The number one reason brilliant companies with stellar products and services fail is that they run out of money. They have rousing press. They have fervent customer acceptance. They revel in month-over-month increases in traffic and revenue. And they have no idea what is influencing their bottom line.
The greatest challenge in building a company is determining where to focus our valuable resources – time, energy, and capital.
Let’s look at four basic metrics that will help us gain control of our bottom line and in turn help us make money: customer acquisition costs, value of customers, viral coefficient, and DAU.
Customer Acquisition Costs and Value of Customers
Macrohard Software just completed a new campaign, which set them back $30,000. But they are not worried because the campaign yielded 100 new customers, who have each signed up to pay $10 per month to use their software.
Was this the most effective use of their capital? The customer acquisition cost was $300 per user. The value of the customer is $120 per year. This means it will take over 2 years to recoup the $300 they spent.
Clearly, this campaign was not as effective as it could have been. When we understand the true cost of each customer and the real value they will yield, we will have greater visibility into our bottom line.
Viral Coefficient
OliOrange designs yoga wear for the most discerning yoginis. They’ve enjoyed robust sales online and are ready to take their experience into the physical world. Knowing that a retail build out is expensive, they set out to gather data to ascertain the most lucrative location. They emailed 100 promotional “refer a friend” codes to each of their two largest markets – Brooklyn, NY and Corte Madera, CA – and analyzed the results:
The 100 emails sent to Brooklyn, NY customers were zealously distributed, yielding 100 new customer purchases online (a viral coefficient of 1). The 100 codes sent to Corte Madera, CA barely saw the light of day, yielding 50 new customer purchases online (a viral coefficient of .5).
OliOrange set up shop in Brooklyn, NY knowing that their Brooklyn, NY customers were more passionate about their brand.
Spending money on less than enthusiastic customer segments deteriorates our bottom line. When we understand where our loyal customers are, we can invest our resources appropriately, enhancing our bottom line.
DAU
Live Forever is a popular site providing daily tips to help users live longer, happier lives. Unfortunately, as they move into their third year of operations, they are still not able to breakeven, as revenue fails to cover the expenses of running their site.
They monitor their traffic and are pleased with the general increase in the number of people who come to their site. However, despite their strong traffic they have never been able to build a cohesive community, which negatively affects their ad revenue. They investigated their daily active users (DAU) and monthly active users (MAU) and found the following:
Their daily active users were 1 million, yet their monthly active users were a staggering 10 million. Only 10% of their users visit the site on a daily basis, which is paltry considering Live Forever is a site that provides daily tips.
They studied sites that enjoyed 50% DAU/MAU rates, such as Twitter and Facebook, and revamped their structure and content to provoke daily viewership. Since their revamp, they’ve been able to increase their monthly ad revenue by 40%, as their viewership has galvanized into a cohesive, active community. This increase in revenue has helped them to achieve profitability.
If we don’t know what is wrong, we can’t fix it. When we monitor our performance based on relevant metrics and compare our findings against our peers, we can enhance the user’s experience and in turn enhance profitability.
In summary, reviewing a few basic metrics can help us gain control of our bottom line and make money. When we understand the true value of our customers, we don’t overspend on acquiring low value customers. The ability to hone in on our most enthusiastic customers allows us to funnel our resources into the most lucrative customer segments. When we measure and benchmark our retention to industry leaders we learn from their success and reap the rewards.
I’d love to learn how you are making money by utilizing metrics. Leave a comment below.
Use code SPRING13 to take my Udemy online course, Finance for Startups, for $79 (originally $99).
A winner is a loser who was relentless in his or her pursuit of success.
Life is hard. 80% of companies started today will fail. As entrepreneurs, we must constantly arm ourselves with the tools needed to maintain our sanity and thrive. We must constantly remind ourselves that the darkest hour is just before the dawn. We must think like a winner when we feel like a loser.
When We Think Like a Winner We See The Opportunity, Not the Obstacle.
A winner prepares his or her mind and body for success:
Meditate – Thoughts create actions, actions create reality. Begin each morning focused on gratitude for what you currently have and visualize the world as you would like to see it. Winners are grateful, not resentful. Winners pour their energy into the good in their life and visualize all the possibilities the world could potentially offer.
Tip: Meditate for (at least) 5 minutes every morning or whenever you need a mental reset.
Connect – We become the people we spend the most time with, so select your circle carefully. Surround yourself with inspiring people. Kindly eliminate negative people from your life.
Tip: Build a circle of people who inspire you to be your best and provide a platform for you to honestly express your fears and concerns about life.
Exercise – Exercise helps to clear the mind and stimulate creativity. If you are stuck on a difficult problem, take a walk. New ideas will flow through your mind, your energy level will increase and you will be more productive when you get back to work.
Tip: Find time to exercise, whether it is walking or biking to work or visiting the gym during lunch or playing sports in the evening.
Laugh – Laughter is proven to decrease stress and increase your immune system. Try this right now: smile. A smile turns into a laugh. A laugh distresses your mind and energizes your body. In fact, a doctor in India, Dr. Madan Kataria, created laughter yoga to combine two powerful tools – laughter and stretching – and people around the world have incorporated his approach.
Tip: The next time you are feeling tied down to your computer, take a second to read Buzzfeed and stretch.
Eat – Food can give us energy or take it away. The opposite of a food coma is a well-fed, active mind. Develop an eating plan based on foods that stimulate your body and mind. Fruits, vegetables, nuts, legumes, whole grain, and water are a good start. Reduce or eliminate; sugar, alcohol, fried and processed food.
Tip: Utilize free tools, such as MyFitnessPal, to analysis your food intake.
Check Yourself Before You Wreck Yourself
Stress, depression, and anxiety are normal parts of life. When handled correctly, they are harmless. If left untreated, they can lead to self-destructive behavior including substance abuse and suicide.
According to a study completed by the Substance Abuse and Mental Health Service Administration in 2004, approximately 10% of Americans were dependent on alcohol and/or drugs. Nearly a decade later this problem persists as people turn to prescription drugs and alcohol to solve their problems, leading to an increase in drug overdoses and alcohol related deaths.
The Ugly Truth
The World Health Organization conducted a study in 2009, concluding that the current average world suicide rate was 10.07 per 100,000 people, while the US rate surpassed this rate with 11.10 per 100,000 people. To put this in perspective; Peru held the lowest rate at .85 and Belarus claimed the highest rate at 36.8. An elementary understanding of each culture makes the contrast crystal clear. Existing in a system with excessive stress and limited resources leads many to deep despair.
If you’re feeling stuck, please know that you are not alone. It is natural to feel overwhelmed while you are building a company. You are not the first person to feel this way.
• There are 20 failed suicide attempts for each successful attempt.
• Every 40 seconds somebody dies by suicide.
• Worldwide suicide rates increased by 60% in last 45 years.
There are several organizations that can guide you through a rough patch. I’ve listed the most well known below. Feel free to add any I have missed in the comments.
While advising entrepreneurs over the past six years, I observed distinct patterns amongst insanely successful entrepreneurs. I observed that those who experienced the most dramatic trials and tribulations in their formative years, were the best suited for managing chaos as CEOs. How can this be?
It is logical that a lifestyle of self-parenting, living with less and dealing with severe disappointment would yield an adult who is able to handle the, often difficult, role of building a company.
Below are the most common traits I observed:
Resourcefulness
If you were often required to prepare your own meals, organize your own activities or wash your own clothing, you were preparing yourself to become an entrepreneur.
When building a company, we are often attempting to do much with very little. We may start with a co-founder and a few employees, but we are most definitely running with a deficit in our skill set. This requires us to be able to figure out things on our own and wear multiple hats.
I often see this trait in entrepreneurs who craft brilliant, inexpensive customer acquisition campaigns by cold calling, asking for favors and networking their way in front of their target audience. They don’t need $100,000 for a CMO. They have a million dollar attitude. Simply put, they get it done with minimal resources.
Intellectual Curiosity
If you were raised in sub par conditions, chances are that your education did not come via expensive boarding schools and private tutors. If you had to trek 5 miles to the public library to enrich your mind, you were preparing yourself to become an entrepreneur.
Entrepreneurs who are innovating new technology or products will not have all the information they need at their fingertips. They will need to be comfortable aggressively seeking information. If education is the key to prosperity, a healthy dose of intellectual curiosity is the fuel needed to prosper.
I often see this trait in entrepreneurs who are able to extract knowledge through self-constructed data. If the information they need does not exist, they create it.
Faith
If you were forced to overcome difficult situations in your formative years, and emerged stronger, you were preparing yourself to become an entrepreneur.
As entrepreneurs we need to be well equipped to handle the ups and down and uncertainty of building a company. We need to remain calm during difficult times and trust that we will find the answer.
I often see this trait in entrepreneurs who have been trumped by a competitor, yet fail to see it as the end of the road. In Only the Paranoid Survive, Andy Grove eloquently calls Intel’s failures an inflection point. Of course, it is easy to be optimistic when you have already won some heavy battles at an early age. By the age of 20, Andy Grove overcame a near fatal encounter with scarlet fever, escaped a concentration camp and fled a Communist regime.
The most common traits of an insanely successful entrepreneur can be summed up in two words: battle tested.
“Here’s to the crazy ones, the misfits, the rebels, the troublemakers, the round pegs in the square holes… the ones who see things differently — they’re not fond of rules. You can quote them, disagree with them, glorify or vilify them, but the only thing you can’t do is ignore them because they change things… they push the human race forward, and while some may see them as the crazy ones, we see genius, because the ones who are crazy enough to think that they can change the world, are the ones who do.” Steve Jobs
Did I miss a trait? Let me know what traits you’ve observed in insanely successful entrepreneurs.
Venture capital investing decreased by approximately 30% from 2011 to 2012.
This left many companies unable to secure funding. So, where do companies go when VCs say no?
We all know about crowd funding, but there are several sources of capital that are rarely discussed: revenue-based loans and asset-based loans. Both types of loans are similar to venture capital in that they work best with companies that have demonstrated potential for strong future growth.
Revenue-based Loans
Revenue-based loans have been around for decades, under the name royalty-based loans. Recently, this type of capital was reintroduced through Lighter Capital, a fund run by serial entrepreneur Andy Sack.
Revenue-based loans work well for companies that have solid revenue and healthy margins, as the loan is repaid as a percentage of future revenue. Unlike a bank loan, the revenue-based loan sets the monthly payment as a percentage of monthly revenue. This is ideal for companies who may not have smooth revenue streams. If they make zero revenue in any given month, their monthly payment is zero.
Arctaris Income Fund offers a hybrid version of the revenue-based loan in addition to the standard revenue-based loan. Companies are able to pay monthly payments of principal and interest, plus a small royalty on revenue.
Asset-based Loans
Asset-based loans have also been around for decades and have a wide variety of offerings. The one thing all asset-based loans have in common is the underlying need for collateral (read: assets).
The most commonly used asset-based loan is factoring, which is the exchange of invoices to allow for better cash flow. For example, if you manufacture clothing but need capital to produce the line, you may be a candidate for factoring.
Rosenthal and Rosenthal is a commonly used firm in the fashion industry. They purchase invoices from customers who need capital to manufacture merchandise that has already been ordered and invoiced. Once the companies deliver the merchandise and receive payment from their client, they repay their loan.
Of course, there are fees involved. A revenue-based loan ranges from 20% to 40% per annum and an asset-based loan ranges from 2% to 10% of the invoice amount. These fees may seem high, but keep in mind that you have not diluted your company’s equity as you would have by giving equity to a venture capital fund. Most companies use revenue-based and asset-based loans as a short term financing strategy. It allows them to grow their companies without diluting or giving away control of the company.
Have you used either source of capital? Let me know in the comments.
I recently created a workbook and spreadsheet tutorial titled, Master the Finance Game: A Guide to Building Financial Models, Valuing Companies, and Raising the Right Type of Capital, which focuses on selecting the right type of capital. You can read more about it at www.atelieradvisors.com/growth
One of the top reasons companies fail is that they run out of money. That seems easy to avoid, right? Oddly enough, many entrepreneurs do not have clarity around their revenue sources and even fewer have a strong grasp of their operational costs.
How can so many brilliant and tenacious entrepreneurs fail to get a clear picture of their business operations? Unfortunately, most entrepreneurs dread building financial models, as the process is rarely laid out in an easy-to-follow format. I want to change that. I believe that all entrepreneurs can quickly and easily get a handle on their financial operations.
Let’s take a look at the construction of an easy-to-follow financial model.
Traditional financial statements include the income statement, the balance sheet, and the statement of cash flow. We’re going to focus on the most critical aspect – the income statement.
The income statement is important, as it will allow you to develop and analyze your revenues and expenses. This is the thrust of what we want to understand as business owners. How much revenue flows through and how much does it cost?
Revenue – everything that comes in through sales
Cost of Revenue – all expenses associated with each revenue stream
Gross Revenue = Revenue – Cost of Revenue
Research and Development (R&D) – all expenses associated with developing your product or service.
Sales, General, and Administrative (SG&A) – all expenses associated with maintaining, promoting, and selling your product or service.
Operating Revenue = Gross Revenue – R&D and SG&A
Interest Expense – interest paid
Tax – generally 30% of taxable income
Net Income = (Operating Revenue – Interest Expense) x Tax
If you have $100 in revenue and $30 in cost of revenue, you would have $70 in gross revenue or 70% gross margins. If you spent $10 on R&D and $30 on SG&A, you would have $30 in operating revenue or 30% operating margins. If you paid $5 in interest, you would have $25 in taxable income. Uncle Sam would take $7.5 and you would have $17.5 in net income of 17.5% net margins
You keep $17.5 from every $100 you make. This is a healthy company.
If your net margins are negative for a long period of time, you want to reassess your operations. The average company should attempt to break even by year two and achieve net margins greater than 10%. Of course, there are certain companies that fall outside of this range. Typically, companies that derive their revenue from ads take three times longer to reach profitability.
The one item that you should always include from the balance sheet is cash. View the amount of cash that comes into the company each month, against the amount of cash it takes to run the company each month. This will give you a clear picture of your operations.
If you have questions about building financial models, feel free to leave a comment.
I recently created a workbook and spreadsheet tutorial titled, Master the Finance Game: A Guide to Building Financial Models, Valuing Companies, and Raising the Right Type of Capital, to teach entrepreneurs how to create a streamlined version of the traditional financial model. You can read more about it at www.atelieradvisors.com/growth
In my past six years of advising early-stage companies, I have come across a myriad of founders who fear the F word. Finance should not be feared.
Understanding finance empowers you to build your company, motivate your team, attract customers and secure capital. So let’s dive in!
The most critical aspect of financial statements is the income statement. Understanding your balance sheet and statement of cash flow is helpful, but we are going to focus on what is critical — how will you make money, how much will it cost you and how will you track it?
Get Rid of the Box
The presentation illustrates four basic revenue models. You are not confined to these structures. Your job is to research your target audience and determine the best way to deliver your product or service to them and at what price. Five years ago, nobody was renting their car by the hour. Don’t be afraid to rethink existing revenue models. The pricing mechanics of your product or service are determined by what the current market will bear.
1) Get the Facts
We want to know what we are getting into before we start. Do you think you can build a company similar to Facebook? It should be easy to get people to sign up for a free profile and post interesting content. Actually, take a look at the amount of capital that is required to build a company that derives revenue from advertisers.
As you see in the presentation, it took about six years and $280 million for Facebook to reach profitability. This revenue model requires extensive resources and time.
Maybe you decide you will just build an app. That should be easy, right? Yes it is easy to build, but how will you monetize it? Poshmark, an innovative fashion resale company, was able to solve a huge problem at a price point that was substantially less than the alternative (consignment stores). They brought the experience in-house by creating in-app shopping parties, which yield 40% of their sales, and allows them to better control the user experience. To make the experience even more enticing, they handle all shipping materials and fees.
As you see in the presentation, if we assume that merchandise is sold at 50% of the initial value, this model could potentially yield approximately $7,475,000 in 12 months. This model has required $3.5 million thus far. Perhaps this model is more aligned with your appetite for risk.
If you want to sell merchandise online, you can do so as an e-tailer or as a marketplace. Unlike Poshmark, which is a marketplace as they do not purchase and hold inventory, Fab curates hard-to-find inventory. The Fab model requires more capital, but if done well can be a great site.
So by now, we see the broad continuum we are working with. Doing just a bit of research can really help us refine our financial strategy and increase our chances of success.
Keep in mind, if you take venture capital dollars you should be prepared to sell your company or file for a public offering. If that is not what you had in mind, determine a financial strategy that you can sustain on your own. More on this later.
2) Stay Alive
Most companies fail because they run out of money. Pretty simple, right? Actually, you would be surprised by the number of companies that build, but don’t budget, for growth. You have heard it before, “We don’t need a business plan.” You may not need a business plan, but I believe you need to build a business model and that business model should include a well-researched financial strategy.
Many people believe that they will “go viral.” That’s a commendable goal but how much does that cost? Perhaps you are Munchery and you send out invites that offer a free meal plus a bonus meal if you get 15 friends to sign up. I believe this is a brilliant strategy as everyone loves free food. But keep in mind, there is a cost associated with delivering this perk.
Your product or service may not have the ability to deliver a delicious meal, so how will you entice your target audience to get on board and share with their network? Make sure you have estimated this cost in your budget before you utilize this strategy. It is critical that you know how much you will give away to get the actual sale. You can give away $5 bills all day. At some point, you need to make money.
You must understand what motivates your target audience. Why do they need your product or service?
Customer acquisition cost is only one component. Make sure you understand other costs associated with running your type of company. Search www.sec.gov to review historical financials of similar companies. You can also pull together estimates via company interviews, blogs and other resources.
You do not need to spend a lot of money to gather data for your revenue and expense assumptions.
3) Keep Your Mind on Your Money and Your Money on Your Mind
Your goal is to acquire, engage and retain. Similar to our revenue model example, there are numerous ways to measure your company’s performance. Develop a system that works for your specific revenue model.
If you have a user-based model, you will want to understand how many users are coming through each campaign, how often they are engaging and how long they stay. It is one thing to get the user via a free account, but you should be as focused on getting them to visit often and engage for life. Facebook and Twitter have high engagement rates, with more than 50% of users logging in daily and spending 700 minutes or more per month.
Facebook and Twitter have high engagement numbers because they provide critical news and information to the user. Does your service invoke users to provide important content that is timely?
If you are building an app, you will want to understand the relationship users have with your app. If you monetize via in-app purchases or advertising, measure to ensure that your monetization rate is consistent with your industry. The average in-app purchase is $14 and over 70% of apps monetize via in-app purchases, as opposed to advertising. It is critical that your app motivate the user to further spend as advertising revenue is growing, but is not currently as lucrative.
Games are notorious for strong in-app purchases as players tend to bond with the competitive nature of the game. Is your app delivering a compelling experience that motivates users to continue usage?
If you have a subscription-based model, you want to understand how many users sign up beyond their 30-day trial or convert from the free account. As the free trial ends, reach out to understand why they didn’t make the transition to a paying customer. Is the monthly rate too high? Would they be interested if your offering had more robust features? Some of your free users may never convert, but it is important to communicate your value proposition on a regular basis as your users’ needs will change over time. LinkedIn has done a great job of continuing to increase premium services and communicating their value to users.
Services that deliver tangible value (save time, save money, increase health, increase wealth) have a stronger retention rate with users. Is your product or service enhancing the user’s life in a measurable way?
What’s it All Worth
Another important data point is valuation. By quickly estimating the value of your company, you can assess whether there will be interest from the venture capital community. Always use industry data to determine your company’s valuation range. Find the revenue multiple (transaction value or valuation / revenue) and apply it to your company. Do not rely on public comparables (they are too few) and discounted cash flow (you may not have positive cash flow) to determine valuation.
Not All Money is Equal
Develop a plan specific to your company’s goals. This includes your funding strategy. If you do not plan to sell your company in five years or file for an IPO in ten years, you should not pursue venture capital. There are other routes, such as loans or crowd funding.
If you have questions, feel free to reach us at [email protected] or comment below.
