December 22, 2014
By Mark Littlewood
If you haven’t subscribed to Patrick McKenzie’s email newsletter, click the link above, read this article, then subscribe. It is a brilliant piece on scaling a small software business written by a brilliant software guy. The post is much more about the practicalities of scaling a small software business but it also contained something that resonated strongly.
Read the full article but I have taken a small piece of it which explains very clearly why growth can be an expensive process and what this means for both bootstrapped and venture backed companies.
“Ramping up” is a very important thing for you to understand if this is your first rodeo. It takes a while for a sales rep to learn your product, your sales process, and what works and doesn’t work with your customer base. Even very smart people don’t hit peak efficiency for a few months. Even if you could wave a magic wand and make them peak efficient on day one, they would still be cash-flow negative.
[Removed excellent explanation of why so you click on his blog post]
Why do it, then? Because in month 4, the rep is finally cash-flow positive (for $0.5k). The $4.5k loss is repaid in month 6. And then the magic of calculus happens and the business starts to make a lot of money.
This early cash flow crunch is why SaaS companies, despite having very little costs to get going these days, choose to raise outside investment. You hire dozens of sales reps in parallel, wash out the ones who don’t successfully hit quota consistently, buy very nice cars for the ones who do, and reinvest the revenue they bring in into more marketing spend to buy more leads to keep more sales reps busy on their phones. (Many SaaS companies you’re aware of have floors upon floors of sales reps. A company which raises an A round has basically committed itself to hiring dozens to start, scaling up to hundreds on the way to IPO.)
Reasonable people can disagree on whether that model is sustainable as executed (and S-1 filings of SaaS companies trying to IPO are, to many people, hilarious for this reason), but at my scale, I’m less looking for explosive growth and more for continuing to run the business in a way which makes sense for us and our customers. So we’d self-fund the ramp-up period and reinvest profits in a fashion similar to the way we have for years. Click to read the full post or subscribe to his occasional newsletter
Many bootstrapped business seem to sneer at the idea of venture capital as it means a business is ‘doomed’, ‘ for sale’ founders have lost control etc.
Dharmesh Shah once said that Venture Capital is neither necessary, not evil. True that. The problems come when you take money without understanding the cost of money of the implications that having external investors have.
Joel Spolsky used to have a very combative approach to venture firms and external investors. It drove VCs wild and made them want to invest in him more. It was only when he was very clear what the business he was running was, and could see a clear route to scaling faster with cash from outside the company that he chose to accept it at a point when the business was ready, the control remained within the business and the investors were able to provide both cash and additional support for the business.
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