Stop claiming you’re profitable
blog.asmartbear.com
blog.asmartbear.com
The key in any communication is accurately conveying the facts. So use words that will be understood in context by the audience. For example, my own friends would use the same standard as a professional investor to define the term "profitable". They would think I'd lost my marbles if I claimed I was profitable making just $200 a month.
But if you're a high school student, and you're talking to your Aunt Nelly, sure you can use the term "profitable" to describe making $200 a month above expenses. In fact, if you were making $200K a month you would have to say "WAAAY more than profitable", lest she assume that "profitable" meant $200 a month.
Just be clear so that you're understood, in context.
That sounds like a pedantic distinction but it's not: ramen-profitability have runways denominated by the willpower of the founders, not extrinsic factors like "founders will soon be homeless".
Beer-money profitable carries none of the same connotations.
It's really easy to look around at huge venture-funded flameouts that have never had a dime in revenue and be proud of what you've built. I know I sure am. But that doesn't mean, at the end of the day, you've created a truly profitable business. That shouldn't take away from what you've done, but it does provide a little more nuance that can be hard to swallow.
Once, you can pay everyone a competitive salary and still have money left over there is no caveat and your just plain old profitable.
PS: And yes the IRS has a specific definition for profit so it actually matters.
The idea of paying a founder a salary and accounting for that is also pretty atypical; most small businessmen are sole proprietors, and do not pay themselves salaries. You don't "deserve" some specific hourly rate as an owner, as that's the whole difference between owning a company and working for an hourly wage.
This doesn't seem very complex in other areas of business. If your business is turning a small profit, but not enough to live on, that's what you say. "Q: How's the restaurant doing? A: It's turning a modest profit now, but not really enough for it to be a living yet."
Minimum wage might not be enough to "live" on, but it should be enough to survive on.
Or maybe this is a recent-ish development where I live because people were using small businesses to avoid paying taxes, retirement funds and so on. Or maybe the government has just recently-ish started really clamping down on not paying yourself a minimum wage. Not really sure about the specifics.
What they are required to do is account for their income as if at least a market-salary's worth of it was salary.
You can pay yourself $1/year at an S Corp and be just fine, as long as you don't also issue yourself $200,000 in distributions in that same year and claim to have earned no salary.
This is because (this may set off a little brush fire in the threads, but hey, it beats the silly semantic argument over what the word "profitable" means) S Corps are a giant scam.
For the benefit of the class:
An S Corp, like an LLC, is a pass-through tax entity: the tax liability in an S goes straight to the owners.
LLC owners generally don't make salaries at all. They are paid entirely in distributions (ie, "profit sharing"). LLC owners are subject to self-employment tax on all that income; in fact, an LLC owner must typically pay taxes quarterly, instead of at the end of the year as W2 employees are accustomed. The LLC structure does not (that I know of) afford a huge and obvious opportunity to cheat on your taxes.
Owners of S Corps do take salaries, and do withholding in much the same way as a W2 employee would.
Additionally, as company owners, S Corp owners routinely pay themselves bonuses (profit sharing, distribution, whatever you want to call it). This is normal and reasonable. The business does well, payroll is made, money is reinvested in the company, and what's left over is distributed back to the owners.
The scam is that this money is not for tax purposes treated as payroll. In particular, that money isn't subject to FICA.
As a result, S Corp owners are incentivized to claim the lowest possible salary (today, "lowest" meaning "lowest you could reasonably get away with calling a market salary"). That's because the salary money is going to be subject to FICA. If the remainder of what the owner should fairly have been paid is issued in distributions, that money avoids FICA liability.
And so the IRS case files are littered with lawyers and doctors and dentists who set up their practices as S Corps and then try to claim the fair market rate for their participation in the company is, say, $5,000/year ("oh, I only come in on alternate Tuesdays!"). Their secretaries pay the full bite of FICA while living paycheck to paycheck, while the business owner makes payments on a vacation house with the money they save from this trick.
Both secretaries and business owners are on the receiving end of social security benefits.
It might be ok to call S Corp way of setting up payroll for owners a loophole (debatable), but it's definitely not scam.
If anyone is doing this, or interested in doing this, the way they deal with these cases is as follows: he picks a number based on a combination of what salary surveys say and what kind of mood he is in, multiplies it by 7 (since you've probably been doing this for 7 years by the time he gets it, which is how far they can go back), and assesses that as unreported income. They then tack on penalties and interest for the tax liability of said income. That makes for a really bad day.
It would seem to me that if full payroll taxes are paid on Sub-s dividends, that the requirement there would no longer make any real sense.
Only if there are distributions so if you are losing money or breaking even (by the IRS definition of that) you won't be paying any taxes:
IRS: "The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. "
Parent says: "pay yourself a market rate salary."
IRS:
"There are no specific guidelines for reasonable compensation in the Code or the Regulations."
http://www.irs.gov/newsroom/article/0,,id=200293,00.html
The point I am clearing up is the issue of "having to pay yourself a market rate salary" which only comes into play if you are making enough to pay anything.
I suppose one "benefit" of such a requirement is that a lawyer could no longer take on worthy projects for free ;-)
This post was a real eye-opener for me, having considered my last business 'profitable' over the course of two years, I realize that it was only just barely so, and only for the last 3-6 months.
Not that I think you should work for BigCos, but, the realization will let some of the air out of the balloon.
http://www.investopedia.com/financial-edge/0411/Is-Your-Smal...
Sadly, TFA even says pretty much the same thing, when he makes the distinction between profitable and sustainably profitable. It's like he admits there is a distinction, but then insists we ignore the distinction and only talk about being "sustainably profitable" when talking about being "profitable." WTF? Load of bollocks if you ask me.
Even in accounting here, the (company) profit is what remains after everyone, founders included, has been paid.
And if your recurring expenses are low enough, it doesn't mean necessarily a high amount of money either (eg: here our coming SaaS will be profitable for us at around 2500€/mo ex VAT).
Profitable means making a profit. End of story.
This is a petty, semantic issue. if a company is making $50/month in profits, then the issue isn't that they're calling themselves profitable, its that they're only making $50/month.
Of course there are cases in which your time is worth less than $5 an hour (you don't have any other prospects for making money). Or if you enjoy what you're doing it might only be 1 hour of "work" with 9 hours of enjoyment. The point is that completely ignoring time spent is just bad accounting.
Because the business is supposed to be an entity in its own right, you have to value the founder's contribution somehow in deciding whether it is profitable. One way might be to consider what the salary would be to hire someone to take it over such that it continues to produce the same revenue. Another way might be to pay the founders their living expenses (ramen-profitable.) But discounting the cost of the founders working on it to zero? As the article says, that is meaningless.
It's like the old joke: Q: How can you quickly make a million dollars? A: Invest two million dollars in $TOPICAL_RISKY_ACTIVITY
If you hack it together on weekends and with no oversight it is reliably making a $100 more than hosting a month and will do for the foreseeable future, it's profitable (albeit at a small level and not necessarily sustainable).
But if you're living off savings and working full time on it, and it's making $1000 dollars a month, its not profitable.
Entrepreneur: "At my last consulting gig, I was making $8,000/mo before I left to start this company. I haven't been taking any salary for the last two months while I built a prototype, so I would certainly say I've got skin in the game. At the same time, this business is going to sustain a lot more than just one $4,000/mo salary - if you don't think it can, then you shouldn't invest in the first place"
Of course Cuban then said he was out, stating he wanted the kid to be sweating on a mac 'n cheese diet in order to ensure he was working his ass off as opposed to living the "LA lifestyle." Was a pretty interesting conversation, because the kid was currently turning a decent profit already and claimed he had already done the blood sweat and tears thing.
The whole show is really quite hilarious. I think it gives people the wrong impression though.
The sharks pass if a company is profitable and the owner wants a fair valuation. The sharks pass if the company has no traction yet.
What the sharks really bite on is profitable companies (or high potential companies) where they can get a controlling stake for cheap, or a minority stake for super cheap.
The show is correctly named, that's for sure.
He did say that he wanted a 6 figure salary to "live the L.A. life", and he repeated that statement more than once.
I like the show but agree with a lot of your points, my understanding is that these pitches are more than an hour so we only get to see the "juicy" parts.
Pretty much a useless article, as far as I can tell.
I'd urge you to re-read it and not fall into the trap of believing he's making an argument on semantics. There's a useful point there.
But even if we acknowledge that that inflection point is important, what conclusion is he asking us to draw from it? Does acknowledging or not acknowledging this point make much difference to any strategic or tactical decision a hypothetical startup founder is going to make? I mean, if the OP had made a point about "this is how you know when to go raise outside money" or "this is how you know it's time to shut down the "profitable" startup," then I'd have found this valuable.
The idea Cohen is expressing is so extraordinarily simple it would almost be banal, if it didn't target such a widely held misconception:
You cannot factor out opportunity costs when accounting for your business.
When a new founder with a business throwing off $1500/mo after line-item costs like hosting claims to be "profitable", what they are effectively saying is that their own time is worth $0/mo.
In reality, that founder is almost definitely losing at least $11,000 per month --- by taking a SWAG at what any person capable of booting up a product to reliable $1500/mo can earn as an employee or freelance consultant, that SWAG being almost certainly so lowballed as to be insulting.
To my mind, not being able to tell the difference between "profitable to the tune of $1500/mo" and "losing 5 figures a month" is an alarming difference that is very much worth calling out.
Is it really? I mean, that makes sense if the only point of being an entrepreneur is to make money, and you're totally fine with working a $DAYJOB as an employee. But, for some of us, it's about more than the money, and fighting to make the startup succeed is totally "worth it" even if "it" is tens, or hundreds of thousands of dollars that we might otherwise have earned as an employee.
You cannot factor out opportunity costs when accounting for your business.
Indeed.
But if your company is bringing in $1500/mo after line-item expenses and before wages, you are making less than minimum wage; you are not profitable. Happy? Sure. Profitable? No.
But since a founder owns equity which he/she expects to become valuable in the future, it's a tradeoff some people choose to make - forgoing a salary now, so the company can thrive.
Say you can earn $20k a month as a consultant.
If you are only making $19k from your own small business, are you therefore making a loss?
I would take the latter scenario all day long. If that's a loss, please bring it on.
If you still have to be a consultant to pay the bills because your side project isn't making enough money for you to quit, don't run around telling people your 'startup is profitable'.
Speaking as someone who has done the side project thing, I was never happy having to work a full time job when I wanted to be full time on my sideproject.
Opportunity cost has nothing to do with it. If I have created a business that pays me $50k a year (to live off of) and throws off an additional $25k in earnings that I can reinvest in the business, I have a profitable business. It can be grown through reinvestment of profits, and has value to investors.
None of that changes if I could be making $1M per year doing something else. You can't say that the business isn't profitable just because I have a high value alternative. It just means I'm not maximizing my income (which is a personal choice, not some indication of business health).
But if you create a business that pays you $0k/yr, and offers $2000/mo worth of revenue to split somehow between reinvestment and wages, I have a real problem calling that "profitable". That business is "profitable" only so long as you are willing to donate your time to it.
In reality, that second class of business is virtually always pro-forma cash-flow negative; the founders simply aren't accounting for the rent/mortgage and food payments slowly draining away at their savings cushion. That cushion is a phantom capital investment on their books, but they don't want to account for it, because if they did it'd be obvious they weren't profitable.
For example, two founders each have identical businesses. One has a $10k/month mortgage. One lives in a $400/month apartment. Which one is more profitable? Neither. If either founder chose to sell their business, they'd get the same amount. That is, the present value of the profits of either business is the same to a would-be purchaser.
The question that needs to be adressed is not "How much do I need to live the way I want?", but "What is the market salary of someone I could hire to do my job while I sit at home and watch Shark Tank on DVR?" If you account for that, and the business comes out ahead, you have a profitable business. (Even if you're blowing the profits on your mortgage.)
There is also the potential that the $1k will grow over time.
I therefore don't think it's reasonable to value my time at $10k for the purpose calculating my profits.
[The figures will obviously vary on a person by person basis.]
More broadly, I view this from the E-Myth [1] perspective:
If you work within the business as a job, you're selling yourself short if your business is generating $1k a month when you could be earning $10k working for someone else. The money you have left on the table has a real opportunity cost to you as an individual and should probably be valued closer to the shortfall you are taking of $9k.
However, if you view your business as a system - something that has money going out (product, marketing, people you pay) and money coming in (sales) then that money is a genuine excess that the system is kicking out and into the entrepreneurs pocket and is most certainly profit from his endeavor, whether $1 or $1MM.
A year later I ran into my former boss from Apple when I was out eating lunch. He asked how it's going, I said well. Then he asked, "Ok, are you making more, or less, than you were at Apple?"
Embarassed by the question, I admitted the answer was "more".
I think his question captured perfectly the real issue here.
I guess it depends on your perspective. If the only goal of doing a startup is to make more money, then sure. But if your goals involve having more control over your own destiny, fulfilling a desire to build something for the sake of building it, or having a kind of freedom you could never have when working for $BIGCORP, then it doesn't really matter if you're making more or less than you would at $BIGCORP. As long as you are either "ramen profitable" or have runway left to burn, you still have a shot at fulfilling that ambition, which is what matters, IMO.
What if I have five businessses, but none can pay for my salary individually, though in aggregate they make me fairly well off.
Can't I call any one of the busineseses (seperate entities, mind you, not just apps in the store) profitable?
It basically states that multiple-streams of income means the smallest stream doesn't deserve the definition "profitable".
So questions like mine are valuable to fleshing out this theory....
He's talking about the difference between paying yourself and not, in a round about way of getting to this concept: not paying yourself a sustainable wage leaves nothing for investors (even if the "investor" is just you.)
If you have five separate entities that combine to pay you a salary, you win. Any extra money can be used to grow one or more of those businesses. ..if they are all tied together in ownership (for example, they are all owned by one person).
If those 5 entities are not tied together in some way, then no, they are not sustainably profitable on their own. That is, each entity does not throw off enough cash so that there is some left over for reinvestment unless you combine them all together.
If you could be earning a salary of $80k/yr from a BigCorp( ~$40/hr) and you have a business that you put 10 hours/month into, then a profit of $400/month from that business is breaking even relative to a full-time job.
Is that profitable?
Life is full of generalisations, do you expect every post made by every person, every day, on every blog, to contain every possible excruciating detail about every super tiny little aspect of exactly what they did, how they did it, when they did it? You're only short-changing yourself if you reject every communication from someone who doesn't happen to share your obsession with pedantry and trivia.
"I launched a startup today. First, I went to the bathroom, then read an article in Entrepreneur, then pushed the site code to production, but had to back that out because the db config was wrong, so we did another push, then we brought the site up... and we waited 7.323212 minutes before submitting a "Show HN" to HN, then waited 19.11111111 seconds for the first hit to our site...
...
...
...
...
...
...
7 hours later
...
and that's how we made $400.00 dollars on day one, which is way more than the $230.00 it cost to run the site, but since that doesn't include the cost of our own salaries, our startup isn't quite profitable yet. Check back tomorrow for the next exciting installment! Same bat time, same bat channel."
In my mind, a business that excludes the time spent by its founder from its expenses is not honestly assessing its profitability.
Right, but if somebody is selling you something, you're going to do due diligence and probe this stuff. If it turns out that they are only "profitable" in the narrowest sense, but not "sustainably profitable," then that's a good thing to find out.
Given the debate that this idea appears to be generating perhaps another way of looking his idea is to say that the business has no value as a business until it is sustainably profitable (even though it may control assets that may be valuable when liquidated such as a web domain or even talent which another company may wish to acquire) - i.e. until it is sustainably profitable a business has no value as an ongoing enterprise and can only be sold for the value of its assets.
http://jerzygangi.com/2012/06/17/youre-making-money-but-are-...
For starters, for any business, let's look at the numbers:
- market size, market share, market dynamics
- gross & net revenue - abs $ and % growth
- gross margin, gross profit, operating income, net income - abs $, % of revenue & % growth
- Balance Sheet, Income Statement and Cash Flow
Then we can talk semantics.
Edit: formatting
Most posts like this just bitch and moan, but he actually provides valuable advice.
That's fair. But the Internet doesn't work that way. If you develop something once, you don't need to keep standing there and keep developing it. The whole reason the article is wrong can be boiled down to this. For more nuanced response you can see my other comments.
Basically, it would be like saying, "A restaurant that makes 50,000 per month in profit isn't profitable if the person who made it is Bill Gates."
Since, "automatically" Bill Gate's time is worth a lot more doing just about anything else other than launching a restaurant. But come on. When it comes time to buy the restaurant and see how much it makes in profit so you can see how much you will pay for it - do you really think you'll reconsider the whole thing as unprofitable just because Bill Gates spent way more of his time on it than can possibly be valued at as low as that?
Get real. From an investment standpoint, nobody cares about the founder's development time. And guess what the article is about? Investment standpoint.
If you have a business that throws off $1500/mo and requires one hour of your time in each of those months on average, you absolutely are ~$1300/mo profitable. That much is obvious.
The problem is when your business is throwing off $1500/mo and you are spending more than 8 hours on it in a month.
Nobody, however, is saying that once you've recouped your investment, your hourly bill rate needs to somehow factor into your profitability.
This is obviously totally false.
Let's do this thought experiment.
Say I would accept this if the author said that true profitability is only the amount that the company would clear if you spent less than a minimal frictional amount of time hiring someone (from company revenue) at rock-bottom wages, to keep running the company.
but if we accept this, notice something interesting. What if the way to get someone at rock-bottom wages is for the company to issue some shares (which means a percentage) and pay the worker in those shares?
Can the company still be profitable (though you're diluting the profit) on those terms? From your point of view, OF COURSE!
The author is talking about the point of view of an investor. ("Stop telling me your company is profitable.") He's not arguing from the point of view of what's worth your time: "stop thinking that if you're profitable it's worth it for you to do that."
The two are totally distinct. If the company has someone on payroll at $0 because they think their work is worth investing in exchange for the 30% equity they have, then the profit the company generates for the 70% stakeholder who doesn't have to put time in is simply 70% of company revenues minus company expenses such as hosting.
That doesn't mean the person who is working for $0 and equity isn't getting screwed. But it also does't mean the company isn't profitable.
The whole article is completely wrong and I've told you why here and in my other comments.
Would you buy a company for a thousand dollars that had paper profits of five thousand dollars a month and will for the next two years, but actually this isn't "real profit" because the founder, who had been earning five hundred thousand as a President at Microsoft, put five years of labor into it unpaid?
Of course you would buy it. That's real profit the company's making. It doesn't have to recoup the founder's lost opportunity cost over the ENTIRE life of the company in order for it to be a profitable company.
The thing is, people want to use the term "profitable" because they want to spin where their business is at.
Operationally break-even would mean your income exceeds your hosting expenses.
Breakeven sans salaries, would imply that you're ramen profitable but nobody is getting paid.
And from there you could say "we're profitable enough to hire one programmer, but no more" or whatever.
The thing is people would rather say "ramen profitable" than break-even. Sure, ramen profitable has a specific meaning with more nuance, but it also has the magic word "profit" in it.
I think founders and investors should both work towards more level headed straightforward language.
I've been watching a lot of startup pitches lately, and combined with what I've seen in the last 2 decades, hyperbole has become quite the turnoff. Maybe it works on investors, they sure all seem to do it (e.g.: watch the Founder Fuel pitches) but for me it undermines credibility.
Kinda like dealing with a used car salesman-- have I got a startup for you! It has the most excellent traction you've ever seen!
There's a whole type of startup (call it type "1" whereas article is about type "2"), which is more traditional, and the only possible model in many sectors such as hotels, restaurants, retail, etcetcetc, that is based on launching a business (as opposed to 'bootstrapping') from sizeable funds - often 20k-50k or more - and not even attempting to become profitable within 3-5 months, during which you expect to continue to pay out one or two thousand on office rental space, equipment, hosting, whatever. An optimistic plan is to scratch the surface of breaking even around the one year mark.
When someone is, and has been, "profitable" since day one, ("type 2") this is in stark contrast to this model. This is the "in our first few months we spent three-fifty on hosting while servicing our five paying customers and working hard coding and developing so we can grow our customer base and make our equity worth enough to sell some of it and raise a round, or at least have enough money coming in to grow organically and bootstrap to sizeable revenues."
There's nothing wrong with either of the two models. It's also probably the most important fact you need to know to contextualize a conversation about your business. And the type 2 business that has paying customers but can't even meet it's hosting bills is fundamentally broken. Hell, I can do that just by hosting up to five hundred gigabytes of files per person for five dollars per decade.
If you're not broken - and running this type of model - go ahead and boast. And if boasting isn't enough, keep growing.
Also: if the only reasonable trajectory for your business is to "raise a round"...
This, it seems to me, is one of the most common mistakes people make when talking about their businesses on HN.
Secondly I don't see a rule that says that a business has to support a full time employee to be profitable.
Now something may be profitable and not sustainably so, and that's a point the author kinda sorta halfway makes later on. The point where the business is supporting the owners and there is money to reinvest, that's sustainable. Profitability however is where the net profits > 0.
This is actually important if you are looking at the health of the business.
The point of this post isn't that people are wrong about the definition of a word.
The point is that the underlying meaning often communicated by the word is absent in its usage by lots of startups.
Is your usage of the word "profitable" defensible? Of course it is. You win. Can we get on with discussing the actual point of this post? Because this comes up a lot on HN: "profitable" startups that are actually secretly costing their owners many tens of thousands of dollars a year, because to many first-time startup founders, the concept of "opportunity cost" is just an abstraction.
I think what the article is trying to get at is the difference between sustainability and profitability. Something may be profitable and yet not sustainable (for a variety of reasons). Something may be sustainable and yet have no profit (the Apache foundation), but one key part of sustainability is being able to fund core activities.
As for why folks should care, I think it is important to be clear about things when analyzing financial health of a business. A business which makes $1000/month net profit a month may not be able to support the founder (but presumably the founder has some other source of money to live on) but what it can do is absorb $1000/month in additional expenses without requiring additional investment. A business with no money in the bank but $1000 in net profits every month may be better able to weather unexpected mishaps than a business that's losing 2000/mo with 20k in the bank.
First you can't put "opportunity cost" in your ledger on the expense side. Opportunity cost doesn't really work that way.
I stopped reading here. I had a hard time believing the rest of the comment was going to provoke anything but annoying yelling from me.
See my other comments on this thread.
At one extreme, a company that is cash flow positive before founder wages to ~$2000/mo is paying two founders less than minimum wage. That's not a profitable company.
At the other extreme, a company throwing off $20,000/mo before founder wages is potentially paying founders as much as $120k gross. That's a profitable company.
A lot of first-time founders on HN will post "Show HN" threads talking about how they're profitable when they're in that first scenario.
Maybe once in a blue moon, someone will try to argue that a founder in the second category isn't "profitable" because they could be making $200k/yr at a BigCo instead of $120k/yr.
The question is, where's the line. What's interesting to me is that the line right now is drawn in a very silly place: right at "cash flow positive". I don't care how much further beyond cash flow positive we draw the line, just as long we recognize that right at cash flow positive is a silly place to draw it.
I don't often say this, but I've thought this through completely, and the people who say that people working for equity, options, etc, should be accounted for as though they were working for a straight market salary before you can say you're profitable, are simply wrong. I'm right and they're wrong. And it's important.
Let me put it this way. Say Facebook was already very profitable, making millions.
It had superstar elite ninja developers who worked a thousand times faster than a normal developer and any one of which was worth their weight in gold. To hire them on salary you would have to pay them a million dollars a year, because they don't want a salary, they want to be part of the next big thing.
So, like all Internet companies, Facebook gave out a lot of options and employee equity.
Now when Facebook was making millions and quite profitable, you're saying it wasn't REALLY profitable, since it didn't REALLY get to use the labor of those people who had equity as part of their compensation. But this is obviously completely wrong. THe founder's equity falls into the same category.
The fact that you're getting something below market rate doesn't mean you're not REALLY profitable.
This is like crying "Apple isn't REALLY profitable because they get their components below market rates by being good negotiators!! If they had to pay market rates they would be operating at a LOSS".
Well, too bad for the component sellers. Apple is still profitable.
Too bad for you if you could be making 200k per year and instead are giving it up for equity in a company that is worth less than that. The company is still profitable.
This would be like saying that back when Rackspace gave all YCombinator companies free hosting, if their hosting bills "would normally" be more than their profits, they weren't ACTUALLY profitable. Regardless of what they were making.
Well, that's obviously not true at all.
This is equivalent to saying that you can't be considered profitable unless you're paying through the nose for everything, including super-expensive managers who are able to single-handedly get a business off the ground and are easily worht 200k-500k to a fortune 500 company, and then STILL have left over.
why should anyone say that??? why should the line for "profit" be drawn anywhere other than whether the company pays more than it receives in revenue or pays less than it receives in revenue?
That is a real line, Facebook had every right to boast about it when it crossed it, the entire Internet startup sector depends on people having the right to work for equity and startups getting access to that labor by issuing shares and paying a low salary.
I mean, by this argument of what is a "natural" salary, you could say that there isn't a single profitable prostitute working in California, because the "true cost" of a job as a prostitute is firstly spending $1800 million dollars and four years fighting to legalize prostitution, and only afterward hiring a prostitute at a market (not black market) rate. Therefore, since they are empoying themselves only at a black-market rate (where a legal rate is $1800 million and four years of lobbying more expensive), they aren't actually profitable. Any prostitute in California would have to make another $1800 billion or so and spend it on hiring an actual prostitute at "market rate" not black-market or (in the startup analogy) equity rate.
That's nuts. Of course a business can be profitable without accounting for a DIFFERENT kind of rate. (one that doesn't include equity, for example).
the whole perspective of other people here is simply wrong. It's that simple.
Suppose I live on $2k/month with one kid, and I choose to live somewhere rural where this can actually work. So I bring in approx $24k after business expenses, and in the end I end up getting a little more back from taxes than I pay via the EIC. Suppose I like this life.
Suppose I could go to work for BigCo Inc and make $130k/year. You wouldn't say my business is losing $100k/year. That would be silly.
If your business gets to use your labor for "free" just because you happen to be a 100% owner, it is no different from Facebook getting to use employee's at 30% of market rates because, collectively, they own 6% of the company. It's exactly the same thing.
The article and people who defend it are very wrong. You're right.
That doesn't mean it's the only metric. But it is probably the single most important one. It gives you an idea of whether a business can survive and meet its financial obligations in the face of unforeseen events. For a corporation of course equity ratio or debt to equity ratio are also important.
I humbly submit that "profitable from day 1" (or day 7 or 14 )is a useful shortcut to name all of the above. Of course it doesn't mean really profitable.
But it also doesn't mean that you're hosting a news a blog that has readerships but hasn't made a penny.
The mistake Cohen is talking about is mostly about not fully accounting for costs.
If, after factoring in opportunity cost (ie: what your full-time salary would be had you done something other than start your venture), that equation produces a negative number, you are not "profitable".
It's weird that this should generate so much controversy. The concept of opportunity cost is not controversial among businesspeople, among investors, or among economists.
The term you are looking for to describe the "kind of profitable" to which you're referring is "cash flow positive".
Why do people keep talking as if this is a semantic argument?
It isn't a semantic argument.
I know it feels amazing to build something with enough traction to reliably put $1500 a month in the founder's pockets, but that "profitability" is counterfeit. You cannot run that business forever; it is paying you less than the minimum wage.
If you think this is a semantic difference, try re-reading Steve Albini's "Some Of Your Friends May Already Be This Fucked" rant.
This is like saying that a surgeon can't launch a profitable web business, because the time spent on it will not generate as much profit for him as if he had spent the time practicing surgery.
that's plainly completely false, and the web business can be very much profitable (just not to him.). Just THINK about it.
You're telling me when people say "profitable since day 1" they should instead say "cash-flow positive not including consumer expenses I'm using for business". Fine. Go ahead. Say that instead. Or say the synonym "profitable since day 1" since everyone knows that's what you mean.
Let's do this. Do you think the article would still make the same argument if it read, instead, "Stop claiming to be cash-flow positive since day 1 - meaning day 6-23, besides your fixed consumer expenses!"
Then the article would read: (In parentheses is my point-by-point critique).
Stop claiming you’re cash-flow positive (not including consumer expenses) JUNE 19, 2012 2 COMMENTS
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My company is cash-flow positive, and has been from day one. (meaning day 7-23 after coding it up and getting customers very soon) – every high-tech bootstrapped founder (Actually, only a SMALL percentage of ALL projects, and a LARGE percentage of projects that can justify you giving them money.)
I know what you really mean.
What you mean is that the only business-related charges on your PayPal MasterCard — aside from those on intentional detour for tax-deduction like the external DVD drive you needed to rip CDs after you realized the MacBook Air in all its luxurious, silent, thin, sexy glory still cannot import “The Best of Pat Benatar” without the aid of a peripheral half the size and weight of the laptop itself — is an account with Amazon AWS where a medium instance whirs away for only $40/mo, just two clicks away from rebirthing as an XXL should you need “scale,” plus $0.67/mo for the S3 storage for web app uploads, plus $0.072/mo of S3 storage to back up the Pat Benatar mp3s.
(And you also don't count your rent, phone, Internet, and other expenses you currently have related to launching your business.)
So all you needed to do is sell one $49/mo account — which you did — and you’re cash-flow positive! (Except the above-mentioned things).
I know that’s what you mean, but when you say “I’m cash-flow positive” to someone with a modicum of experience it’s a turnoff, (unless they care about a scalable, repeatable business model you have already proven) because it’s actually bullshit (if somebody with "common sense" thought that any Internet business on the planet got ten thousand customers the very first day the founder had the thought to start coding it up). And when someone’s streaming bullshit at 720i, it means they’re either a full-blown bullshit artiste or they’re merely ignorant; in neither case do I want to hear more. (in other words, I've been burned by the recent bubble pop and I need some time to see you grow some more before I continue gambling. That doesn't mean it's not great that you're already cash-flow-positive. It means I'm a sore loser.)
The first and biggest error is thinking you can ignore your own salary. (Which nobody expects you to include when you say you're cash-flow positive.) Sure your time is worth $1000/hr (your opportunity cost is more like 80 dollars per hour if you weren't running the business, since you would accept a salary at 160k... the 1000 dollars heuristic is only to keep you on track if your business will keep growing and be acquired), but no you do not have to cover that to be dubbed “profitable.” (nor do you have to cover your foregone salary of 160k). But you do need at least a ramen-profitable definition of valuing your time. (no, you don't. even 2 dollars per hour is not necessary, nor is being able to pay for your apartment, car, phone, and Internet.) If your business makes $3000/mo after direct expenses, but isn’t paying you, and you still have a full-time day job to keep up with the mortgage on your under-water house, then you’re not profitable. (and if you can stop doing any work on it and the venture keeps generating $3000/mo after direct expenses, making 36k in a year or 200k in ten years as usage tapers off and customers switch away, and you use that 200k to buy a house somewhere. Well, you didn't just buy a house with the profits or positive cash-flow of your company, no-siree, you bought it with, uh...)
Why not? Because the business cannot sustain even one person to run itself, which means that $3000 is not “extra money which can be plowed back into the business or distributed for an awesome vacation.” (Unless the business can operate without one person, which is not mentioned here, or unless you can hire someone for a thousand dollars a month to maintain it and pocket the 2k per month difference). It’s just made-up leftovers because you’re not acknowledge the actual costs of a startup, which include time and you having to work a second job. (Likewise, your salary isn't actual cash-flow you can use to buy stuff. It's an illusion! If you make 200k in salary, but could be making the equivalent of 500k by founding a startup and selling it 5 years from now, that's not 200k you're earning. That's 300k you're losing. You don't have a job: you're a parasite on, well not society, but on your alternate self, whom you're robbing of 200k...)
In that case what have you proved? That if you slam yourself to the limit of endurance and ability, you can earn less money than Dell would give you for creating 1/34th of BIOS version 8.4.3.5?
That’s not a “cash-flow positive business.” (Unless you look at cashflow).
If you are living off it, even if that’s $3000/mo, then you’ve made it. You might not have a dynamo on your hands (yet!) but at least you’re in a somewhat sustainable place. Maybe next month you’ll make $3200 and you can “plow that extra $200 back into the company.” (likewise, if someone gives you 500k per year to be VP of Vatever at their company, and you spend it all on your lifestyle, you haven't made it at all.)
The other error is that it’s a misuse of what’s normally connoted by the phrase “profitable business.” (cash-flow positive business. Normally it means, in the first year of a business especially, but usually in the first couple of years of a startup, that you could keep putting time in and getting more money out than your business uses up. If you have savings of twenty k, you can run the business for two years and have savings of...thirty k. Where does the extra 10k come from? Oh, that's right the "non-profit" we all totally rightly call "profit.")
When someone says they’ve been in business for two years and they turned profitable last month, what that really means (if it’s a healthy, growing business) is that they are sustainably profitable, able to indeed “plow the rest back into the company” with a quantity of cash that could visibly move the needle on top-line revenue, or could significantly reduce further risk, or would allow for investment in a long-term project, or could be a down payment on a superstar, or something similarly valuable. (Or maybe it means the restaurant costs 10,000 per month in property, commodity prices, waitstaff, and all other expenses, and has just turned a profit of 200 for the first month after all that stuff was paid for, and at this rate you'll regain the 50k you invested to get it there in...well I'll let you do the math. That doesn't mean it's healthy does it.)
Therefore, in the normal sense of the phrase “profitable business,” it’s not. (unless you mean "profitable business" as a person normally means it when it comes to a startup).
So now that I’ve perhaps unfairly ridiculed you, (now that the author has ridiculed himself) let’s just recognize what’s really going on, because it’s wonderful and amazing and fantastic and exciting: (since it's not descriptive of most projects)
You’re building a business! (your project is cash-flow positive.) Sure it’s just begun, sure it might need a kick in the ass, sure it might be struggling, sure sure sure, so what? You and every other little new business. You and every other bootstrapper who by very definition doesn’t explode out of the blocks because you’re doing it part-time and with no cash. (that's not anyone's definition. you can explode out of the blocks or you can languish.) This is exactly what you’d expect it would do, even if you’re actually the next 37signals. (unless your expectation is different.)
That’s exactly what my company WP Engine looked like for the first 9 months. Now we’re making millions of dollars, employ 20 people, growing at 15%/mo, etc.. But we started just like that — slowly, and not profitable. (sounds like you did it from 50-100k in savings or seed capital, which puts you squarely in the type 1 bracket.)
Same with my previous company Smart Bear — it took 2.5 years before I could even hire one employee, and even then it was 1/4 of the salary he deserved (and later ended up making). Eventually we, too, made millions of dollars a year — in profit! — but not for years. (during those years I bet the net cash flow ever had reached -20k easily. all in direct costs.)
In other words, there’s nothing strange or bad here. It’s just not “profitable from day one.” Stop saying that. (unless you're cash-flow positive from day one, which is a different type of internet project).
Dispense with the feather-fluffing and get to what is — the strengths you have, the challenges you want to overcome, the resources at your disposal. (And if you've proven a scalable, repeatable business model that pays for its own hosting and direct expenses other than the time to develop it, I suppose you shouldn't boast about that fact? After all, it's not like if a web service is developed in 100 hours, you can keep running it without redevolping it from scratch every month, as though you'd just lost all your backups.)
And then set your mind and goals on making that sucker profitable for real! (turn your positive cashflow into a sizeable source of revenue. which nobody assumes you have if you mention the former.)
P.S. Need help figuring out how to do that? Go here to learn about the Smart Bear Live podcast where I’ll help you one-on-one, or email me to see whether I can turn your question into a blog post. (step 1: start with some money to burn.)
I will not grand the author the contention that you shouldn't tell people if this is the case.
If the business requires 0 energy from you, and makes money, then his point becomes much less relevant. But most of the businesses in question are not like that. You have paperwork to keep them going, decisions to make, customers to serve...
And he's not wrong, because on oDesk you could be bringing in $4000 a month with the same time investment, and the only reason your startup is profitable is because you're not factoring in all of the capital costs (not just cash).
we're not talking about whether it's "worth it" for him, we're talking about from the point of view of whether the online business can be called profitable to an outside investor. Nobody cares about your unpaid sunk development costs.
Not if they happened a year or six months ago, but if your unpaid sunk development costs are happening every day, then you're not profitable. You're not profitable until you're paying everyone who is working for you something relatively close to the wage they could be making as a regular employee somewhere else.
I think this is a much better metric to seek than the "we've grown our user base by 1 million percent!" from a company that isn't taking in any money from its users, and whose users would never pay money to use the service (perfect example: Facebook) but has also gotten $1M+ in investment and has spent significant money. How do you tell the difference between that and buying users? The latest thing these days is to say "we got X users and we didn't spend any money on marketing".
Really? So you don't know what your acquisition cost really is? You want me to think that your social network for accountants is going viral? When your user base is about the size I'd expect it to be when all the other "Social Network for X" founders from Angel.co show up to see what you're up to?
Back to the article-- I think he's spot on to point out the difference between ramen profitable and profitable enough to hire an employee who's getting a real salary. That is another milestone.
But I think "we're profitable from day one" is really not a bad thing, because many of the other companies out there have no path to profitability without a whole lot more funding (Eg: Facebook, which took a lot of money.) It did pay off for Facebook, but your social network for taxidermists is not another Facebook.
So, "we're profitable from day one, even though we're only covering operational expenses and not covering employee living expenses yet" is still a significant piece of information compared to the companies that will take another $5-$50M to get even to that point.
Also, FWIW, my startup, which will likely be "profitable from day one" (but not ramen profitable) will be requiring about $300 a month in hosting-- and that's getting a dirt cheap deal. Not all of us are just a website that can run on a single server... we're building a cluster of dedicated machines and we need to do that before we open the doors. Fortunately, $300 a month for ~5-6 dedicated machines is kinda amazing![1] This is also one way where "immediately profitable" is more achievable than it was a decade ago.
[1] Hetzner.de has dedicated machines for cheap. Our product is very amendable to a CDN, and our major partner is hosting a lot of the higher bandwidth stuff on their own global CDN anyway, so locating in germany is not nearly the issue it would be for us if we were doing a social network for philatelists.