|  
  
July 2008  
  
At this year's startup school, David Heinemeier Hansson gave a talk in which
he suggested that startup founders should do things the old fashioned way.
Instead of hoping to get rich by building a valuable company and then selling
stock in a "liquidity event," founders should start companies that make money
and live off the revenues.  
  
Sounds like a good plan. Let's think about the optimal way to do this.  
  
One disadvantage of living off the revenues of your company is that you have
to keep running it. And as anyone who runs their own business can tell you,
that requires your complete attention. You can't just start a business and
check out once things are going well, or they stop going well surprisingly
fast.  
  
The main economic motives of startup founders seem to be freedom and security.
They want enough money that (a) they don't have to worry about running out of
money and (b) they can spend their time how they want. Running your own
business offers neither. You certainly don't have freedom: no boss is so
demanding. Nor do you have security, because if you stop paying attention to
the company, its revenues go away, and with them your income.  
  
The best case, for most people, would be if you could hire someone to manage
the company for you once you'd grown it to a certain size. Suppose you could
find a really good manager. Then you would have both freedom and security. You
could pay as little attention to the business as you wanted, knowing that your
manager would keep things running smoothly. And that being so, revenues would
continue to flow in, so you'd have security as well.  
  
There will of course be some founders who wouldn't like that idea: the ones
who like running their company so much that there's nothing else they'd rather
do. But this group must be small. The way you succeed in most businesses is to
be fanatically attentive to customers' needs. What are the odds that your own
desires would coincide exactly with the demands of this powerful, external
force?  
  
Sure, running your own company can be fairly interesting. Viaweb was more
interesting than any job I'd had before. And since I made much more money from
it, it offered the highest ratio of income to boringness of anything I'd done,
by orders of magnitude. But was it _the_ most interesting work I could imagine
doing? No.  
  
Whether the number of founders in the same position is asymptotic or merely
large, there are certainly a lot of them. For them the right approach would be
to hand the company over to a professional manager eventually, if they could
find one who was good enough.  
  
_____  
  
So far so good. But what if your manager was hit by a bus? What you really
want is a management company to run your company for you. Then you don't
depend on any one person.  
  
If you own rental property, there are companies you can hire to manage it for
you. Some will do everything, from finding tenants to fixing leaks. Of course,
running companies is a lot more complicated than managing rental property, but
let's suppose there were management companies that could do it for you. They'd
charge a lot, but wouldn't it be worth it? I'd sacrifice a large percentage of
the income for the extra peace of mind.  
  
I realize what I'm describing already sounds too good to be true, but I can
think of a way to make it even more attractive. If company management
companies existed, there would be an additional service they could offer
clients: they could let them insure their returns by pooling their risk. After
all, even a perfect manager can't save a company when, as sometimes happens,
its whole market dies, just as property managers can't save you from the
building burning down. But a company that managed a large enough number of
companies could say to all its clients: we'll combine the revenues from all
your companies, and pay you your proportionate share.  
  
If such management companies existed, they'd offer the maximum of freedom and
security. Someone would run your company for you, and you'd be protected even
if it happened to die.  
  
Let's think about how such a management company might be organized. The
simplest way would be to have a new kind of stock representing the total pool
of companies they were managing. When you signed up, you'd trade your
company's stock for shares of this pool, in proportion to an estimate of your
company's value that you'd both agreed upon. Then you'd automatically get your
share of the returns of the whole pool.  
  
The catch is that because this kind of trade would be hard to undo, you
couldn't switch management companies. But there's a way they could fix that:
suppose all the company management companies got together and agreed to allow
their clients to exchange shares in all their pools. Then you could, in
effect, simultaneously choose all the management companies to run yours for
you, in whatever proportion you wanted, and change your mind later as often as
you wanted.  
  
If such pooled-risk company management companies existed, signing up with one
would seem the ideal plan for most people following the route David advocated.  
  
Good news: they do exist. What I've just described is an acquisition by a
public company.  
  
_____  
  
Unfortunately, though public acquirers are structurally identical to pooled-
risk company management companies, they don't think of themselves that way.
With a property management company, you can just walk in whenever you want and
say "manage my rental property for me" and they'll do it. Whereas acquirers
are, as of this writing, extremely fickle. Sometimes they're in a buying mood
and they'll overpay enormously; other times they're not interested. They're
like property management companies run by madmen. Or more precisely, by
Benjamin Graham's Mr. Market.  
  
So while on average public acquirers behave like pooled-risk company managers,
you need a window of several years to get average case performance. If you
wait long enough (five years, say) you're likely to hit an up cycle where some
acquirer is hot to buy you. But you can't choose when it happens.  
  
You can't assume investors will carry you for as long as you might have to
wait. Your company has to make money. Opinions are divided about how early to
focus on that. Joe Kraus says you should try charging customers right away.
And yet some of the most successful startups, including Google, ignored
revenue at first and concentrated exclusively on development. The answer
probably depends on the type of company you're starting. I can imagine some
where trying to make sales would be a good heuristic for product design, and
others where it would just be a distraction. The test is probably whether it
helps you to understand your users.  
  
You can choose whichever revenue strategy you think is best for the type of
company you're starting, so long as you're profitable. Being profitable
ensures you'll get at least the average of the acquisition market—in which
public companies do behave as pooled-risk company management companies.  
  
David isn't mistaken in saying you should start a company to live off its
revenues. The mistake is thinking this is somehow opposed to starting a
company and selling it. In fact, for most people the latter is merely the
optimal case of the former.  
  
  
  
  
  
**Thanks** to Trevor Blackwell, Jessica Livingston, Michael Mandel, Robert
Morris, and Fred Wilson for reading drafts of this.  
  
  
  
  
---  
  
  
---  
Russian Translation  
  
  
  
  

* * *  
  
---