Why Positive Cashflow Matters
avc.com
avc.com
This article talks about what negative cash flow means for the company. But what does it mean for the investor? A company that cannot go cash flow positive is worth zero - the value of the company is max(all future cash flows discounted by the interest rate curve, 0). The max(, 0) comes from the concept of the limited liability company.
Investments in machinery almost invariably depreciate significantly the moment they are bought, and salaries paid to personnel, electricity to power the lights in your office building, money spent on legal, etc, all lead to zero assets.
It can happen if most of the assets are products the company made, and the company can produce them below market value, but then, why would it have have products in store, and not sell them?
There are exceptions, but they’re easily recognized. On the one hand there’s seasonal demand: companies growing Christmas trees, or producing umbrellas, hockey skates, etc.
On the other hand, there’s companies with long production times such as whiskey distillers or factories building nuclear plants.
Grandparent was talking about the case where CF never goes positive. In that case the company in theory still has some shareholder equity by way of assets. But in reality, especially for something like a software company, there aren't going to be a lot of assets to strip out when you unwind the company.
But that said, it’s not exactly obvious which funded companies will never be profitable. If it was then you’d expect it would be quite hard for them to secure funding. This is simply a conclusion that many HN commenters love to jump to when deriding a particular company, usually without a very good understanding of the company’s financials, or even of finance in general.
In theory that's the case but obviously it depends on a lot of factors, and if we're talking about software startups then they typically would have very little in terms of assets to unwind. Maybe some office furniture or a bit of IP. But most of the cash is going to stuff like employee salaries, leasing office space, and cloud computing infrastructure, so by the time you decide to shut it down there's going to be very little left in terms of shareholder value.
Remember when Yahoo was worth 'negative dollars'?
For example, the generation that remembered the Great Depression and its aftermath did not fully pass from power till around 1990, for instance the elder President Bush.
After that the risks did not seem so great.
Personally, I'd counter it was the inequality compression caused by WWII that lead to the prosperity of the 50s and 60s.
Or in other words, on the timescale of decades, the mob of capital doesn't act in its own best interests. Because individual greed overcomes sustainability.
I think it was the entire productive capacity of the remaining world being bombed to destruction was the reason the USA experienced prosperity during that period. The US dollar becoming the international reserve currency probably helped also.
Just to clarify, I'm not trying to make the claim that the US was prosperous during that period solely because I think the war created more conscientious people. But I do think part of the reason you saw that prosperity distributed better and had things like pensions was because people back then had a better sense of what the cost of NOT distributing more fairly is, along with a better sense of the importance of camaraderie. That's an admittedly romantic view of the time, but I think there's truth to it. Widespread adoption of computers has lead to huge increases in prosperity after that period, and I think part of the reason that hasn't be shared is that the generations since then are more child like and have less of a sense of responsibility.
Although obviously war is horrible and hugely detrimental on net, I think the one silver lining is that you are put into life threatening situations in which you NEED to trust the people around you. Political backstabbing, greed, brown nosing, refusal to take responsibility, laziness... these will get you and/or the people around you killed. I believe people that go through that tend to put more emphasis on creating healthy, sustainable, working organizations than their own self aggrandizement.
When people come on hard times during recessions, I don't think the dynamics are such that it makes strong people, necessarily, or that it offsets selfish impulses in the same way something deeply scaring and emotionally impactful like war can. But I do think people that come out from recessions figure out what lead to the bad times, and generally come out stronger in that they're less likely to repeat the same mistakes.
You can't serve next to folks in combat situations and look at "others" with quite the same distain as is evidenced today.
What happened before 2008/2007 does not apply now.
If you want to know more, look up “moral hazard” and “real options”.
Nowadays it’s almost every company betting their whole business hoping that their product will come out on top or they’ll let the public pay for the debt through IPOs.
However, theory and practice are identical only in theory. If there is a company with negative projected cash flows relying on a negative-expected-value project succeeding unexpectedly that company is probably near worthless. If ordinary investors are relying on "maybe things won't turn out the way we expect them to"-style logic to make their investment decisions then the market is doomed.
Well, Uber is an exception to this rule apparently.
The way I read the GP, they're just saying that LLCs are good to be used for gambling.
"I have never seen growth and profitability so nicely tied together in a simple rule like this. I’ve always felt intuitively that it’s OK to lose money if you are growing fast, and you must make money and increasing amounts of it as your growth slows. Now there’s a formula for that instinct. And I like that very much."
Is payroll not in that COGS equation?
The best way to think about it: "If we had 0 sales, would this expense still exist?" If it wouldn't exist, it's COGS.
It often makes lots of sense putting tech cost efficiency near the bottom of your priorities when you are growing fast and human time is your limiting resource.
This is almost exactly untrue. Take an old school SAAS company with a few EC2 servers, paying say $500/month. If they have one customer paying $30/month they'll make a loss, but if they grow that customer base above 17 customers they'll be in profit.
Nevertheless, it's unusual that a typical database-driven SAAS web app on a couple EC2 servers can't scale beyond a single user.
I think there is some validity to that thinking, but there is an implicit assumption that one could choose to step on the brakes on growth at any time and resume positive cash flow. For many firms, that is simply not the case. The firms in that position are more desperate for growth, and in my opinion the most dangerous to all. When backed into a financial corner they make comprises that harm their customers or the ecosystem as a whole.
Therefore, I think it’s crucial to distinguish strategic cash burn vs unsustainable business model. Metrics like negative return on ad spend (ROAS) are decent indicators.
I think the rest of your point is sound, but growth is important in all markets, regardless of any opportunity to monopolize. Forgoing investment in growth is an opportunity cost for any company in any market.
The only thing I don't like about the idea of a strategic cash burn is that I'd much rather see a strategic cash dividend or share buyback. Any company can hire someone who will find a way to justify spending assets for some potential ROI, and it's pretty easy to spend a company right into bankruptcy.
With positive cash flow, your valuation becomes easier.
With negative cash flow, you're either (a) strategically burning for growth or (b) unsustainable.
But you can pitch as to why it's one instead of the other. Which gives a lot of wiggle room for "early stage unicorn magic" tales.
That being said I know more than one manufacturing company from experience that gave shit about cash flow. Result, so, have been predictable.
When making decisions now, I often step back and think about what types of decisions will give me more opportunities to make more choices. This often involves increasing the funds available to me.
Funds without encumbrance are better than a debt of any kind though... and venture capital is just a different kind of debt.
It makes me wonder what sort of evolutionary advantage that sort of willpower breakdown provides... If any.
I guess that's why VCs generally don't encourage this sort of behavior.
I had a long debate with an accountant, regarding what I should primarily manage. Being bootstrapped I mostly manage cash-flow and made the mistake of saying “profit is made up”. That got him real worked up.
My point was we derive profit. The actual transactions are in the cash-flow statement which does not lie.
Revenue is Vanity
Profit is Sanity
Cash is Reality
I know you know, but it's a real problem with a lot of small operations getting their accounts done; they think they're in the black due to a bank balance, but when the accountant sees the books, things aren't so rosy.
Neither does -2.
He is diversified, so the outcome of one company does not really matter.
You are not diversified, so only you know what best.
Applies to individuals just as much as companies.
An individual would want to have savings (in the form of pension - e.g. 401k - and invested savings), while a company's mandate is NOT to store significant amounts of money to derive capital interest from it.
A quick google reveals that Apple supposedly has over 200 billion in cash reserves...
See Apple [1]
[1] https://www.cnbc.com/2019/01/29/apple-now-has-tk-cash-on-han...
Explicitly so in the case of RIT capital partners which runs a large chunk of the Rothschilds facility money - its a listed IT on the FTSE
I recently went to a job interview for startup, and they were selling me really (like, way below even average) crap salary in exchange for some options (not on contract, just verbal [on the approval, not even the amount]).
I told them that I would take a bit more salary than what they were offering... You wouldn’t believe their faces. It’s like they couldn’t believe I was telling them I pretty much never had debts and I liked positive cash flow, hence my initial salary choice. They dared telling me I could ask for a loan if I needed to keep some of my businesses up.
Anyways, I’m just saying that very few times I dare go negative. I have a house, car, and I travel from time to time (usually what I spent most of the positive flow in). I had to save tons of money for some, and others were result of some businesses. For the big ones mentioned I never went negative.
I’m not saying it’s possible or everyone is lucky enough to happen to them, but these were people that have a lot of money from inheritances (I know them), and what I understood from the whole interview is that they always live without positive cash flows, personal and businesses alike.
Also Silicon Valley: Hey guys, did you know having positive cash flow is a good thing?
Or with Amazon around 2017 after the stock jumped by a factor of more than five and they gave put too much RSUs in the years before?
This kind of articles come out during a down market when the VC go from 'we will make billions' to 'cut your burn rate so I can see sell the startup you worked on for the past few years for pennies on the dollar.'
Everything VCs write is warped by their capital distortion field. Beware
If this post said "Burn as much as you can, you can always raise more" you'd undoubtedly have had an even more negative take on it. So is your position just that VCs who have backed wildly successful businesses can't offer any useful advice on how to build a wildly successful business?
> The whole VC model is burn baby burn until you can get big a flip of the asset.
It's hardest to achieve something when you ask people to give you something that is at odds with that goal, which is basically a long running complaint about the entire VC business.
If occasionally they get a fast growth enduring company it could be luck or a stronger personality on the other side of the table as much as by any action of theirs.
You manage what you measure and what they measure most is growth, not endurance. Half the time when I push for endurance at my place of work I feel like some sort of freedom fighter, subverting a system that wants - no, demands - something very different from me.
I could tell you that I want to find is a company that grew somewhat organically that has a big growth opportunity, but that would be a lie, because I don't want lottery tickets anymore. I just want to work on something a lot of people have a positive experience with and we make an honest living at.
What I mostly find is companies that think if they can just grow all their problems will be solved. And they have VCs that tell them the same thing. The only people who are telling them differently are people who aren't courageous enough to go into business for themselves, or who they've never heard of because they're not a Unicorn. And who listens to those people, right?
There isn't any way around this: at the end of the day, VCs want a return in about a decade. That's their window. They absolutely will sacrifice the long-term success of a company in order to attain a positive return within that decade, because that's when their investors want to see a return. What most people don't realize is that VCs are, usually, just middlemen. Maybe a firm is started by someone hyper-rich, but even in cases like this, they're taking in external money from dozens of sources to build these checks they write to founders.
Of course, they're not evil. In everyone's ideal world, they can see a return in their window and the business can go on to be sustainable and amazing. But the world isn't sunshine and rainbows; if they have to choose between "maybe successful in 20 years" or "sell it and break even", they're going to force a sale (if they can). I've seen it happen first-hand about three times (though, in these cases I witnessed and many I'm sure: the businesses had become "zombie startups" and likely wouldn't have seen substantial growth even with more funding. an early exit was the best outcome for everyone involved. But, in one of them at least, the CEO was pretty angry at them.)
Sometimes the VC thinks that the market the startup is in is a bubble and the VC will push for growth over long term health. Sometimes the VC is right and sometimes they are wrong.
I've seen this play out where the VC pushed for growth probably to get acquired. The VC may have been mostly right since the market was a bubble that popped. One competitor was able to pivot though and ended up with 4X. Most competitors failed. Perhaps the VC wanted the money or perhaps the VC didn't believe in the founders.
Sometimes the startup has no market and then the VC may push for actions that lead to acquisition. Sometimes the founders demand additional incentives in the acquisition.
I've seen this play out since the VCs probably at best break even and want to wash their hands and the founders threaten to stop the deal since they lost out on salary and stock founding the company.
Yes.
Aside from being, you know, crazy, aren't there laws about charging customers below cost in order to fuel expansion and grab market share?
Losing money per transaction is dangerous. Making money per transaction but plowing the profits into expansion is less dangerous. The latter is what Amazon did. The former is what too many companies are doing, not seeing the difference.
Is that not just a form of dumping, and should therefore be illegal/regulated?
I think that's different from dumping, which I consider to be a more deliberate attempt to outlast a competitor.
From a moral point of view, anti-dumping laws are counterproductive. Their prime use is to sue companies that have lower cost than you.