July 2008At this year's startup school, David Heinemeier Hansson gave a talkin which he suggested that startup foundersshould do things the old fashioned way. Instead of hoping to getrich by building a valuable company and then selling stock in a"liquidity event," founders should start companies that make moneyand live off the revenues.Sounds like a good plan. Let's think about the optimal way to dothis.One disadvantage of living off the revenues of your company is thatyou have to keep running it. And as anyone who runs their ownbusiness can tell you, that requires your complete attention. Youcan't just start a business and check out once things are goingwell, or they stop going well surprisingly fast.The main economic motives of startup founders seem to be freedomand security. They want enough money that (a) they don't have toworry about running out of money and (b) they can spend their timehow they want. Running your own business offers neither. Youcertainly don't have freedom: no boss is so demanding. Nor do youhave 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 someoneto 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 haveboth freedom and security. You could pay as little attention tothe business as you wanted, knowing that your manager would keepthings running smoothly. And that being so, revenues would continueto 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 nothingelse they'd rather do. But this group must be small. The way yousucceed in most businesses is to be fanatically attentiveto customers' needs. What are the odds that your own desires wouldcoincide exactly with the demands of this powerful, external force?Sure, running your own company can be fairly interesting. Viawebwas more interesting than any job I'd had before. And since I mademuch more money from it, it offered the highest ratio of income toboringness of anything I'd done, by orders of magnitude. But wasit the most interesting work I could imagine doing? No.Whether the number of founders in the same position is asymptoticor merely large, there are certainly a lot of them. For them theright approach would be to hand the company over to a professionalmanager eventually, if they could find one who was good enough.So far so good. But what if your manager was hit by a bus? Whatyou really want is a management company to run your company foryou. Then you don't depend on any one person.If you own rental property, there are companies you can hire tomanage it for you. Some will do everything, from finding tenantsto fixing leaks. Of course, running companies is a lot morecomplicated than managing rental property, but let's suppose therewere management companies that could do it for you. They'd chargea lot, but wouldn't it be worth it? I'd sacrifice a large percentageof the income for the extra peace of mind.I realize what I'm describing already sounds too good to be true, but Ican think of a way to make it even more attractive. Ifcompany management companies existed, there would be an additionalservice they could offer clients: they could let them insure theirreturns by pooling their risk. After all, even a perfect manager can't save a companywhen, as sometimes happens, its whole market dies, just as propertymanagers can't save you from the building burning down. But acompany that managed a large enough number of companies could sayto all its clients: we'll combine the revenues from all yourcompanies, and pay you your proportionate share.If such management companies existed, they'd offer the maximum offreedom and security. Someone would run your company for you, andyou'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 representingthe total pool of companies they were managing. When you signedup, you'd trade your company's stock for shares of this pool, inproportion to an estimate of your company's value that you'd bothagreed upon. Then you'd automatically get your share of the returnsof 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 theycould fix that: suppose all the company management companies gottogether and agreed to allow their clients to exchange shares inall their pools. Then you could, in effect, simultaneously chooseall the management companies to run yours for you, in whateverproportion you wanted, and change your mind later as often as youwanted.If such pooled-risk company management companies existed, signingup with one would seem the ideal plan for most people following theroute David advocated.Good news: they do exist. What I've justdescribed is an acquisition by a public company.Unfortunately, though public acquirers are structurally identicalto pooled-risk company management companies, they don't think ofthemselves that way. With a property management company, you canjust walk in whenever you want and say "manage my rental propertyfor me" and they'll do it. Whereas acquirers are, as of thiswriting, extremely fickle. Sometimes they're in a buying mood andthey'll overpay enormously; other times they're not interested.They're like property management companies run by madmen. Or moreprecisely, by Benjamin Graham's Mr. Market.So while on average public acquirers behave like pooled-risk companymanagers, you need a window of several years to get average caseperformance. If you wait long enough (five years, say) you'relikely 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 mighthave to wait. Your company has to make money. Opinions are dividedabout how early to focus on that. Joe Kraus says you should trycharging customers right away. And yet some of the most successfulstartups, including Google, ignored revenue at first and concentratedexclusively on development. The answer probably depends on thetype of company you're starting. I can imagine some where tryingto make sales would be a good heuristic for product design, andothers where it would just be a distraction. The test is probablywhether it helps you to understand your users.You can choose whichever revenue strategy you think is best for thetype of company you're starting, so long as you're profitable.Being profitable ensures you'll get at least the average of theacquisition market—in which public companies do behave as pooled-riskcompany management companies.David isn't mistaken in saying you should start a company to liveoff its revenues. The mistake is thinking this is somehow opposedto starting a company and selling it. In fact, for most people thelatter is merely the optimal case of the former.Thanks to Trevor Blackwell, Jessica Livingston, MichaelMandel, Robert Morris, and Fred Wilson for reading drafts of this.
