaurant already had vendors it could afford to lend 300K up front knowing that they would deliver reliably over the next four months. Also an operating business.
Likewise Amazon.
But the Ubers etc start without a viable business. In fact they start by skimming the cream of an existing market. The problem is, you get good at what you do. If you don’t build a viable business it becomes harder and harder to move your company into that mode as the environment changes.
Give an example from the telecoms world - I had a friend who worked for a telecoms startup, bootstrapping for funding and undercutting the local incumbent by using better technology. The incumbent responded by offering free service for a year to all the startup's customers if they switched back. An unsustainable move but hardly a bad decision - it had very deep pockets, and my friend's employer ran out of money first.
If Uber didn't have any competition, it could raise prices to profitability today. Investors still believe in it because they believe that Uber, like the Telecoms incumbent in my anecdote, can bankrupt the competition and then have its way with the consumer. Investors in Uber's competitors presumably have their own reasons for a similar thesis.
Or as some would call it, growth investing.
Sure they don't have subscription like predictability for their revenues. But they have a lot of data, and machine learning, so they may get pretty close in predicting how many people will order steak next month.
And let's say they partner/own a chain of ghost kitchen restaurants who offer a large variety of food(which is a much more competitive business model than restaurants). And that chain can suddenly get steak(and the other stuff), for half the price ?
Amazon FOMO.
Investors are so butt hurt they didn't believe other investors about Amazon's razor thing margins and now its a 1T company.
I think Uber/DD are VERY different though. I don't see the potential either.
More generally, the "flaw with first-principles analysis" is generally as you'd expect. Your premises might appear true when they're not, or your inner reasoning structure might appear valid (logical definition) when it's not, or you might be making assumptions (in the omission of other premises) that are false. It's just really hard. So that's where a slow painstaking process of repeated review will help you. And it's also not a panacea - first-principles analysis does not guarantee your solution, it's more a process that helps you surface your assumptions and learn your argument.
All else equal (including the decision maker), a positive float business will tend to be more growth oriented than a negative float business. In theory, not so much. Float is just a type of capital (working capital). In practice, it's different.
Other people's money businesses will tend to take more risk. Publicly listed companies tend to be risk averse and quarterly report focused. These aren't carved in stone. Some publicly listed companies (eg amazon, tesla) have sailed against this wind. But, the wind is still there.
For a personal example, take the difference between having a trainer vs exercising yourself. It's theoretically possible to do the same training and have the same results, or do better. The tendency though, is meaningful, and when you pay a trainer there's a tendency to be disciplined.
Returning to the "friend's argument," it is observably true that structural constraints affect business owners.
Not all problems that startups are solving are equal. If you want to build a Tesla competitor you're not going to be able to do that without raising money (unless you happen to already be a billionaire).
If you are building an app, yes the author may be right sometimes, where you can often find product market fit without the need of a large influx of cash.
Now, when evaluating the pros and cons of the "should not" half, you have an actual relevant benchmark to compare to. It doesn't matter how awful an idea it is to raise capital in some absolute terms. What actually matters is whether it's worse than what you'd have to do instead.
Almost all decisions are about choosing one from several options, so if you find yourself making an absolute evaluation, that's a sort of "decision smell" that you should instead be doing a comparative analysis.
(Kokonas again): That’s what I said! I went, “I’ll pay you $20 if you tell me why.” And he said, “Well, it’s very simple. I have to slaughter the cows, then I put the beef to dry. For the first 35 days I can sell it. After 35 days there’s only a handful of places that would buy it, after 60 days, I sell it $1 a pound for dog food.” So his waste on the slaughter, and these animals’s lives, and the ethics of all of that, are because of net-120! Seems like someone should have figured this out! As soon as he said that, everything clicked, and I went “We need to call every one of our vendors, every time, and say that we will prepay them.”
It seems like the value to the beef vendor is not from actually receiving the cash flow earlier, but rather from just knowing the order quantity in advance to optimize inventory.
1. Beef that sells within 35 days at regular price 2. Beef that sells within 60 days as a discounted price 3. Beef that sells after 60 days for a loss.
The beef's regular price has to be somewhat higher than in an efficient market because some of it will be sold at a loss.
Getting an order for a set amount per week allows him to disregard the losses he normally has from beef that has to be sold for dog food, because the purchaser is guaranteeing their quantity, smoothing their expectations on how much beef to purchase in the future.
It's possible that at $18 a pound, without any waste, he's making the same margins/profit as he would at $34 with some waste.
"..But I think there's a more pernicious form of failure, which occurs when you reason from the wrong set of true principles. It is pernicious because you can’t easily detect the flaws in your reasoning. It is pernicious because all of your base axioms are true...In other words, the only real test you have is against reality. Your conclusion should be useful. It should produce effective action."
reminds me of the quote by Eric Zemmour:
"When principles are in contradiction with society’s survival then the principles are false, for society is the supreme truth." [1]
[0] https://commoncog.com/blog/how-first-principles-thinking-fai...
[1] https://www.theamericanconservative.com/dreher/eric-zemmour-...
For example, one could argue something like this: Even though increased access to other people's money can cause founders to make irresponsible decisions, raising money has other advantages that tend to offset this.
Well, empirically, check whether the conclusions you get, seem to hold up to reality. The author's experience was that taking investment $$ was necessary (or at least often useful) in a startup, so this put him on the lookout for what missing first principle would explain this.
It doesn't mean axiomatic logic isn't useful, it means that just because the logic seems sound, doesn't mean the conclusion is reliable, because there could be missing axioms (in this case, that profitability is the objective of a company, when cash flow is a more fundamental fact and profit is often either present or not depending on how you do the accounting).
1. Not raising money give you more skin in the game (valid observation)
2. Skin in the game is an advantage (valid observation)
3. There exists at least one advantage of not raising money (valid conclusion)
4. You should not raise money (NOT VALID conclusion)
A sound argument is one whose premises are also true. This is where the quoted argument in the article fails. The premises either are false or don't apply to all startups. This is basically what the author means by a argument that is missing premises. It's not really that a premise is missing, but that without additional into it may seem like the argument is sound,but with additional into you realize it is not sound and therefore leads to a different conclusion instead.
>debunk axiomatic logic itself
He's not though. Your assumptions can be wrong, even if your incremental logic is correct according to the first principle. He's saying the correctness of axiomatic logic will lead you down the wrong path.
>Isn't it sort of like Gödel's incompleteness theorem
Forgive me for being curt, but no, this is absolutely nothing like either of Gödel's incompleteness theorems.
It reminds me of a quote by the WWI French field marshal Foch - "My center is giving way, my right is retreating, situation excellent, I am attacking."
Compare https://en.wikipedia.org/wiki/Hollywood_accounting , in which all movies show a formal loss and the concept of "profit" as opposed to revenue exists only to scam parties who agree to be paid out of profits.
- I believe we are approaching unsustainable levels of public debt
- If a CEO were offered debt on the terms that the US Government gets, they would be fired for not taking it
- If a CEO allocated funds the way the US Government does they would probably also be fired.
- Using debt for growth capital is great
- Using debt to get better terms from suppliers can be good too; particularly when you have access to more favorable credit than your suppliers do.
If the US were investing in infrastructure, I would be much less worried about how much of it is debt financing. However (and this is partly a function of it being a democracy), there's not much rhyme or reason to how the capital is allocated with regards to plans for actually growing the tax base to a point where the US will be able to service the future debt.
The cynic in me wants to say that the government acting like this is merely democracy reflecting a public that finances their lifestyles with debt, without plans for increasing future income to service said debt.
Problem is government finances work completely differently in ways that are so fundamental as to make the analogies completely useless.
It would take more than an HN comment to enumerate every subtlety of why that's the case, but if you were to start you could probably begin with the fact that a government can print money and extract any resource it wants from any entity it wants to at any time at the barrel of a gun, and you and your CEO friend can't.
If you had to choose a single core task for the CEO of a company, it is to create free cash flow and decide best how to spend it, aka capital allocation.
Book Source: https://smile.amazon.com/Outsiders-Unconventional-Radically-...
https://en.wikipedia.org/wiki/Modigliani%E2%80%93Miller_theo...
In essence from my perspective, the axiomatic approach is like "theory" and the operational approach is like "experiment" or "observation" in the sciences.
There's a very good reason why experiment/observation trumps theory in the scientific method.
If you're dealing with psychology, economics or such experimental observations can have the exact same problem. They're true in this case, at this level of abstraction or otherwise "not really wrong but not — but not as useful or as powerful as some other framing".
Framing is the key point here. What's in model or not. What questions are your trying to answer. etc. The harder the science, the less flexibility scientists have in framing.
Know your WACC. https://www.investopedia.com/terms/w/wacc.asp
TCI wasn't a startup. So it can't be compared to 2020 startups in this way. Because...you are starting the comparison at a different point in the companies life.
This is comparing markets almost 50 years apart. Motives and reasoning just aren't what they used to be.
TCI had assets to borrow against. TCI had a monopoly in their areas, and existing customer base. They gamed the tax system for profit. They weren't looking for over valuations from Wall Street with a view to selling out for the $$$
Ok I'm bored now
1. Startups are risky.
True.
2. Raising capital to do a startup reduces skin in the game (you’re spending other people’s money, after all).
Arguable, but not a given. Raising capital does not eliminate risk, especially if one has their own money in it, and/or are using it as a job. Just because someone else invested doesn't necessarily reduce my incentive. I lose money, time, face, and opportunity with or without investment.
3. Once you have less skin in the game, it is easier to make bad decisions. The author argues this is due to a) having a capital buffer to cushion you, and b) having more time to waste.
100% false. It is no easier or harder to make bad decisions with outside money. It is ALWAYS easy to make bad decisions, having more money simply makes it easier to make costlier bad decisions faster. Buying real estate in late 2006 was a bad idea regardless of whose money you used. If anything, having that outside money means you have people to be accountable to, people to run decisions by, and thus it's HARDER to make a bad decision.
How many stories of startup founders blowing money on booze, cocaine, prostitutes and lavish parties do we need to read before we realize that startup founders are humans and behave, well, like humans always have?
> Therefore: startups shouldn’t raise money.
The therefore doesn't apply. The original post makes a good argument that there is a certain detriment to raising money. But he doesn't actually proof that this detriment outweighs the benefits of raising money.
Unfortunately I’m just a software engineer, who has never been able to put this in practice.
Surely that is a proposition that might not be entirely correct?
First because less skin in the game doesn't make you make bad decisions, it just makes it easier. As such every argument following this point is destroyed by "assume we make good decisions anyway", which is just as valid as "assume we make bad decisions from now on".
Second, because your skin in the game probably doesn't change, instead the total amount of skin in the game gets larger. Most founders (at least in the early days) have invested enough of their own money AND time (more valuable than money to founders!) that they have enough skin in the game as to not find it easier to make bad decisions.
Third, because the investor now has skin in the game and has incentive and leverage to prevent you from making bad decisions. You can be forced to make better decisions because of this.
There are many reasons to not take investors, that is a complex trade off decision. However your less skin in the game is not one of them.
But the dimensions of the game grow as well, and that is where mistakes can be made.
Some founders are probably better bosses/managers in a collective of five than in a collective of fifty. If the company grows slowly, they may improve their skills/catch up. If it grows in a sudden leap, which is well possible with a large injection of cash, the space for making bad decisions from ignorance or lack of experience grows as well.
If, for example, your COGS approaches half your unit price and you use BTS, you'll have almost no chance of getting your business off the ground. But with BTO your cash flow explodes.
https://docs.google.com/spreadsheets/d/15JZyPEYJxNHEWTPFmxOI...
[1] https://commoncog.com/blog/how-first-principles-thinking-fai...
Malone cut costs by reducing tax liability, getting better prices on programming, and increasing the subscriber base (revenue). What's that word for revenue minus expenses again?
A more honest explanation: Accounting depreciation != the actual change in value of things, and the cash flow statement can let you know when GAAP accounting isn't giving an accurate picture of success.
And about Malone's insight on leverage: Leverage ups your return on investment (when things don't blow up). Paying interest doesn't help you hide money from the tax man any better than setting dollar bills on fire would, but leverage can make big things happen from small amounts of investment.
This is the golden line. The richest person on Earth (Jeff Bezos) followed this principle religiously since Amazon's inception (or should I say, Cadabra's inception?).
The reason to to take the money now from venture is because it is more valuable now than it is later. The way this author is describing this though reminds me of the folksy, whimsical way some business books are written which makes this article so applealing: e.g. The Goal, How to Win friends and influence people, etc.
I just happened to be trying to learn more about David Friedberg before stumbling upon this article and I watched this lecture he gave on entrepreneurism which I think complements the contents of this article incredibly well. Highly recommend for those looking to learn more
> Raising capital to do a startup reduces skin in the game (you’re spending other people’s money, after all
Peoples most scarce resource is the time they are investing and I have yet to meet a founder that doesn't do 80 hour week to make the wave next week.
The only correct conclusion from those axioms is:
There are advantages to not raising money.
the problem with the argument from first principles that the article attempts to refute, is that the "first principles" given carry an implicit assumption that the minimum viable product is a a null product.
If in reality the mvp or, later, the infrastructure for growth take more to create than the resources you command, you need to raise capital.
The "first principles" also ignore time to market and competitive pressures. They are more "spherical cow on a frictionless plane" principles than actually useful ones.
But some problems can only be solved with VC money. Because of time limitations.
You may only have a small window of opportunity to capture a certain market.
If you grew linearly, and built up product idea A, in order to fund product idea B, in order to fund product idea C, then by the time you’re done with product idea B, a decade may have passed by. You’ve also grown older, and may not have the energy of your younger self anymore.
Also, a competitor, one with a larger funding pool, may have jumped in and captured that market, right in front of you.
I didn’t understand the value of either until this article, but they seem related.