Then, from Briefing.com, a great explanation. No graphs, but a brilliant quote:
“Many Internet business models didn’t pass basic tests of credibility. For example, sites with pure advertising models are usually unable to answer the most basic question about growth: how big can you get? The reason is that growth is entirely dependent upon increased page views, either by more users, or more pages, offset by declining ad rates.
Both have upper limits and most companies with advertising models have fixed costs exceeding current revenues. When you try to compute how many page views a pure advertising model needs to generate just to cover fixed costs, it is usually baffling.“
That’s my emphasis added, but the article makes a great point. The only way to scale an advertising based model is to increase the number of page views. This naturally has an upper limit, and that upper limit is probably much more shocking than you realize. I think we delude ourselves when we hear about someone making ‘millions’ off a blog, and think that’s really a business model. It’s a hobby, possibly a lucrative one, but a business? Probably not.
In his immortal tome, Art of the Start, Guy Kawasaki said “Focus on cash flow.” And like with a lot of things, Guy’s dead on right with this one. As a start up, cash is your most second most important asset (the first? your time!). Controlling your burn rate, the rate at which you are going through that cash, is therefore crucial. Here are some ideas for managing that burn rate.
1. Look at your income statement and/or cash flow statement. Target the largest outflows or expenses and see what you can do with them. If you can get these bonfires of cash under control, you can slow down that burn rate.
2. Don’t obsess over the small ticket items. Chances are they add up, but you’ll run yourself ragged trying to run those down. You’re looking for meaningful and sustainable adjustments to cash flow, not short term gimmicks.
3. The hardest cuts happen at home. The easiest salary to control is your own. If you’re not already eating Ramen noodles, start. Your reward for running a successful business is not in the present salary, but in the fact that you’ll get to keep running it in the future. Don’t sacrifice the future to satisfy the present.
One caution here: when you’re in the planning phase, make sure your plans reflect you taking a reasonable salary at some point. If you don’t have that in your plan, then your business will look better than it really is. You’re looking to stay cash flow positive, not create the illusion that your business is actually turning a profit, when the only reason you’re profitable is that none of the founding team is taking a salary. So set a salary that’s reasonable, reasonable for a startup being significantly below market.
So how do you simultaneously not take a salary, but reflect that you are? That’s easy baby, and it all comes down to the difference between the income statement and the cash flow statement. The income statement typically reflects obligations as they’re incurred not necessarily paid. The cash flow statement does the opposite: it shows the cash flowing out only when the cash is in fact flowing out. Confused? Here’s an easy way to think about it – at the start of the month when the rent is due, you feel broke (obligation incurred), when you actually write the rent check, you are broke (cash flows out). Your income statement will reflect the salary you should be taking, the cash flow statement will reflect what you’re actually taking. To most accurately reflect this, particularly in a way that helps underline for investors the sacrifice you’re willing to take, you can have a line item on the income statement for salaries and a line item for deferred salaries.
A final note on deferred salaries: even if you’re deferring salary, you shouldn’t start out at day one with your salary set at 100% of the reasonable salary you’re looking for. In the early, early days, you’ll be waiving salary entirely, not simply deferring it. So start at zero, scale up to full, but defer along the way.
4. Keep other people’s salaries low. It’s fair to expect that you, as a founder and at least part owner of the enterprise, will be living like a broke college student for a while. This isn’t fair to ask of people who don’t have an ownership stake. It is reasonable to pay them somewhat below market, since most of the people you want to join you in a startup should be smart enough to know that a startup needs to run lean, and that means lower starting salaries. You can ease the pain of this in multiple ways:
Offering deferred compensation
Offering stock options or equity
Offering workplace options that aren’t available at more established, better paying places (e.g. “I can’t pay you any more than $X, but if you need to bring your dog to the office, that’s fine with me.”)
5. Defer any expenses you can. Pay bills as late as you can without destroying your credit or damaging your relationships with suppliers. The direct, honest, and right thing to do is to negotiate terms in advance. The slimy thing is to evade bill collectors. Don’t do the slimy thing. First, it’s not the right thing to do. Second, how are you going to account for that in a proper business plan?
6. Avoid anything too gimmicky. Can you avoid rent by working out of your home office for a while? Sure. Can you expect a team of 20 people who are anticipated to make $900k in revenue to all work out of their homes? That’s a bit odder. Flying coach instead of first class? Sounds good. Claiming that you have a car and can drive anywhere, even if it is 1000 miles away? That’s an unsustainable gimmick. Your business plan should reflect that you’re a savvy manager of cash flow – not that you’re an idiot.