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