Stop claiming you’re profitable(blog.asmartbear.com)
blog.asmartbear.com
Stop claiming you’re profitable
http://blog.asmartbear.com/ramen-profitable.html
121 comments
Note that "ramen profitable", as I understand the term, means "throwing off enough money that the operators of the business can pay for adequate shelter and enough ramen-quality calories to avoid starvation".
That sounds like a pedantic distinction but it's not: ramen-profitability have runways denominated by the willpower of the founders, not extrinsic factors like "founders will soon be homeless".
Beer-money profitable carries none of the same connotations.
That sounds like a pedantic distinction but it's not: ramen-profitability have runways denominated by the willpower of the founders, not extrinsic factors like "founders will soon be homeless".
Beer-money profitable carries none of the same connotations.
I don't think that GP were saying "ramen-profitable" and "beer-profitable" were synonyms, just that both terms are sub-categories of the more general term "profitable." If you're talking to a VC, you should prefer one of these more specific terms.
Paul makes a good point, and I think it's one the post addresses -- eventually. Context is everything, both in terms of talking to other people and being honest with yourself. I was a textbook example of the "Profitable since month one" crowd, since our reimbursed expenses < revenue, but when I'd go around saying that from people who started/ran businesses, there were a lot of rolling eyes.
It's really easy to look around at huge venture-funded flameouts that have never had a dime in revenue and be proud of what you've built. I know I sure am. But that doesn't mean, at the end of the day, you've created a truly profitable business. That shouldn't take away from what you've done, but it does provide a little more nuance that can be hard to swallow.
It's really easy to look around at huge venture-funded flameouts that have never had a dime in revenue and be proud of what you've built. I know I sure am. But that doesn't mean, at the end of the day, you've created a truly profitable business. That shouldn't take away from what you've done, but it does provide a little more nuance that can be hard to swallow.
I think the important point people are missing is Raman profitable does not include the founders cost of living as 'profit'. You still need to pay taxes on your personal income and you don't get to deduct the full cost of rent as a business expense. What it means is you can cover taxes and a subsistence wage for the founders and still have some tiny amount of money aka profit left over.
Once, you can pay everyone a competitive salary and still have money left over there is no caveat and your just plain old profitable.
PS: And yes the IRS has a specific definition for profit so it actually matters.
Once, you can pay everyone a competitive salary and still have money left over there is no caveat and your just plain old profitable.
PS: And yes the IRS has a specific definition for profit so it actually matters.
This is pretty inconsistent with how the phrase "profitable business" has long been used. Maybe the startup world wants to invents its own metric, but to most small businessmen, whether a business is profitable enough for you to live on the profits is a separate question from whether the business is turning a profit in the first place, i.e. whether your endeavor is bringing you more income than it's producing in expenses. A business that's making $1000/mo is profitable, but not necessarily profitable enough to live on.
The idea of paying a founder a salary and accounting for that is also pretty atypical; most small businessmen are sole proprietors, and do not pay themselves salaries. You don't "deserve" some specific hourly rate as an owner, as that's the whole difference between owning a company and working for an hourly wage.
This doesn't seem very complex in other areas of business. If your business is turning a small profit, but not enough to live on, that's what you say. "Q: How's the restaurant doing? A: It's turning a modest profit now, but not really enough for it to be a living yet."
The idea of paying a founder a salary and accounting for that is also pretty atypical; most small businessmen are sole proprietors, and do not pay themselves salaries. You don't "deserve" some specific hourly rate as an owner, as that's the whole difference between owning a company and working for an hourly wage.
This doesn't seem very complex in other areas of business. If your business is turning a small profit, but not enough to live on, that's what you say. "Q: How's the restaurant doing? A: It's turning a modest profit now, but not really enough for it to be a living yet."
In some (many? most?) countries you are legally required to pay yourself at least the minimum wage. Even if you are the sole proprietor and sole employee in the business.
Minimum wage might not be enough to "live" on, but it should be enough to survive on.
Or maybe this is a recent-ish development where I live because people were using small businesses to avoid paying taxes, retirement funds and so on. Or maybe the government has just recently-ish started really clamping down on not paying yourself a minimum wage. Not really sure about the specifics.
Minimum wage might not be enough to "live" on, but it should be enough to survive on.
Or maybe this is a recent-ish development where I live because people were using small businesses to avoid paying taxes, retirement funds and so on. Or maybe the government has just recently-ish started really clamping down on not paying yourself a minimum wage. Not really sure about the specifics.
This depends on the business structure. In the US, if you have what is called an 'S' corp, then you are required to pay yourself a market rate salary. Otherwise, you are dodging social security, medicare, and other employment taxes. If you have a 'C' corp(as most startups seem to have) then you pay a separate corporate tax so you aren't really dodging taxes. Sole proprietors and LLCs pay "self-employment" tax on pass through earnings, so there is no tax dodging.
S Corp owners are not required to pay themselves market salaries.
What they are required to do is account for their income as if at least a market-salary's worth of it was salary.
You can pay yourself $1/year at an S Corp and be just fine, as long as you don't also issue yourself $200,000 in distributions in that same year and claim to have earned no salary.
This is because (this may set off a little brush fire in the threads, but hey, it beats the silly semantic argument over what the word "profitable" means) S Corps are a giant scam.
For the benefit of the class:
An S Corp, like an LLC, is a pass-through tax entity: the tax liability in an S goes straight to the owners.
LLC owners generally don't make salaries at all. They are paid entirely in distributions (ie, "profit sharing"). LLC owners are subject to self-employment tax on all that income; in fact, an LLC owner must typically pay taxes quarterly, instead of at the end of the year as W2 employees are accustomed. The LLC structure does not (that I know of) afford a huge and obvious opportunity to cheat on your taxes.
Owners of S Corps do take salaries, and do withholding in much the same way as a W2 employee would.
Additionally, as company owners, S Corp owners routinely pay themselves bonuses (profit sharing, distribution, whatever you want to call it). This is normal and reasonable. The business does well, payroll is made, money is reinvested in the company, and what's left over is distributed back to the owners.
The scam is that this money is not for tax purposes treated as payroll. In particular, that money isn't subject to FICA.
As a result, S Corp owners are incentivized to claim the lowest possible salary (today, "lowest" meaning "lowest you could reasonably get away with calling a market salary"). That's because the salary money is going to be subject to FICA. If the remainder of what the owner should fairly have been paid is issued in distributions, that money avoids FICA liability.
And so the IRS case files are littered with lawyers and doctors and dentists who set up their practices as S Corps and then try to claim the fair market rate for their participation in the company is, say, $5,000/year ("oh, I only come in on alternate Tuesdays!"). Their secretaries pay the full bite of FICA while living paycheck to paycheck, while the business owner makes payments on a vacation house with the money they save from this trick.
What they are required to do is account for their income as if at least a market-salary's worth of it was salary.
You can pay yourself $1/year at an S Corp and be just fine, as long as you don't also issue yourself $200,000 in distributions in that same year and claim to have earned no salary.
This is because (this may set off a little brush fire in the threads, but hey, it beats the silly semantic argument over what the word "profitable" means) S Corps are a giant scam.
For the benefit of the class:
An S Corp, like an LLC, is a pass-through tax entity: the tax liability in an S goes straight to the owners.
LLC owners generally don't make salaries at all. They are paid entirely in distributions (ie, "profit sharing"). LLC owners are subject to self-employment tax on all that income; in fact, an LLC owner must typically pay taxes quarterly, instead of at the end of the year as W2 employees are accustomed. The LLC structure does not (that I know of) afford a huge and obvious opportunity to cheat on your taxes.
Owners of S Corps do take salaries, and do withholding in much the same way as a W2 employee would.
Additionally, as company owners, S Corp owners routinely pay themselves bonuses (profit sharing, distribution, whatever you want to call it). This is normal and reasonable. The business does well, payroll is made, money is reinvested in the company, and what's left over is distributed back to the owners.
The scam is that this money is not for tax purposes treated as payroll. In particular, that money isn't subject to FICA.
As a result, S Corp owners are incentivized to claim the lowest possible salary (today, "lowest" meaning "lowest you could reasonably get away with calling a market salary"). That's because the salary money is going to be subject to FICA. If the remainder of what the owner should fairly have been paid is issued in distributions, that money avoids FICA liability.
And so the IRS case files are littered with lawyers and doctors and dentists who set up their practices as S Corps and then try to claim the fair market rate for their participation in the company is, say, $5,000/year ("oh, I only come in on alternate Tuesdays!"). Their secretaries pay the full bite of FICA while living paycheck to paycheck, while the business owner makes payments on a vacation house with the money they save from this trick.
It's not secretaries who overpay FICA taxes, it's software developers and other well paid professionals that are making ~$100K/year in salary.
Both secretaries and business owners are on the receiving end of social security benefits.
It might be ok to call S Corp way of setting up payroll for owners a loophole (debatable), but it's definitely not scam.
Both secretaries and business owners are on the receiving end of social security benefits.
It might be ok to call S Corp way of setting up payroll for owners a loophole (debatable), but it's definitely not scam.
You comment alone Sir, needs its own blog post. Pretty interesting. My accountant never told me this.
A relative of mine is an IRS auditor for small businesses. The cheating S Corps, as described by tptacek, take up the majority of his time. I got the same description from him, and he also said doctors were the biggest offenders.
If anyone is doing this, or interested in doing this, the way they deal with these cases is as follows: he picks a number based on a combination of what salary surveys say and what kind of mood he is in, multiplies it by 7 (since you've probably been doing this for 7 years by the time he gets it, which is how far they can go back), and assesses that as unreported income. They then tack on penalties and interest for the tax liability of said income. That makes for a really bad day.
If anyone is doing this, or interested in doing this, the way they deal with these cases is as follows: he picks a number based on a combination of what salary surveys say and what kind of mood he is in, multiplies it by 7 (since you've probably been doing this for 7 years by the time he gets it, which is how far they can go back), and assesses that as unreported income. They then tack on penalties and interest for the tax liability of said income. That makes for a really bad day.
Parent: "then you are required to pay yourself a market rate salary"
Only if there are distributions so if you are losing money or breaking even (by the IRS definition of that) you won't be paying any taxes:
IRS: "The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. "
Parent says: "pay yourself a market rate salary."
IRS:
"There are no specific guidelines for reasonable compensation in the Code or the Regulations."
http://www.irs.gov/newsroom/article/0,,id=200293,00.html
The point I am clearing up is the issue of "having to pay yourself a market rate salary" which only comes into play if you are making enough to pay anything.
Only if there are distributions so if you are losing money or breaking even (by the IRS definition of that) you won't be paying any taxes:
IRS: "The amount of the compensation will never exceed the amount received by the shareholder either directly or indirectly. "
Parent says: "pay yourself a market rate salary."
IRS:
"There are no specific guidelines for reasonable compensation in the Code or the Regulations."
http://www.irs.gov/newsroom/article/0,,id=200293,00.html
The point I am clearing up is the issue of "having to pay yourself a market rate salary" which only comes into play if you are making enough to pay anything.
Is that still the case? My understanding is that the PPACA ("Health care reform") does away with most of the tax benefits of sub-s's if they are profitable (i.e. would pay dividends) and so now they are mostly useful as passthrough entities during the loss stage.
It would seem to me that if full payroll taxes are paid on Sub-s dividends, that the requirement there would no longer make any real sense.
It would seem to me that if full payroll taxes are paid on Sub-s dividends, that the requirement there would no longer make any real sense.
It's more complicated than that: it's (iirc; there are actual accountants like 'rprasad who have real answers) a specific new medicare tax on S Corp profits, and active S-Corp owner/employees can avoid it. It's not my understanding that the loophole has been closed entirely.
I would be very surprised if most countries required this. The justification of minimum wage is to keep the risk-takers from shoving all that risk onto the lowest level of employee. The employee is then given a min. wage and the risk taker may or may not take anything home at the end of the month.
I suppose one "benefit" of such a requirement is that a lawyer could no longer take on worthy projects for free ;-)
I suppose one "benefit" of such a requirement is that a lawyer could no longer take on worthy projects for free ;-)
I believe most EU countries require you to pay the social/health insurance on a "virtual salary" (usually tied to minimal wage or similar.) This is to curb evasion of the social security payments by setting up "businesses" whose sole purpose is to provide labour to a single employer.
In the Nordic countries, at least, that only applies under pretty specific circumstances (which try to target the tax-evading cases you mentioned). In a normal case, if you're self-employed, you pay social contributions only on what you actually make, which might be considerably less than minimum wage if your business is not very successful. Actually have a friend who recently filed taxes in that circumstance, since his one-man mobile-game studio didn't sell very many games in 2012.
I don't know, really: around me (France) people who say they are profitable definitely include their salaries in the equation.
Even in accounting here, the (company) profit is what remains after everyone, founders included, has been paid.
And if your recurring expenses are low enough, it doesn't mean necessarily a high amount of money either (eg: here our coming SaaS will be profitable for us at around 2500€/mo ex VAT).
Even in accounting here, the (company) profit is what remains after everyone, founders included, has been paid.
And if your recurring expenses are low enough, it doesn't mean necessarily a high amount of money either (eg: here our coming SaaS will be profitable for us at around 2500€/mo ex VAT).
Not really. If you're not accounting for your own time, then almost any startup can be 'profitable.'
This post was a real eye-opener for me, having considered my last business 'profitable' over the course of two years, I realize that it was only just barely so, and only for the last 3-6 months.
This post was a real eye-opener for me, having considered my last business 'profitable' over the course of two years, I realize that it was only just barely so, and only for the last 3-6 months.
Where this will really sink in is when you have your first equity liquidity event, and you're bouncing off the walls, and then your pesky brain does the math on how much money you made annualized relative to what you would have made as an FTE at a BigCo.
Not that I think you should work for BigCos, but, the realization will let some of the air out of the balloon.
Not that I think you should work for BigCos, but, the realization will let some of the air out of the balloon.
The reason we closed up shop is because, with a 50:50 split in ownership, my partner was making more money than he could at a BigCo but I wasn't. I didn't have the heart to tell him that (or ask for a different equity distribution) so I just went and got myself a salary.
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Maybe the startup world wants to invents its own metric, but to most small businessmen, whether a business is profitable enough for you to live on the profits is a separate question from whether the business is turning a profit in the first place, i.e. whether your endeavor is bringing you more income than it's producing in expenses.
Sadly, TFA even says pretty much the same thing, when he makes the distinction between profitable and sustainably profitable. It's like he admits there is a distinction, but then insists we ignore the distinction and only talk about being "sustainably profitable" when talking about being "profitable." WTF? Load of bollocks if you ask me.
Sadly, TFA even says pretty much the same thing, when he makes the distinction between profitable and sustainably profitable. It's like he admits there is a distinction, but then insists we ignore the distinction and only talk about being "sustainably profitable" when talking about being "profitable." WTF? Load of bollocks if you ask me.
In your restaurant example, profitable could mean that you're able to sustainably pay salaries of the cooks, cleaners, and wait staff as well as rent, utilities, supplies, and overhead... but not much left over for yourself. In that case you could say that was minimally profitable. If, however, the restaurant depends on all the cooks, cleaners, and wait staff volunteering their time then that's hardly profitable.
I'd disagree. You might have a profitable hobby.
http://www.investopedia.com/financial-edge/0411/Is-Your-Smal...
http://www.investopedia.com/financial-edge/0411/Is-Your-Smal...
I agree with this assessment, and the reason that startups are being asked to have higher standards is just because tech startups today have such low costs vis-a-vis 90s startups or a restaurant.
Profitable does not mean 'making more money than you could otherwise', profitable does not mean 'worthwhile', profitable does not mean 'sustainable without ones founders.'
Profitable means making a profit. End of story.
This is a petty, semantic issue. if a company is making $50/month in profits, then the issue isn't that they're calling themselves profitable, its that they're only making $50/month.
Profitable means making a profit. End of story.
This is a petty, semantic issue. if a company is making $50/month in profits, then the issue isn't that they're calling themselves profitable, its that they're only making $50/month.
It's really a question of how time factors into your accounting. If you're spending 10 hours to make $50, then it's tough to claim that as a $50 profit unless your time is worth less than $5 an hour.
Of course there are cases in which your time is worth less than $5 an hour (you don't have any other prospects for making money). Or if you enjoy what you're doing it might only be 1 hour of "work" with 9 hours of enjoyment. The point is that completely ignoring time spent is just bad accounting.
Of course there are cases in which your time is worth less than $5 an hour (you don't have any other prospects for making money). Or if you enjoy what you're doing it might only be 1 hour of "work" with 9 hours of enjoyment. The point is that completely ignoring time spent is just bad accounting.
The point is that a business (at least from this point of view) is an entity in its own right. The founders are a bit like a life-support machine – if you switch them off, does the business die? (Of course, even a profitable business might die if the business can't hire some people to replace the founders.)
Because the business is supposed to be an entity in its own right, you have to value the founder's contribution somehow in deciding whether it is profitable. One way might be to consider what the salary would be to hire someone to take it over such that it continues to produce the same revenue. Another way might be to pay the founders their living expenses (ramen-profitable.) But discounting the cost of the founders working on it to zero? As the article says, that is meaningless.
It's like the old joke: Q: How can you quickly make a million dollars? A: Invest two million dollars in $TOPICAL_RISKY_ACTIVITY
If you hack it together on weekends and with no oversight it is reliably making a $100 more than hosting a month and will do for the foreseeable future, it's profitable (albeit at a small level and not necessarily sustainable).
But if you're living off savings and working full time on it, and it's making $1000 dollars a month, its not profitable.
Because the business is supposed to be an entity in its own right, you have to value the founder's contribution somehow in deciding whether it is profitable. One way might be to consider what the salary would be to hire someone to take it over such that it continues to produce the same revenue. Another way might be to pay the founders their living expenses (ramen-profitable.) But discounting the cost of the founders working on it to zero? As the article says, that is meaningless.
It's like the old joke: Q: How can you quickly make a million dollars? A: Invest two million dollars in $TOPICAL_RISKY_ACTIVITY
If you hack it together on weekends and with no oversight it is reliably making a $100 more than hosting a month and will do for the foreseeable future, it's profitable (albeit at a small level and not necessarily sustainable).
But if you're living off savings and working full time on it, and it's making $1000 dollars a month, its not profitable.
Potential Investor: "I loved your pitch, and I think your business model is great, but in going over your projected financials, I see you're planning on taking a $4,000/mo salary from day one. Don't you think you should have a little more skin in the game?"
Entrepreneur: "At my last consulting gig, I was making $8,000/mo before I left to start this company. I haven't been taking any salary for the last two months while I built a prototype, so I would certainly say I've got skin in the game. At the same time, this business is going to sustain a lot more than just one $4,000/mo salary - if you don't think it can, then you shouldn't invest in the first place"
Entrepreneur: "At my last consulting gig, I was making $8,000/mo before I left to start this company. I haven't been taking any salary for the last two months while I built a prototype, so I would certainly say I've got skin in the game. At the same time, this business is going to sustain a lot more than just one $4,000/mo salary - if you don't think it can, then you shouldn't invest in the first place"
There was a Shark Tank a few months back of a guy starting a "design your own shoes" clothing company -- When Mark Cuban asked him what salary he could comfortably live with, the guy said "I guess I could be comfortable with anything over six figures"
Of course Cuban then said he was out, stating he wanted the kid to be sweating on a mac 'n cheese diet in order to ensure he was working his ass off as opposed to living the "LA lifestyle." Was a pretty interesting conversation, because the kid was currently turning a decent profit already and claimed he had already done the blood sweat and tears thing.
Of course Cuban then said he was out, stating he wanted the kid to be sweating on a mac 'n cheese diet in order to ensure he was working his ass off as opposed to living the "LA lifestyle." Was a pretty interesting conversation, because the kid was currently turning a decent profit already and claimed he had already done the blood sweat and tears thing.
I saw it. That shoe guy is exactly the kind of guy you should fund. He wasn't saying he demanded a high lifestyle income they were asking what he was working for and then they pretend like he was expecting that now.
The whole show is really quite hilarious. I think it gives people the wrong impression though.
The sharks pass if a company is profitable and the owner wants a fair valuation. The sharks pass if the company has no traction yet.
What the sharks really bite on is profitable companies (or high potential companies) where they can get a controlling stake for cheap, or a minority stake for super cheap.
The show is correctly named, that's for sure.
The whole show is really quite hilarious. I think it gives people the wrong impression though.
The sharks pass if a company is profitable and the owner wants a fair valuation. The sharks pass if the company has no traction yet.
What the sharks really bite on is profitable companies (or high potential companies) where they can get a controlling stake for cheap, or a minority stake for super cheap.
The show is correctly named, that's for sure.
I recently saw this episode and you misheard.
He did say that he wanted a 6 figure salary to "live the L.A. life", and he repeated that statement more than once.
I like the show but agree with a lot of your points, my understanding is that these pitches are more than an hour so we only get to see the "juicy" parts.
He did say that he wanted a 6 figure salary to "live the L.A. life", and he repeated that statement more than once.
I like the show but agree with a lot of your points, my understanding is that these pitches are more than an hour so we only get to see the "juicy" parts.
Agreed -- while I absolutely love watching the show, there have been very few times when I have felt the entrepreneur has gotten a great deal from the sharks.
Well, that wasn't what I expected from a post on asmartbear. Trite quibbling over minor semantic distinctions? For an early stage startup, spending even two seconds worrying about the exact definition of "profitable" and whether or not your definition is suitable to someone else, is two seconds one could have spent writing code or doing something productive.
Pretty much a useless article, as far as I can tell.
Pretty much a useless article, as far as I can tell.
Wow do I ever think you (and even 'damoncali below) are wrong about this. This is the opposite of a "useless post". This is a post about how lying to yourself about the definition of "profitable" can cost you tens of thousands of dollars.
The idea Cohen is expressing is so extraordinarily simple it would almost be banal, if it didn't target such a widely held misconception:
You cannot factor out opportunity costs when accounting for your business.
When a new founder with a business throwing off $1500/mo after line-item costs like hosting claims to be "profitable", what they are effectively saying is that their own time is worth $0/mo.
In reality, that founder is almost definitely losing at least $11,000 per month --- by taking a SWAG at what any person capable of booting up a product to reliable $1500/mo can earn as an employee or freelance consultant, that SWAG being almost certainly so lowballed as to be insulting.
To my mind, not being able to tell the difference between "profitable to the tune of $1500/mo" and "losing 5 figures a month" is an alarming difference that is very much worth calling out.
The idea Cohen is expressing is so extraordinarily simple it would almost be banal, if it didn't target such a widely held misconception:
You cannot factor out opportunity costs when accounting for your business.
When a new founder with a business throwing off $1500/mo after line-item costs like hosting claims to be "profitable", what they are effectively saying is that their own time is worth $0/mo.
In reality, that founder is almost definitely losing at least $11,000 per month --- by taking a SWAG at what any person capable of booting up a product to reliable $1500/mo can earn as an employee or freelance consultant, that SWAG being almost certainly so lowballed as to be insulting.
To my mind, not being able to tell the difference between "profitable to the tune of $1500/mo" and "losing 5 figures a month" is an alarming difference that is very much worth calling out.
Wow do I ever think you (and even 'damoncali below) are wrong about this. This is the opposite of a "useless post". This is a post about how lying to yourself about the definition of "profitable" can cost you tens of thousands of dollars.
Is it really? I mean, that makes sense if the only point of being an entrepreneur is to make money, and you're totally fine with working a $DAYJOB as an employee. But, for some of us, it's about more than the money, and fighting to make the startup succeed is totally "worth it" even if "it" is tens, or hundreds of thousands of dollars that we might otherwise have earned as an employee.
You cannot factor out opportunity costs when accounting for your business.
Indeed.
Is it really? I mean, that makes sense if the only point of being an entrepreneur is to make money, and you're totally fine with working a $DAYJOB as an employee. But, for some of us, it's about more than the money, and fighting to make the startup succeed is totally "worth it" even if "it" is tens, or hundreds of thousands of dollars that we might otherwise have earned as an employee.
You cannot factor out opportunity costs when accounting for your business.
Indeed.
If you're happy, you're happy. That's great.
But if your company is bringing in $1500/mo after line-item expenses and before wages, you are making less than minimum wage; you are not profitable. Happy? Sure. Profitable? No.
But if your company is bringing in $1500/mo after line-item expenses and before wages, you are making less than minimum wage; you are not profitable. Happy? Sure. Profitable? No.
You seem to be blurring the line between "the company is profitable" and "I (an individual) am profitable." It's certainly possible for the company to be profitable in a narrow sense (which can be an important bit of information) while you (the founder) as an individual are not.
But since a founder owns equity which he/she expects to become valuable in the future, it's a tradeoff some people choose to make - forgoing a salary now, so the company can thrive.
But since a founder owns equity which he/she expects to become valuable in the future, it's a tradeoff some people choose to make - forgoing a salary now, so the company can thrive.
Your work to keep the company going is one of the company's costs.
How is it a cost if the company isn't paying you a salary?
Perhaps the downvoters would like to explain their logic here? If a worker chooses to donate his/her time to the company, how is that a cost for the company? Again, there is a distinction between the finances of the company and the finances of the individual involved. It's entirely reasonable, for example, for a founder to "donate" his/her time to the company, because he/she expects to gain from their equity stake in the future.
The point is that the goal is to generate growth through reinvestable cash flow. Only when a business has money left over for owners (after they have eaten) is it profitable in this sense.
Opportunity cost has nothing to do with it. If I have created a business that pays me $50k a year (to live off of) and throws off an additional $25k in earnings that I can reinvest in the business, I have a profitable business. It can be grown through reinvestment of profits, and has value to investors.
None of that changes if I could be making $1M per year doing something else. You can't say that the business isn't profitable just because I have a high value alternative. It just means I'm not maximizing my income (which is a personal choice, not some indication of business health).
Opportunity cost has nothing to do with it. If I have created a business that pays me $50k a year (to live off of) and throws off an additional $25k in earnings that I can reinvest in the business, I have a profitable business. It can be grown through reinvestment of profits, and has value to investors.
None of that changes if I could be making $1M per year doing something else. You can't say that the business isn't profitable just because I have a high value alternative. It just means I'm not maximizing my income (which is a personal choice, not some indication of business health).
If you create a business that pays you $50k/yr and generates $25k/yr in reinvestable cash flow, I have no problem with you calling it "profitable".
But if you create a business that pays you $0k/yr, and offers $2000/mo worth of revenue to split somehow between reinvestment and wages, I have a real problem calling that "profitable". That business is "profitable" only so long as you are willing to donate your time to it.
In reality, that second class of business is virtually always pro-forma cash-flow negative; the founders simply aren't accounting for the rent/mortgage and food payments slowly draining away at their savings cushion. That cushion is a phantom capital investment on their books, but they don't want to account for it, because if they did it'd be obvious they weren't profitable.
But if you create a business that pays you $0k/yr, and offers $2000/mo worth of revenue to split somehow between reinvestment and wages, I have a real problem calling that "profitable". That business is "profitable" only so long as you are willing to donate your time to it.
In reality, that second class of business is virtually always pro-forma cash-flow negative; the founders simply aren't accounting for the rent/mortgage and food payments slowly draining away at their savings cushion. That cushion is a phantom capital investment on their books, but they don't want to account for it, because if they did it'd be obvious they weren't profitable.
I don't think we disagree much. I would argue that personal finances and business finances are totally separate, though. Whether or not you are making your mortgage payment is not all that relavent to the business in terms of its profitability.
For example, two founders each have identical businesses. One has a $10k/month mortgage. One lives in a $400/month apartment. Which one is more profitable? Neither. If either founder chose to sell their business, they'd get the same amount. That is, the present value of the profits of either business is the same to a would-be purchaser.
The question that needs to be adressed is not "How much do I need to live the way I want?", but "What is the market salary of someone I could hire to do my job while I sit at home and watch Shark Tank on DVR?" If you account for that, and the business comes out ahead, you have a profitable business. (Even if you're blowing the profits on your mortgage.)
For example, two founders each have identical businesses. One has a $10k/month mortgage. One lives in a $400/month apartment. Which one is more profitable? Neither. If either founder chose to sell their business, they'd get the same amount. That is, the present value of the profits of either business is the same to a would-be purchaser.
The question that needs to be adressed is not "How much do I need to live the way I want?", but "What is the market salary of someone I could hire to do my job while I sit at home and watch Shark Tank on DVR?" If you account for that, and the business comes out ahead, you have a profitable business. (Even if you're blowing the profits on your mortgage.)
Again, what is the entrepreneur is happy with this scenario?
Say you can earn $20k a month as a consultant.
If you are only making $19k from your own small business, are you therefore making a loss?
I would take the latter scenario all day long. If that's a loss, please bring it on.
Say you can earn $20k a month as a consultant.
If you are only making $19k from your own small business, are you therefore making a loss?
I would take the latter scenario all day long. If that's a loss, please bring it on.
That's more like "I took a pay-cut in exchange for a better quality of life", which is understandable and totally a choice I might make. But the important bit is that you would, in fact, take a pay-cut.
The article basically boils down to 'if the startup can't support you fulltime, it's not profitable'.
If you still have to be a consultant to pay the bills because your side project isn't making enough money for you to quit, don't run around telling people your 'startup is profitable'.
Speaking as someone who has done the side project thing, I was never happy having to work a full time job when I wanted to be full time on my sideproject.
If you still have to be a consultant to pay the bills because your side project isn't making enough money for you to quit, don't run around telling people your 'startup is profitable'.
Speaking as someone who has done the side project thing, I was never happy having to work a full time job when I wanted to be full time on my sideproject.
I don't think the word "profitable" is the interesting part of the article--rather it's looking for inflection points in the time/utility function of your startup. It's making the point that the interesting point is not when the final figure in some parboiled accounting books is positive, but when you have enough confidence in it to use it as your primary source of income.
I'd urge you to re-read it and not fall into the trap of believing he's making an argument on semantics. There's a useful point there.
I'd urge you to re-read it and not fall into the trap of believing he's making an argument on semantics. There's a useful point there.
Fair enough, maybe it's just that the headline is misleading. No doubt, that inflection point does matter... But I wish he'd been clearer in saying that that's what he's talking about.
But even if we acknowledge that that inflection point is important, what conclusion is he asking us to draw from it? Does acknowledging or not acknowledging this point make much difference to any strategic or tactical decision a hypothetical startup founder is going to make? I mean, if the OP had made a point about "this is how you know when to go raise outside money" or "this is how you know it's time to shut down the "profitable" startup," then I'd have found this valuable.
But even if we acknowledge that that inflection point is important, what conclusion is he asking us to draw from it? Does acknowledging or not acknowledging this point make much difference to any strategic or tactical decision a hypothetical startup founder is going to make? I mean, if the OP had made a point about "this is how you know when to go raise outside money" or "this is how you know it's time to shut down the "profitable" startup," then I'd have found this valuable.
I think you missed the good stuff. It's a great post about what positive traction looks like wrapped up in a pointless, link-baity, semantic argument.
The article ignores the sentiment that applies to me and probably others on this site. I would rather earn the $1k working on my own products than $10k working for someone else.
There is also the potential that the $1k will grow over time.
I therefore don't think it's reasonable to value my time at $10k for the purpose calculating my profits.
[The figures will obviously vary on a person by person basis.]
More broadly, I view this from the E-Myth [1] perspective:
If you work within the business as a job, you're selling yourself short if your business is generating $1k a month when you could be earning $10k working for someone else. The money you have left on the table has a real opportunity cost to you as an individual and should probably be valued closer to the shortfall you are taking of $9k.
However, if you view your business as a system - something that has money going out (product, marketing, people you pay) and money coming in (sales) then that money is a genuine excess that the system is kicking out and into the entrepreneurs pocket and is most certainly profit from his endeavor, whether $1 or $1MM.
[1] http://www.e-myth.com/
There is also the potential that the $1k will grow over time.
I therefore don't think it's reasonable to value my time at $10k for the purpose calculating my profits.
[The figures will obviously vary on a person by person basis.]
More broadly, I view this from the E-Myth [1] perspective:
If you work within the business as a job, you're selling yourself short if your business is generating $1k a month when you could be earning $10k working for someone else. The money you have left on the table has a real opportunity cost to you as an individual and should probably be valued closer to the shortfall you are taking of $9k.
However, if you view your business as a system - something that has money going out (product, marketing, people you pay) and money coming in (sales) then that money is a genuine excess that the system is kicking out and into the entrepreneurs pocket and is most certainly profit from his endeavor, whether $1 or $1MM.
[1] http://www.e-myth.com/
I left Apple to start my first business in 1991.
A year later I ran into my former boss from Apple when I was out eating lunch. He asked how it's going, I said well. Then he asked, "Ok, are you making more, or less, than you were at Apple?"
Embarassed by the question, I admitted the answer was "more".
I think his question captured perfectly the real issue here.
A year later I ran into my former boss from Apple when I was out eating lunch. He asked how it's going, I said well. Then he asked, "Ok, are you making more, or less, than you were at Apple?"
Embarassed by the question, I admitted the answer was "more".
I think his question captured perfectly the real issue here.
I think his question captured perfectly the real issue here.
I guess it depends on your perspective. If the only goal of doing a startup is to make more money, then sure. But if your goals involve having more control over your own destiny, fulfilling a desire to build something for the sake of building it, or having a kind of freedom you could never have when working for $BIGCORP, then it doesn't really matter if you're making more or less than you would at $BIGCORP. As long as you are either "ramen profitable" or have runway left to burn, you still have a shot at fulfilling that ambition, which is what matters, IMO.
I guess it depends on your perspective. If the only goal of doing a startup is to make more money, then sure. But if your goals involve having more control over your own destiny, fulfilling a desire to build something for the sake of building it, or having a kind of freedom you could never have when working for $BIGCORP, then it doesn't really matter if you're making more or less than you would at $BIGCORP. As long as you are either "ramen profitable" or have runway left to burn, you still have a shot at fulfilling that ambition, which is what matters, IMO.
This is definitely not a useless article. If you've ever read an article or blog post where someone is talking about how they built their business and said something about being profitable at some x point in time, then they proceed to NOT describe what they exactly mean, then I just end up disregarding the whole thing because I can't take what they say at face value. I'm glad someone spoke up about this because it should (hopefully) mean higher quality articles in the future.
If you've ever read an article or blog post where someone is talking about how they built their business and said something about being profitable at some x point in time, then they proceed to NOT describe what they exactly mean, then I just end up disregarding the whole thing because I can't take what they say at face value.
Life is full of generalisations, do you expect every post made by every person, every day, on every blog, to contain every possible excruciating detail about every super tiny little aspect of exactly what they did, how they did it, when they did it? You're only short-changing yourself if you reject every communication from someone who doesn't happen to share your obsession with pedantry and trivia.
"I launched a startup today. First, I went to the bathroom, then read an article in Entrepreneur, then pushed the site code to production, but had to back that out because the db config was wrong, so we did another push, then we brought the site up... and we waited 7.323212 minutes before submitting a "Show HN" to HN, then waited 19.11111111 seconds for the first hit to our site...
...
...
...
...
...
...
7 hours later
...
and that's how we made $400.00 dollars on day one, which is way more than the $230.00 it cost to run the site, but since that doesn't include the cost of our own salaries, our startup isn't quite profitable yet. Check back tomorrow for the next exciting installment! Same bat time, same bat channel."
Life is full of generalisations, do you expect every post made by every person, every day, on every blog, to contain every possible excruciating detail about every super tiny little aspect of exactly what they did, how they did it, when they did it? You're only short-changing yourself if you reject every communication from someone who doesn't happen to share your obsession with pedantry and trivia.
"I launched a startup today. First, I went to the bathroom, then read an article in Entrepreneur, then pushed the site code to production, but had to back that out because the db config was wrong, so we did another push, then we brought the site up... and we waited 7.323212 minutes before submitting a "Show HN" to HN, then waited 19.11111111 seconds for the first hit to our site...
...
...
...
...
...
...
7 hours later
...
and that's how we made $400.00 dollars on day one, which is way more than the $230.00 it cost to run the site, but since that doesn't include the cost of our own salaries, our startup isn't quite profitable yet. Check back tomorrow for the next exciting installment! Same bat time, same bat channel."
Well, sometimes saying you're profitable is important to the topic at hand, and sometimes it's not. If it is and you gloss over the details, people will find it less helpful, and I personally have less confidence the author knows what they're talking about. Everyone has their filters and this is part of mine since there's so much bullshit out there. If you want to call that pedantry go ahead. No sweat off my back.
Let's not redefined profits to mean "this busienss can pay for X people's salary".
What if I have five businessses, but none can pay for my salary individually, though in aggregate they make me fairly well off.
Can't I call any one of the busineseses (seperate entities, mind you, not just apps in the store) profitable?
What if I have five businessses, but none can pay for my salary individually, though in aggregate they make me fairly well off.
Can't I call any one of the busineseses (seperate entities, mind you, not just apps in the store) profitable?
One of the key points in that article has to do with valuing your time. If you're running 5 businesses, then you're clearly not putting full-time 40hr/week into each one. Adjust accordingly.
If you could be earning a salary of $80k/yr from a BigCorp( ~$40/hr) and you have a business that you put 10 hours/month into, then a profit of $400/month from that business is breaking even relative to a full-time job.
If you could be earning a salary of $80k/yr from a BigCorp( ~$40/hr) and you have a business that you put 10 hours/month into, then a profit of $400/month from that business is breaking even relative to a full-time job.
One of my businesses can easily pay the wages of an employee for the time they are needed, but being highly seasonal work, it would not pay for an employee year round. Or to put it another way: On a per hour of work basis, it makes a programmers salaries look like chump-change, but amortized out to a yearly income it's not enough to sustain a living.
Is that profitable?
Is that profitable?
Sure - that's the same as "my business is profitable, but can't afford to hire another employee yet", only it's a fractional employee that you can't afford to hire.
In the context of this article, you have one business.
According to the article, if you have one business and still work for someone else then the business is not profitable.
It basically states that multiple-streams of income means the smallest stream doesn't deserve the definition "profitable".
So questions like mine are valuable to fleshing out this theory....
It basically states that multiple-streams of income means the smallest stream doesn't deserve the definition "profitable".
So questions like mine are valuable to fleshing out this theory....
It's not so much a theory as it is a colorful way of explaining basic entrepreneurial accounting.
He's talking about the difference between paying yourself and not, in a round about way of getting to this concept: not paying yourself a sustainable wage leaves nothing for investors (even if the "investor" is just you.)
If you have five separate entities that combine to pay you a salary, you win. Any extra money can be used to grow one or more of those businesses. ..if they are all tied together in ownership (for example, they are all owned by one person).
If those 5 entities are not tied together in some way, then no, they are not sustainably profitable on their own. That is, each entity does not throw off enough cash so that there is some left over for reinvestment unless you combine them all together.
He's talking about the difference between paying yourself and not, in a round about way of getting to this concept: not paying yourself a sustainable wage leaves nothing for investors (even if the "investor" is just you.)
If you have five separate entities that combine to pay you a salary, you win. Any extra money can be used to grow one or more of those businesses. ..if they are all tied together in ownership (for example, they are all owned by one person).
If those 5 entities are not tied together in some way, then no, they are not sustainably profitable on their own. That is, each entity does not throw off enough cash so that there is some left over for reinvestment unless you combine them all together.
What? Profitable is profitable, there is no ambiguity there. The post linked above is talking mostly about opportunity cost (your own) and growth. Is your business sustainable? Is it growing? Is it worth doing full time? Those are all critical questions but the concept of profit does not include them.
The disagreements in just these small sample of comments is a little bit of an example that people don't always have the same idea of what 'profit' means no matter how well defined you think it is in the lexicon. The alternative is to always take what people say at face value, but then that can be a little bit reckless as well.
Great post. If someone is trying to sell you an idea or technique and they use their own profitability to justify this technique, then the definition of "profitable" is very relevant.
In my mind, a business that excludes the time spent by its founder from its expenses is not honestly assessing its profitability.
In my mind, a business that excludes the time spent by its founder from its expenses is not honestly assessing its profitability.
Great post. If someone is trying to sell you an idea or technique and they use their own profitability to justify this technique, then the definition of "profitable" is very relevant.
Right, but if somebody is selling you something, you're going to do due diligence and probe this stuff. If it turns out that they are only "profitable" in the narrowest sense, but not "sustainably profitable," then that's a good thing to find out.
Right, but if somebody is selling you something, you're going to do due diligence and probe this stuff. If it turns out that they are only "profitable" in the narrowest sense, but not "sustainably profitable," then that's a good thing to find out.
The article makes the point that a business should only be considered profitable when it is sustainably profitable - e.g. when it can pay its workers for their time.
Given the debate that this idea appears to be generating perhaps another way of looking his idea is to say that the business has no value as a business until it is sustainably profitable (even though it may control assets that may be valuable when liquidated such as a web domain or even talent which another company may wish to acquire) - i.e. until it is sustainably profitable a business has no value as an ongoing enterprise and can only be sold for the value of its assets.
Given the debate that this idea appears to be generating perhaps another way of looking his idea is to say that the business has no value as a business until it is sustainably profitable (even though it may control assets that may be valuable when liquidated such as a web domain or even talent which another company may wish to acquire) - i.e. until it is sustainably profitable a business has no value as an ongoing enterprise and can only be sold for the value of its assets.
[deleted]
I'm not going to say the author stole my post from yesterday, but it sure is eerily similar... What a coincidence!
http://jerzygangi.com/2012/06/17/youre-making-money-but-are-...
http://news.ycombinator.com/item?id=4126955
http://jerzygangi.com/2012/06/17/youre-making-money-but-are-...
http://news.ycombinator.com/item?id=4126955
Having worked in finance 16 years, I do not understand this fuss about semantics - "ramen", "beer", "sushi" ... profitable.
For starters, for any business, let's look at the numbers:
- market size, market share, market dynamics
- gross & net revenue - abs $ and % growth
- gross margin, gross profit, operating income, net income - abs $, % of revenue & % growth
- Balance Sheet, Income Statement and Cash Flow
Then we can talk semantics.
Edit: formatting
For starters, for any business, let's look at the numbers:
- market size, market share, market dynamics
- gross & net revenue - abs $ and % growth
- gross margin, gross profit, operating income, net income - abs $, % of revenue & % growth
- Balance Sheet, Income Statement and Cash Flow
Then we can talk semantics.
Edit: formatting
Love this: "So now that I’ve perhaps unfairly ridiculed you, let’s just recognize what’s really going on, because it’s wonderful and amazing and fantastic and exciting"
Most posts like this just bitch and moan, but he actually provides valuable advice.
Most posts like this just bitch and moan, but he actually provides valuable advice.
"profitable" is not equal to true or false. People who understand business use numbers to represent it and evaluate accordingly.
Let's try more succinctly. "Stop claiming your lemonade stand is profitable if it only pays for itself if you don't count the person selling the lemonade."
That's fair. But the Internet doesn't work that way. If you develop something once, you don't need to keep standing there and keep developing it. The whole reason the article is wrong can be boiled down to this. For more nuanced response you can see my other comments.
Basically, it would be like saying, "A restaurant that makes 50,000 per month in profit isn't profitable if the person who made it is Bill Gates."
Since, "automatically" Bill Gate's time is worth a lot more doing just about anything else other than launching a restaurant. But come on. When it comes time to buy the restaurant and see how much it makes in profit so you can see how much you will pay for it - do you really think you'll reconsider the whole thing as unprofitable just because Bill Gates spent way more of his time on it than can possibly be valued at as low as that?
Get real. From an investment standpoint, nobody cares about the founder's development time. And guess what the article is about? Investment standpoint.
That's fair. But the Internet doesn't work that way. If you develop something once, you don't need to keep standing there and keep developing it. The whole reason the article is wrong can be boiled down to this. For more nuanced response you can see my other comments.
Basically, it would be like saying, "A restaurant that makes 50,000 per month in profit isn't profitable if the person who made it is Bill Gates."
Since, "automatically" Bill Gate's time is worth a lot more doing just about anything else other than launching a restaurant. But come on. When it comes time to buy the restaurant and see how much it makes in profit so you can see how much you will pay for it - do you really think you'll reconsider the whole thing as unprofitable just because Bill Gates spent way more of his time on it than can possibly be valued at as low as that?
Get real. From an investment standpoint, nobody cares about the founder's development time. And guess what the article is about? Investment standpoint.
Nobody disagrees with this. If the business runs without your consistent involvement, the value of your time doesn't factor in, because your time isn't one of the costs of the business.
If you have a business that throws off $1500/mo and requires one hour of your time in each of those months on average, you absolutely are ~$1300/mo profitable. That much is obvious.
The problem is when your business is throwing off $1500/mo and you are spending more than 8 hours on it in a month.
If you have a business that throws off $1500/mo and requires one hour of your time in each of those months on average, you absolutely are ~$1300/mo profitable. That much is obvious.
The problem is when your business is throwing off $1500/mo and you are spending more than 8 hours on it in a month.
The author does disagree with this. He's saying if you're still sinking your time into the development, you have to subtract it from sales before you can cry "profit!", even if the profit is the result of previously sunk development costs that don't require ongoing involvement. The author doesn't differentiate types of development costs on this point. Most Internet development is invested into future profit: it's not standing in front of your lemonade stand.
He's right about that.
Nobody, however, is saying that once you've recouped your investment, your hourly bill rate needs to somehow factor into your profitability.
Nobody, however, is saying that once you've recouped your investment, your hourly bill rate needs to somehow factor into your profitability.
I will just say that people very much are saying that. You're pretty much saying that as demand for you goes up and down elsewhere, the profitability of your business goes up and down. And if someone wants to make your business unprofitable, they can just offer you a hundred million dollars to go work for them and drop it - even if you continue on the business, it's suddenly unprofitable.
This is obviously totally false.
Let's do this thought experiment.
Say I would accept this if the author said that true profitability is only the amount that the company would clear if you spent less than a minimal frictional amount of time hiring someone (from company revenue) at rock-bottom wages, to keep running the company.
but if we accept this, notice something interesting. What if the way to get someone at rock-bottom wages is for the company to issue some shares (which means a percentage) and pay the worker in those shares?
Can the company still be profitable (though you're diluting the profit) on those terms? From your point of view, OF COURSE!
The author is talking about the point of view of an investor. ("Stop telling me your company is profitable.") He's not arguing from the point of view of what's worth your time: "stop thinking that if you're profitable it's worth it for you to do that."
The two are totally distinct. If the company has someone on payroll at $0 because they think their work is worth investing in exchange for the 30% equity they have, then the profit the company generates for the 70% stakeholder who doesn't have to put time in is simply 70% of company revenues minus company expenses such as hosting.
That doesn't mean the person who is working for $0 and equity isn't getting screwed. But it also does't mean the company isn't profitable.
The whole article is completely wrong and I've told you why here and in my other comments.
Would you buy a company for a thousand dollars that had paper profits of five thousand dollars a month and will for the next two years, but actually this isn't "real profit" because the founder, who had been earning five hundred thousand as a President at Microsoft, put five years of labor into it unpaid?
Of course you would buy it. That's real profit the company's making. It doesn't have to recoup the founder's lost opportunity cost over the ENTIRE life of the company in order for it to be a profitable company.
This is obviously totally false.
Let's do this thought experiment.
Say I would accept this if the author said that true profitability is only the amount that the company would clear if you spent less than a minimal frictional amount of time hiring someone (from company revenue) at rock-bottom wages, to keep running the company.
but if we accept this, notice something interesting. What if the way to get someone at rock-bottom wages is for the company to issue some shares (which means a percentage) and pay the worker in those shares?
Can the company still be profitable (though you're diluting the profit) on those terms? From your point of view, OF COURSE!
The author is talking about the point of view of an investor. ("Stop telling me your company is profitable.") He's not arguing from the point of view of what's worth your time: "stop thinking that if you're profitable it's worth it for you to do that."
The two are totally distinct. If the company has someone on payroll at $0 because they think their work is worth investing in exchange for the 30% equity they have, then the profit the company generates for the 70% stakeholder who doesn't have to put time in is simply 70% of company revenues minus company expenses such as hosting.
That doesn't mean the person who is working for $0 and equity isn't getting screwed. But it also does't mean the company isn't profitable.
The whole article is completely wrong and I've told you why here and in my other comments.
Would you buy a company for a thousand dollars that had paper profits of five thousand dollars a month and will for the next two years, but actually this isn't "real profit" because the founder, who had been earning five hundred thousand as a President at Microsoft, put five years of labor into it unpaid?
Of course you would buy it. That's real profit the company's making. It doesn't have to recoup the founder's lost opportunity cost over the ENTIRE life of the company in order for it to be a profitable company.
More like "A restaurant that makes 50,000 per month in profit isn't profitable if the person who made it is Bill Gates, if Bill Gates has to work as the maitre d'hotel for 40 hours a week, and that's the only way the restaurant can get any foot traffic". And, actually, that seems like a reasonable analysis.
Except what you miss is that Internet sites don't have maitre d's. They only have development costs and hosting/service agreement costs.
You seem determined to not look for similarities, so, to spell it out, the "is Bill Gates" translates as "is willing to work for less than market rate" (presumably in the expectation of upside). If your work isn't so exciting that you can get people at less than market rate, wonderful, but I imagine most isn't.
Breakeven is the term people really should be using. It has been around for a very long time, and it is very clear about what it means.
The thing is, people want to use the term "profitable" because they want to spin where their business is at.
Operationally break-even would mean your income exceeds your hosting expenses.
Breakeven sans salaries, would imply that you're ramen profitable but nobody is getting paid.
And from there you could say "we're profitable enough to hire one programmer, but no more" or whatever.
The thing is people would rather say "ramen profitable" than break-even. Sure, ramen profitable has a specific meaning with more nuance, but it also has the magic word "profit" in it.
I think founders and investors should both work towards more level headed straightforward language.
I've been watching a lot of startup pitches lately, and combined with what I've seen in the last 2 decades, hyperbole has become quite the turnoff. Maybe it works on investors, they sure all seem to do it (e.g.: watch the Founder Fuel pitches) but for me it undermines credibility.
Kinda like dealing with a used car salesman-- have I got a startup for you! It has the most excellent traction you've ever seen!
The thing is, people want to use the term "profitable" because they want to spin where their business is at.
Operationally break-even would mean your income exceeds your hosting expenses.
Breakeven sans salaries, would imply that you're ramen profitable but nobody is getting paid.
And from there you could say "we're profitable enough to hire one programmer, but no more" or whatever.
The thing is people would rather say "ramen profitable" than break-even. Sure, ramen profitable has a specific meaning with more nuance, but it also has the magic word "profit" in it.
I think founders and investors should both work towards more level headed straightforward language.
I've been watching a lot of startup pitches lately, and combined with what I've seen in the last 2 decades, hyperbole has become quite the turnoff. Maybe it works on investors, they sure all seem to do it (e.g.: watch the Founder Fuel pitches) but for me it undermines credibility.
Kinda like dealing with a used car salesman-- have I got a startup for you! It has the most excellent traction you've ever seen!
Disagree completely. EDIT: it's an important distinction to make, and when you say "profitable since day one" obvoiusly nobody expects that you made seventeen thousand dollars in sales your first day. Maybe there is a better word for it (scantily profitable over the direct-but-not-opportunity-costs since day 1?) but if it's something you can claim, go ahead and do so for contextualization. This is why:
There's a whole type of startup (call it type "1" whereas article is about type "2"), which is more traditional, and the only possible model in many sectors such as hotels, restaurants, retail, etcetcetc, that is based on launching a business (as opposed to 'bootstrapping') from sizeable funds - often 20k-50k or more - and not even attempting to become profitable within 3-5 months, during which you expect to continue to pay out one or two thousand on office rental space, equipment, hosting, whatever. An optimistic plan is to scratch the surface of breaking even around the one year mark.
When someone is, and has been, "profitable" since day one, ("type 2") this is in stark contrast to this model. This is the "in our first few months we spent three-fifty on hosting while servicing our five paying customers and working hard coding and developing so we can grow our customer base and make our equity worth enough to sell some of it and raise a round, or at least have enough money coming in to grow organically and bootstrap to sizeable revenues."
There's nothing wrong with either of the two models. It's also probably the most important fact you need to know to contextualize a conversation about your business. And the type 2 business that has paying customers but can't even meet it's hosting bills is fundamentally broken. Hell, I can do that just by hosting up to five hundred gigabytes of files per person for five dollars per decade.
If you're not broken - and running this type of model - go ahead and boast. And if boasting isn't enough, keep growing.
There's a whole type of startup (call it type "1" whereas article is about type "2"), which is more traditional, and the only possible model in many sectors such as hotels, restaurants, retail, etcetcetc, that is based on launching a business (as opposed to 'bootstrapping') from sizeable funds - often 20k-50k or more - and not even attempting to become profitable within 3-5 months, during which you expect to continue to pay out one or two thousand on office rental space, equipment, hosting, whatever. An optimistic plan is to scratch the surface of breaking even around the one year mark.
When someone is, and has been, "profitable" since day one, ("type 2") this is in stark contrast to this model. This is the "in our first few months we spent three-fifty on hosting while servicing our five paying customers and working hard coding and developing so we can grow our customer base and make our equity worth enough to sell some of it and raise a round, or at least have enough money coming in to grow organically and bootstrap to sizeable revenues."
There's nothing wrong with either of the two models. It's also probably the most important fact you need to know to contextualize a conversation about your business. And the type 2 business that has paying customers but can't even meet it's hosting bills is fundamentally broken. Hell, I can do that just by hosting up to five hundred gigabytes of files per person for five dollars per decade.
If you're not broken - and running this type of model - go ahead and boast. And if boasting isn't enough, keep growing.
You haven't rebutted his point at all. Jason Cohen been around the block a couple times. He saw the "type 2" startup argument coming and addressed it very early on. Specifically: you are losing money if you are not accounting for the fair market value of your time, no matter what your pro forma cash flows in Excel tell you is going on.
Also: if the only reasonable trajectory for your business is to "raise a round"...
This, it seems to me, is one of the most common mistakes people make when talking about their businesses on HN.
Also: if the only reasonable trajectory for your business is to "raise a round"...
This, it seems to me, is one of the most common mistakes people make when talking about their businesses on HN.
Well, what do you suggest instead of "profitable"? It's an extremely useful fact and contextualization, and obviously no one thinks you really mean "profitable"? What do you suggest we call it? "monetarily self-sustaining hobby that pays for the direct - but not opportunity - costs the founders, er, hobbyists, incur in, uh, playing with it, which they are doing in the hopes that beyond paying for the current direct costs, in the future the hobby's revenue is able to be used, either through sale of the hobbyist's ownership at a rate commensurate with a multiple of the hobby's then-present revenues and which valuation will factor in the ability - as of the extent to which it will have been proven by that future date, of the founders to use outside money to generate value for the outside shareholder, -- or, in lieu of such a sale of ownership, through sufficient growth of revenue, to have made the hobby a more valuable use of the founders' time, in retrospect, than the amount of money they lost by not doing something different?"
I humbly submit that "profitable from day 1" (or day 7 or 14 )is a useful shortcut to name all of the above. Of course it doesn't mean really profitable.
But it also doesn't mean that you're hosting a news a blog that has readerships but hasn't made a penny.
I humbly submit that "profitable from day 1" (or day 7 or 14 )is a useful shortcut to name all of the above. Of course it doesn't mean really profitable.
But it also doesn't mean that you're hosting a news a blog that has readerships but hasn't made a penny.
Profit = Revenue - Costs.
The mistake Cohen is talking about is mostly about not fully accounting for costs.
If, after factoring in opportunity cost (ie: what your full-time salary would be had you done something other than start your venture), that equation produces a negative number, you are not "profitable".
It's weird that this should generate so much controversy. The concept of opportunity cost is not controversial among businesspeople, among investors, or among economists.
The term you are looking for to describe the "kind of profitable" to which you're referring is "cash flow positive".
The mistake Cohen is talking about is mostly about not fully accounting for costs.
If, after factoring in opportunity cost (ie: what your full-time salary would be had you done something other than start your venture), that equation produces a negative number, you are not "profitable".
It's weird that this should generate so much controversy. The concept of opportunity cost is not controversial among businesspeople, among investors, or among economists.
The term you are looking for to describe the "kind of profitable" to which you're referring is "cash flow positive".
That actually isn't his point. He's very clear that what he's talking about is that your cost of living should be counted as a business cost. Once your business is covering your cost of living, he says that you should count it as profitable, even though you're not yet making the salary that you could.
But that's obviously stupid. See my other comments. If you stop working on it and pay someone 800 per month to maintain it and do nothing else, and ten years later the account payments go into has 200k in it, what, is that 200k from another dimension? This is so obviously wrong. The article is completely wrong economically, and can be summarized as: "Don't say you're profitable from day 1: say what you mean, that your business is cash-flow positive with respect to its own business expenses other than your original time in developing it." whoop-de-doo. not an important semantic distinction, but I will grant the author it.
I will not grand the author the contention that you shouldn't tell people if this is the case.
I will not grand the author the contention that you shouldn't tell people if this is the case.
The difference is that the author is implicitly assuming that you've got a business that requires your active involvement to keep going.
If the business requires 0 energy from you, and makes money, then his point becomes much less relevant. But most of the businesses in question are not like that. You have paperwork to keep them going, decisions to make, customers to serve...
If the business requires 0 energy from you, and makes money, then his point becomes much less relevant. But most of the businesses in question are not like that. You have paperwork to keep them going, decisions to make, customers to serve...
Fine, the article should therefore argue, "Stop claiming to be profitable since day 3: claim to be cash flow positive not including consumer expenses such as apartment, car, home Internet and mobile telephone, since day 1." Such an important semantic difference. (Not.)
For virtually everyone on HN, the difference between $1000/mo profitable (which BTW is a dream scenario for the majority of would-be founders here) and $11k/mo underwater is about as extreme a distinction as can be made.
Why do people keep talking as if this is a semantic argument?
It isn't a semantic argument.
I know it feels amazing to build something with enough traction to reliably put $1500 a month in the founder's pockets, but that "profitability" is counterfeit. You cannot run that business forever; it is paying you less than the minimum wage.
If you think this is a semantic difference, try re-reading Steve Albini's "Some Of Your Friends May Already Be This Fucked" rant.
Why do people keep talking as if this is a semantic argument?
It isn't a semantic argument.
I know it feels amazing to build something with enough traction to reliably put $1500 a month in the founder's pockets, but that "profitability" is counterfeit. You cannot run that business forever; it is paying you less than the minimum wage.
If you think this is a semantic difference, try re-reading Steve Albini's "Some Of Your Friends May Already Be This Fucked" rant.
...When your business throws off $1500/mo (without salaries), that’s not the case. If you’ve been at this for a year, clearly next month won’t be $5000, (unless it's an internet business, where a single good source of publicity can easily bring you from 500 from x paying customers to 5000 from 10x as many) which means even in the sense that it’s “kicking off cash” it’s not sustainable in the long-term, (unless, like all Internet companies, costs are largely fixed or at the least certainly don't grow linearly with number of paying customers) not defensible in the market, not supporting even one human being in that effort, etc.. (unless it's an Internet business that can go from paying you 200 per month to 2000 per month without you so much as being sure where all these customers came from, how they heard about you.)
Therefore, in the normal sense of the phrase “profitable business,” it’s not. (unless you mean "profitable business" as a person normally means it when it comes to a startup).
So now that I’ve perhaps unfairly ridiculed you, (now that the author has ridiculed himself) let’s just recognize what’s really going on, because it’s wonderful and amazing and fantastic and exciting: (since it's not descriptive of most projects)
You’re building a business! (your project is cash-flow positive.) Sure it’s just begun, sure it might need a kick in the ass, sure it might be struggling, sure sure sure, so what? You and every other little new business. You and every other bootstrapper who by very definition doesn’t explode out of the blocks because you’re doing it part-time and with no cash. (that's not anyone's definition. you can explode out of the blocks or you can languish.) This is exactly what you’d expect it would do, even if you’re actually the next 37signals. (unless your expectation is different.)
That’s exactly what my company WP Engine looked like for the first 9 months. Now we’re making millions of dollars, employ 20 people, growing at 15%/mo, etc.. But we started just like that — slowly, and not profitable. (sounds like you did it from 50-100k in savings or seed capital, which puts you squarely in the type 1 bracket.)
Same with my previous company Smart Bear — it took 2.5 years before I could even hire one employee, and even then it was 1/4 of the salary he deserved (and later ended up making). Eventually we, too, made millions of dollars a year — in profit! — but not for years. (during those years I bet the net cash flow ever had reached -20k easily. all in direct costs.)
In other words, there’s nothing strange or bad here. It’s just not “profitable from day one.” Stop saying that. (unless you're cash-flow positive from day one, which is a different type of internet project).
Dispense with the feather-fluffing and get to what is — the strengths you have, the challenges you want to overcome, the resources at your disposal. (And if you've proven a scalable, repeatable business model that pays for its own hosting and direct expenses other than the time to develop it, I suppose you shouldn't boast about that fact? After all, it's not like if a web service is developed in 100 hours, you can keep running it without redevolping it from scratch every month, as though you'd just lost all your backups.)
And then set your mind and goals on making that sucker profitable for real! (turn your positive cashflow into a sizeable source of revenue. which nobody assumes you have if you mention the former.)
P.S. Need help figuring out how to do that? Go here to learn about the Smart Bear Live podcast where I’ll help you one-on-one, or email me to see whether I can turn your question into a blog post. (step 1: start with some money to burn.)
Therefore, in the normal sense of the phrase “profitable business,” it’s not. (unless you mean "profitable business" as a person normally means it when it comes to a startup).
So now that I’ve perhaps unfairly ridiculed you, (now that the author has ridiculed himself) let’s just recognize what’s really going on, because it’s wonderful and amazing and fantastic and exciting: (since it's not descriptive of most projects)
You’re building a business! (your project is cash-flow positive.) Sure it’s just begun, sure it might need a kick in the ass, sure it might be struggling, sure sure sure, so what? You and every other little new business. You and every other bootstrapper who by very definition doesn’t explode out of the blocks because you’re doing it part-time and with no cash. (that's not anyone's definition. you can explode out of the blocks or you can languish.) This is exactly what you’d expect it would do, even if you’re actually the next 37signals. (unless your expectation is different.)
That’s exactly what my company WP Engine looked like for the first 9 months. Now we’re making millions of dollars, employ 20 people, growing at 15%/mo, etc.. But we started just like that — slowly, and not profitable. (sounds like you did it from 50-100k in savings or seed capital, which puts you squarely in the type 1 bracket.)
Same with my previous company Smart Bear — it took 2.5 years before I could even hire one employee, and even then it was 1/4 of the salary he deserved (and later ended up making). Eventually we, too, made millions of dollars a year — in profit! — but not for years. (during those years I bet the net cash flow ever had reached -20k easily. all in direct costs.)
In other words, there’s nothing strange or bad here. It’s just not “profitable from day one.” Stop saying that. (unless you're cash-flow positive from day one, which is a different type of internet project).
Dispense with the feather-fluffing and get to what is — the strengths you have, the challenges you want to overcome, the resources at your disposal. (And if you've proven a scalable, repeatable business model that pays for its own hosting and direct expenses other than the time to develop it, I suppose you shouldn't boast about that fact? After all, it's not like if a web service is developed in 100 hours, you can keep running it without redevolping it from scratch every month, as though you'd just lost all your backups.)
And then set your mind and goals on making that sucker profitable for real! (turn your positive cashflow into a sizeable source of revenue. which nobody assumes you have if you mention the former.)
P.S. Need help figuring out how to do that? Go here to learn about the Smart Bear Live podcast where I’ll help you one-on-one, or email me to see whether I can turn your question into a blog post. (step 1: start with some money to burn.)
What if the 1500 per month only requires 10 hours per month maintenence for the year after launch?
You don't understand. Internet profit isn't profit, we just learned that. Obviously the Internet works such that if it took you 100 hours to develop it, the Internet eats your hard drives every 30 days and you have to spend 100 hours again just to be at the same place. It's no different from standing at a lemonade stand for 100 hours. No different at all in any way. /s
You realize that's a total straw-man argument, right?
It's not a straw-man argument. The post would make perfect sense if it were talking about an offline, labor-intensive business. Unpaid development time has nothing to do with cost-of-running-a-business expense. That's a fact. You can say from YOUR point of view it does. But it does not from the business's point of view.
This is like saying that a surgeon can't launch a profitable web business, because the time spent on it will not generate as much profit for him as if he had spent the time practicing surgery.
that's plainly completely false, and the web business can be very much profitable (just not to him.). Just THINK about it.
This is like saying that a surgeon can't launch a profitable web business, because the time spent on it will not generate as much profit for him as if he had spent the time practicing surgery.
that's plainly completely false, and the web business can be very much profitable (just not to him.). Just THINK about it.
I'm sorry, what are you talking about. When people say "profitable since day 1" that doesn't mean $1000/mo profitable since day 1 - i.e. that within 30 days of deciding to do the project they billed $1000/mo. Nobody thinks that's what you mean.
You're telling me when people say "profitable since day 1" they should instead say "cash-flow positive not including consumer expenses I'm using for business". Fine. Go ahead. Say that instead. Or say the synonym "profitable since day 1" since everyone knows that's what you mean.
Let's do this. Do you think the article would still make the same argument if it read, instead, "Stop claiming to be cash-flow positive since day 1 - meaning day 6-23, besides your fixed consumer expenses!"
Then the article would read: (In parentheses is my point-by-point critique).
Stop claiming you’re cash-flow positive (not including consumer expenses) JUNE 19, 2012 2 COMMENTS
4 Share
My company is cash-flow positive, and has been from day one. (meaning day 7-23 after coding it up and getting customers very soon) – every high-tech bootstrapped founder (Actually, only a SMALL percentage of ALL projects, and a LARGE percentage of projects that can justify you giving them money.)
I know what you really mean.
What you mean is that the only business-related charges on your PayPal MasterCard — aside from those on intentional detour for tax-deduction like the external DVD drive you needed to rip CDs after you realized the MacBook Air in all its luxurious, silent, thin, sexy glory still cannot import “The Best of Pat Benatar” without the aid of a peripheral half the size and weight of the laptop itself — is an account with Amazon AWS where a medium instance whirs away for only $40/mo, just two clicks away from rebirthing as an XXL should you need “scale,” plus $0.67/mo for the S3 storage for web app uploads, plus $0.072/mo of S3 storage to back up the Pat Benatar mp3s.
(And you also don't count your rent, phone, Internet, and other expenses you currently have related to launching your business.)
So all you needed to do is sell one $49/mo account — which you did — and you’re cash-flow positive! (Except the above-mentioned things).
I know that’s what you mean, but when you say “I’m cash-flow positive” to someone with a modicum of experience it’s a turnoff, (unless they care about a scalable, repeatable business model you have already proven) because it’s actually bullshit (if somebody with "common sense" thought that any Internet business on the planet got ten thousand customers the very first day the founder had the thought to start coding it up). And when someone’s streaming bullshit at 720i, it means they’re either a full-blown bullshit artiste or they’re merely ignorant; in neither case do I want to hear more. (in other words, I've been burned by the recent bubble pop and I need some time to see you grow some more before I continue gambling. That doesn't mean it's not great that you're already cash-flow-positive. It means I'm a sore loser.)
The first and biggest error is thinking you can ignore your own salary. (Which nobody expects you to include when you say you're cash-flow positive.) Sure your time is worth $1000/hr (your opportunity cost is more like 80 dollars per hour if you weren't running the business, since you would accept a salary at 160k... the 1000 dollars heuristic is only to keep you on track if your business will keep growing and be acquired), but no you do not have to cover that to be dubbed “profitable.” (nor do you have to cover your foregone salary of 160k). But you do need at least a ramen-profitable definition of valuing your time. (no, you don't. even 2 dollars per hour is not necessary, nor is being able to pay for your apartment, car, phone, and Internet.) If your business makes $3000/mo after direct expenses, but isn’t paying you, and you still have a full-time day job to keep up with the mortgage on your under-water house, then you’re not profitable. (and if you can stop doing any work on it and the venture keeps generating $3000/mo after direct expenses, making 36k in a year or 200k in ten years as usage tapers off and customers switch away, and you use that 200k to buy a house somewhere. Well, you didn't just buy a house with the profits or positive cash-flow of your company, no-siree, you bought it with, uh...)
Why not? Because the business cannot sustain even one person to run itself, which means that $3000 is not “extra money which can be plowed back into the business or distributed for an awesome vacation.” (Unless the business can operate without one person, which is not mentioned here, or unless you can hire someone for a thousand dollars a month to maintain it and pocket the 2k per month difference). It’s just made-up leftovers because you’re not acknowledge the actual costs of a startup, which include time and you having to work a second job. (Likewise, your salary isn't actual cash-flow you can use to buy stuff. It's an illusion! If you make 200k in salary, but could be making the equivalent of 500k by founding a startup and selling it 5 years from now, that's not 200k you're earning. That's 300k you're losing. You don't have a job: you're a parasite on, well not society, but on your alternate self, whom you're robbing of 200k...)
In that case what have you proved? That if you slam yourself to the limit of endurance and ability, you can earn less money than Dell would give you for creating 1/34th of BIOS version 8.4.3.5?
That’s not a “cash-flow positive business.” (Unless you look at cashflow).
If you are living off it, even if that’s $3000/mo, then you’ve made it. You might not have a dynamo on your hands (yet!) but at least you’re in a somewhat sustainable place. Maybe next month you’ll make $3200 and you can “plow that extra $200 back into the company.” (likewise, if someone gives you 500k per year to be VP of Vatever at their company, and you spend it all on your lifestyle, you haven't made it at all.)
The other error is that it’s a misuse of what’s normally connoted by the phrase “profitable business.” (cash-flow positive business. Normally it means, in the first year of a business especially, but usually in the first couple of years of a startup, that you could keep putting time in and getting more money out than your business uses up. If you have savings of twenty k, you can run the business for two years and have savings of...thirty k. Where does the extra 10k come from? Oh, that's right the "non-profit" we all totally rightly call "profit.")
When someone says they’ve been in business for two years and they turned profitable last month, what that really means (if it’s a healthy, growing business) is that they are sustainably profitable, able to indeed “plow the rest back into the company” with a quantity of cash that could visibly move the needle on top-line revenue, or could significantly reduce further risk, or would allow for investment in a long-term project, or could be a down payment on a superstar, or something similarly valuable. (Or maybe it means the restaurant costs 10,000 per month in property, commodity prices, waitstaff, and all other expenses, and has just turned a profit of 200 for the first month after all that stuff was paid for, and at this rate you'll regain the 50k you invested to get it there in...well I'll let you do the math. That doesn't mean it's healthy does it.)
You're telling me when people say "profitable since day 1" they should instead say "cash-flow positive not including consumer expenses I'm using for business". Fine. Go ahead. Say that instead. Or say the synonym "profitable since day 1" since everyone knows that's what you mean.
Let's do this. Do you think the article would still make the same argument if it read, instead, "Stop claiming to be cash-flow positive since day 1 - meaning day 6-23, besides your fixed consumer expenses!"
Then the article would read: (In parentheses is my point-by-point critique).
Stop claiming you’re cash-flow positive (not including consumer expenses) JUNE 19, 2012 2 COMMENTS
4 Share
My company is cash-flow positive, and has been from day one. (meaning day 7-23 after coding it up and getting customers very soon) – every high-tech bootstrapped founder (Actually, only a SMALL percentage of ALL projects, and a LARGE percentage of projects that can justify you giving them money.)
I know what you really mean.
What you mean is that the only business-related charges on your PayPal MasterCard — aside from those on intentional detour for tax-deduction like the external DVD drive you needed to rip CDs after you realized the MacBook Air in all its luxurious, silent, thin, sexy glory still cannot import “The Best of Pat Benatar” without the aid of a peripheral half the size and weight of the laptop itself — is an account with Amazon AWS where a medium instance whirs away for only $40/mo, just two clicks away from rebirthing as an XXL should you need “scale,” plus $0.67/mo for the S3 storage for web app uploads, plus $0.072/mo of S3 storage to back up the Pat Benatar mp3s.
(And you also don't count your rent, phone, Internet, and other expenses you currently have related to launching your business.)
So all you needed to do is sell one $49/mo account — which you did — and you’re cash-flow positive! (Except the above-mentioned things).
I know that’s what you mean, but when you say “I’m cash-flow positive” to someone with a modicum of experience it’s a turnoff, (unless they care about a scalable, repeatable business model you have already proven) because it’s actually bullshit (if somebody with "common sense" thought that any Internet business on the planet got ten thousand customers the very first day the founder had the thought to start coding it up). And when someone’s streaming bullshit at 720i, it means they’re either a full-blown bullshit artiste or they’re merely ignorant; in neither case do I want to hear more. (in other words, I've been burned by the recent bubble pop and I need some time to see you grow some more before I continue gambling. That doesn't mean it's not great that you're already cash-flow-positive. It means I'm a sore loser.)
The first and biggest error is thinking you can ignore your own salary. (Which nobody expects you to include when you say you're cash-flow positive.) Sure your time is worth $1000/hr (your opportunity cost is more like 80 dollars per hour if you weren't running the business, since you would accept a salary at 160k... the 1000 dollars heuristic is only to keep you on track if your business will keep growing and be acquired), but no you do not have to cover that to be dubbed “profitable.” (nor do you have to cover your foregone salary of 160k). But you do need at least a ramen-profitable definition of valuing your time. (no, you don't. even 2 dollars per hour is not necessary, nor is being able to pay for your apartment, car, phone, and Internet.) If your business makes $3000/mo after direct expenses, but isn’t paying you, and you still have a full-time day job to keep up with the mortgage on your under-water house, then you’re not profitable. (and if you can stop doing any work on it and the venture keeps generating $3000/mo after direct expenses, making 36k in a year or 200k in ten years as usage tapers off and customers switch away, and you use that 200k to buy a house somewhere. Well, you didn't just buy a house with the profits or positive cash-flow of your company, no-siree, you bought it with, uh...)
Why not? Because the business cannot sustain even one person to run itself, which means that $3000 is not “extra money which can be plowed back into the business or distributed for an awesome vacation.” (Unless the business can operate without one person, which is not mentioned here, or unless you can hire someone for a thousand dollars a month to maintain it and pocket the 2k per month difference). It’s just made-up leftovers because you’re not acknowledge the actual costs of a startup, which include time and you having to work a second job. (Likewise, your salary isn't actual cash-flow you can use to buy stuff. It's an illusion! If you make 200k in salary, but could be making the equivalent of 500k by founding a startup and selling it 5 years from now, that's not 200k you're earning. That's 300k you're losing. You don't have a job: you're a parasite on, well not society, but on your alternate self, whom you're robbing of 200k...)
In that case what have you proved? That if you slam yourself to the limit of endurance and ability, you can earn less money than Dell would give you for creating 1/34th of BIOS version 8.4.3.5?
That’s not a “cash-flow positive business.” (Unless you look at cashflow).
If you are living off it, even if that’s $3000/mo, then you’ve made it. You might not have a dynamo on your hands (yet!) but at least you’re in a somewhat sustainable place. Maybe next month you’ll make $3200 and you can “plow that extra $200 back into the company.” (likewise, if someone gives you 500k per year to be VP of Vatever at their company, and you spend it all on your lifestyle, you haven't made it at all.)
The other error is that it’s a misuse of what’s normally connoted by the phrase “profitable business.” (cash-flow positive business. Normally it means, in the first year of a business especially, but usually in the first couple of years of a startup, that you could keep putting time in and getting more money out than your business uses up. If you have savings of twenty k, you can run the business for two years and have savings of...thirty k. Where does the extra 10k come from? Oh, that's right the "non-profit" we all totally rightly call "profit.")
When someone says they’ve been in business for two years and they turned profitable last month, what that really means (if it’s a healthy, growing business) is that they are sustainably profitable, able to indeed “plow the rest back into the company” with a quantity of cash that could visibly move the needle on top-line revenue, or could significantly reduce further risk, or would allow for investment in a long-term project, or could be a down payment on a superstar, or something similarly valuable. (Or maybe it means the restaurant costs 10,000 per month in property, commodity prices, waitstaff, and all other expenses, and has just turned a profit of 200 for the first month after all that stuff was paid for, and at this rate you'll regain the 50k you invested to get it there in...well I'll let you do the math. That doesn't mean it's healthy does it.)
If you are making more money on your bootstrapped startup than you could be on oDesk with similar time investment, you are profitable.
These guys are saying, "If you're a businessman that can make a cash-cow from buying 500 hours on oDesk, but instead of buying that time you're also a coder and do it yourself - BAM, suddenly the cash-cow isn't profitable anymore." Fine, it's not profitable. It's still profitable.
What this guy is saying is "If you're a businessman that is 'profitable' because your server costs $20 a month and your startup brings in $1500 a month, while you put more than 200 hours a month into it, then you're not profitable."
And he's not wrong, because on oDesk you could be bringing in $4000 a month with the same time investment, and the only reason your startup is profitable is because you're not factoring in all of the capital costs (not just cash).
And he's not wrong, because on oDesk you could be bringing in $4000 a month with the same time investment, and the only reason your startup is profitable is because you're not factoring in all of the capital costs (not just cash).
Yes, the guy is saying "if your startup brings in $1500 while you put more than 200 hours a month into it, then you're not profitable." But it's wrong. Because you're developing it, you're not hired labor. This is the fundamental reason it's wrong.
That's not how business works. For any definition of 'business.'
So let's get this straight. You're saying that a surgeon can't create a profitable online business if the total profit from it to him is less than if he had spent the same time practicing surgery?
we're not talking about whether it's "worth it" for him, we're talking about from the point of view of whether the online business can be called profitable to an outside investor. Nobody cares about your unpaid sunk development costs.
we're not talking about whether it's "worth it" for him, we're talking about from the point of view of whether the online business can be called profitable to an outside investor. Nobody cares about your unpaid sunk development costs.
> Nobody cares about your unpaid sunk development costs.
Not if they happened a year or six months ago, but if your unpaid sunk development costs are happening every day, then you're not profitable. You're not profitable until you're paying everyone who is working for you something relatively close to the wage they could be making as a regular employee somewhere else.
Not if they happened a year or six months ago, but if your unpaid sunk development costs are happening every day, then you're not profitable. You're not profitable until you're paying everyone who is working for you something relatively close to the wage they could be making as a regular employee somewhere else.
I still disagree. Profitable, to me means the business owner takes home something at the end of the month from earnings. It may not be much. But it has to be something.
Secondly I don't see a rule that says that a business has to support a full time employee to be profitable.
Now something may be profitable and not sustainably so, and that's a point the author kinda sorta halfway makes later on. The point where the business is supporting the owners and there is money to reinvest, that's sustainable. Profitability however is where the net profits > 0.
This is actually important if you are looking at the health of the business.
Secondly I don't see a rule that says that a business has to support a full time employee to be profitable.
Now something may be profitable and not sustainably so, and that's a point the author kinda sorta halfway makes later on. The point where the business is supporting the owners and there is money to reinvest, that's sustainable. Profitability however is where the net profits > 0.
This is actually important if you are looking at the health of the business.
Your disagreement is noted, but why should we care?
The point of this post isn't that people are wrong about the definition of a word.
The point is that the underlying meaning often communicated by the word is absent in its usage by lots of startups.
Is your usage of the word "profitable" defensible? Of course it is. You win. Can we get on with discussing the actual point of this post? Because this comes up a lot on HN: "profitable" startups that are actually secretly costing their owners many tens of thousands of dollars a year, because to many first-time startup founders, the concept of "opportunity cost" is just an abstraction.
The point of this post isn't that people are wrong about the definition of a word.
The point is that the underlying meaning often communicated by the word is absent in its usage by lots of startups.
Is your usage of the word "profitable" defensible? Of course it is. You win. Can we get on with discussing the actual point of this post? Because this comes up a lot on HN: "profitable" startups that are actually secretly costing their owners many tens of thousands of dollars a year, because to many first-time startup founders, the concept of "opportunity cost" is just an abstraction.
First you can't put "opportunity cost" in your ledger on the expense side. Opportunity cost doesn't really work that way. Moreover opportunity cost is am abstraction. It's an abstraction which is partly there to keep you aware of the fact that where you take one road, there are others, and you can't take them all.
I think what the article is trying to get at is the difference between sustainability and profitability. Something may be profitable and yet not sustainable (for a variety of reasons). Something may be sustainable and yet have no profit (the Apache foundation), but one key part of sustainability is being able to fund core activities.
As for why folks should care, I think it is important to be clear about things when analyzing financial health of a business. A business which makes $1000/month net profit a month may not be able to support the founder (but presumably the founder has some other source of money to live on) but what it can do is absorb $1000/month in additional expenses without requiring additional investment. A business with no money in the bank but $1000 in net profits every month may be better able to weather unexpected mishaps than a business that's losing 2000/mo with 20k in the bank.
I think what the article is trying to get at is the difference between sustainability and profitability. Something may be profitable and yet not sustainable (for a variety of reasons). Something may be sustainable and yet have no profit (the Apache foundation), but one key part of sustainability is being able to fund core activities.
As for why folks should care, I think it is important to be clear about things when analyzing financial health of a business. A business which makes $1000/month net profit a month may not be able to support the founder (but presumably the founder has some other source of money to live on) but what it can do is absorb $1000/month in additional expenses without requiring additional investment. A business with no money in the bank but $1000 in net profits every month may be better able to weather unexpected mishaps than a business that's losing 2000/mo with 20k in the bank.
Respectfully:
First you can't put "opportunity cost" in your ledger on the expense side. Opportunity cost doesn't really work that way.
I stopped reading here. I had a hard time believing the rest of the comment was going to provoke anything but annoying yelling from me.
First you can't put "opportunity cost" in your ledger on the expense side. Opportunity cost doesn't really work that way.
I stopped reading here. I had a hard time believing the rest of the comment was going to provoke anything but annoying yelling from me.
Here's the point: Profitability is one key performance indicator and a very important one. In a sole proprietorship model, you don't count the proprietor's earnings into profit. In a corporate model you track executive compensation but this isn't really the same as tracking salaries since it could be on a minimal salary + bonus model.
That doesn't mean it's the only metric. But it is probably the single most important one. It gives you an idea of whether a business can survive and meet its financial obligations in the face of unforeseen events. For a corporation of course equity ratio or debt to equity ratio are also important.
That doesn't mean it's the only metric. But it is probably the single most important one. It gives you an idea of whether a business can survive and meet its financial obligations in the face of unforeseen events. For a corporation of course equity ratio or debt to equity ratio are also important.
I'm interested in what you have to say (not your parent), try to think it through. There's really maybe this tension in this thread between profitability from the point of view of the business entity and "whether it's worth it" to the founder. It sounds like you are almost trying to say Mark Zuckerberg couldn't possibly anonymously launch a profitable business by himself as a sole coder using nothing but an AWS instance, since his time is worth so much at Facebook. Yes, that's true in some sense, but no, not at all true. Of course he can still launch a profitable business. Maybe he "shouldn't", but that doesn't mean the business is suddenly unprofitable.
See my other comments on this thread.
See my other comments on this thread.
It's really simple, isn't it?
At one extreme, a company that is cash flow positive before founder wages to ~$2000/mo is paying two founders less than minimum wage. That's not a profitable company.
At the other extreme, a company throwing off $20,000/mo before founder wages is potentially paying founders as much as $120k gross. That's a profitable company.
A lot of first-time founders on HN will post "Show HN" threads talking about how they're profitable when they're in that first scenario.
Maybe once in a blue moon, someone will try to argue that a founder in the second category isn't "profitable" because they could be making $200k/yr at a BigCo instead of $120k/yr.
The question is, where's the line. What's interesting to me is that the line right now is drawn in a very silly place: right at "cash flow positive". I don't care how much further beyond cash flow positive we draw the line, just as long we recognize that right at cash flow positive is a silly place to draw it.
At one extreme, a company that is cash flow positive before founder wages to ~$2000/mo is paying two founders less than minimum wage. That's not a profitable company.
At the other extreme, a company throwing off $20,000/mo before founder wages is potentially paying founders as much as $120k gross. That's a profitable company.
A lot of first-time founders on HN will post "Show HN" threads talking about how they're profitable when they're in that first scenario.
Maybe once in a blue moon, someone will try to argue that a founder in the second category isn't "profitable" because they could be making $200k/yr at a BigCo instead of $120k/yr.
The question is, where's the line. What's interesting to me is that the line right now is drawn in a very silly place: right at "cash flow positive". I don't care how much further beyond cash flow positive we draw the line, just as long we recognize that right at cash flow positive is a silly place to draw it.
could you read all my other responses and respond (in a summary) to all of the major points I brought up? Let's get to the bottom of this.
It's not "where's the line." There is a line in the sand there, and the author is saying you shouldn't tell people when you've crossed it. That's debatable. But he goes beyond that: he says the line isn't there at all. Of course it is.
I don't often say this, but I've thought this through completely, and the people who say that people working for equity, options, etc, should be accounted for as though they were working for a straight market salary before you can say you're profitable, are simply wrong. I'm right and they're wrong. And it's important.
Let me put it this way. Say Facebook was already very profitable, making millions.
It had superstar elite ninja developers who worked a thousand times faster than a normal developer and any one of which was worth their weight in gold. To hire them on salary you would have to pay them a million dollars a year, because they don't want a salary, they want to be part of the next big thing.
So, like all Internet companies, Facebook gave out a lot of options and employee equity.
Now when Facebook was making millions and quite profitable, you're saying it wasn't REALLY profitable, since it didn't REALLY get to use the labor of those people who had equity as part of their compensation. But this is obviously completely wrong. THe founder's equity falls into the same category.
The fact that you're getting something below market rate doesn't mean you're not REALLY profitable.
This is like crying "Apple isn't REALLY profitable because they get their components below market rates by being good negotiators!! If they had to pay market rates they would be operating at a LOSS".
Well, too bad for the component sellers. Apple is still profitable.
Too bad for you if you could be making 200k per year and instead are giving it up for equity in a company that is worth less than that. The company is still profitable.
This would be like saying that back when Rackspace gave all YCombinator companies free hosting, if their hosting bills "would normally" be more than their profits, they weren't ACTUALLY profitable. Regardless of what they were making.
Well, that's obviously not true at all.
This is equivalent to saying that you can't be considered profitable unless you're paying through the nose for everything, including super-expensive managers who are able to single-handedly get a business off the ground and are easily worht 200k-500k to a fortune 500 company, and then STILL have left over.
why should anyone say that??? why should the line for "profit" be drawn anywhere other than whether the company pays more than it receives in revenue or pays less than it receives in revenue?
That is a real line, Facebook had every right to boast about it when it crossed it, the entire Internet startup sector depends on people having the right to work for equity and startups getting access to that labor by issuing shares and paying a low salary.
I mean, by this argument of what is a "natural" salary, you could say that there isn't a single profitable prostitute working in California, because the "true cost" of a job as a prostitute is firstly spending $1800 million dollars and four years fighting to legalize prostitution, and only afterward hiring a prostitute at a market (not black market) rate. Therefore, since they are empoying themselves only at a black-market rate (where a legal rate is $1800 million and four years of lobbying more expensive), they aren't actually profitable. Any prostitute in California would have to make another $1800 billion or so and spend it on hiring an actual prostitute at "market rate" not black-market or (in the startup analogy) equity rate.
That's nuts. Of course a business can be profitable without accounting for a DIFFERENT kind of rate. (one that doesn't include equity, for example).
the whole perspective of other people here is simply wrong. It's that simple.
I don't often say this, but I've thought this through completely, and the people who say that people working for equity, options, etc, should be accounted for as though they were working for a straight market salary before you can say you're profitable, are simply wrong. I'm right and they're wrong. And it's important.
Let me put it this way. Say Facebook was already very profitable, making millions.
It had superstar elite ninja developers who worked a thousand times faster than a normal developer and any one of which was worth their weight in gold. To hire them on salary you would have to pay them a million dollars a year, because they don't want a salary, they want to be part of the next big thing.
So, like all Internet companies, Facebook gave out a lot of options and employee equity.
Now when Facebook was making millions and quite profitable, you're saying it wasn't REALLY profitable, since it didn't REALLY get to use the labor of those people who had equity as part of their compensation. But this is obviously completely wrong. THe founder's equity falls into the same category.
The fact that you're getting something below market rate doesn't mean you're not REALLY profitable.
This is like crying "Apple isn't REALLY profitable because they get their components below market rates by being good negotiators!! If they had to pay market rates they would be operating at a LOSS".
Well, too bad for the component sellers. Apple is still profitable.
Too bad for you if you could be making 200k per year and instead are giving it up for equity in a company that is worth less than that. The company is still profitable.
This would be like saying that back when Rackspace gave all YCombinator companies free hosting, if their hosting bills "would normally" be more than their profits, they weren't ACTUALLY profitable. Regardless of what they were making.
Well, that's obviously not true at all.
This is equivalent to saying that you can't be considered profitable unless you're paying through the nose for everything, including super-expensive managers who are able to single-handedly get a business off the ground and are easily worht 200k-500k to a fortune 500 company, and then STILL have left over.
why should anyone say that??? why should the line for "profit" be drawn anywhere other than whether the company pays more than it receives in revenue or pays less than it receives in revenue?
That is a real line, Facebook had every right to boast about it when it crossed it, the entire Internet startup sector depends on people having the right to work for equity and startups getting access to that labor by issuing shares and paying a low salary.
I mean, by this argument of what is a "natural" salary, you could say that there isn't a single profitable prostitute working in California, because the "true cost" of a job as a prostitute is firstly spending $1800 million dollars and four years fighting to legalize prostitution, and only afterward hiring a prostitute at a market (not black market) rate. Therefore, since they are empoying themselves only at a black-market rate (where a legal rate is $1800 million and four years of lobbying more expensive), they aren't actually profitable. Any prostitute in California would have to make another $1800 billion or so and spend it on hiring an actual prostitute at "market rate" not black-market or (in the startup analogy) equity rate.
That's nuts. Of course a business can be profitable without accounting for a DIFFERENT kind of rate. (one that doesn't include equity, for example).
the whole perspective of other people here is simply wrong. It's that simple.
I don't think that works though and here's why.
Suppose I live on $2k/month with one kid, and I choose to live somewhere rural where this can actually work. So I bring in approx $24k after business expenses, and in the end I end up getting a little more back from taxes than I pay via the EIC. Suppose I like this life.
Suppose I could go to work for BigCo Inc and make $130k/year. You wouldn't say my business is losing $100k/year. That would be silly.
Suppose I live on $2k/month with one kid, and I choose to live somewhere rural where this can actually work. So I bring in approx $24k after business expenses, and in the end I end up getting a little more back from taxes than I pay via the EIC. Suppose I like this life.
Suppose I could go to work for BigCo Inc and make $130k/year. You wouldn't say my business is losing $100k/year. That would be silly.
Exactly. We are in total agreement. The argument, most posters here, and the parent who I responded to disagrees with us. They're wrong and you and I are right.
If your business gets to use your labor for "free" just because you happen to be a 100% owner, it is no different from Facebook getting to use employee's at 30% of market rates because, collectively, they own 6% of the company. It's exactly the same thing.
The article and people who defend it are very wrong. You're right.
If your business gets to use your labor for "free" just because you happen to be a 100% owner, it is no different from Facebook getting to use employee's at 30% of market rates because, collectively, they own 6% of the company. It's exactly the same thing.
The article and people who defend it are very wrong. You're right.
I misread you. Sorry. We are in total agreement.
The author explicitly, expressly contextualized the usage by including the example "profitable since day 1." Which everyone understands, first, not to mean literally within 8 hours of when you started working on it, but more the first few days or even couple of weeks, and secondly, everybody understands it refers to the direct expenses of the project. There is no misunderstanding. There is no miscommunication. Everyone knows you're talking about cash-flow and hosting costs.
I normally agree with Jason but I don't think he should be so upset on this one. "ramen profitable" the amount of profits you have to plow back into the company are as much as the cost of a Ramen package. It is a way of saying you're not profitable to a significant degree, but you are covering your expenses and thus you're not in the process of dying. This is an important milestone, because it means the company is sustainable and the stress level on the founders is going to be a lot less than ones who are slowly depleting their life savings (or quickly depleting it.) And it also means that any additional money will be going into growth, rather than into keeping the startup alive. This is pretty important, or should be, to investors.
I think this is a much better metric to seek than the "we've grown our user base by 1 million percent!" from a company that isn't taking in any money from its users, and whose users would never pay money to use the service (perfect example: Facebook) but has also gotten $1M+ in investment and has spent significant money. How do you tell the difference between that and buying users? The latest thing these days is to say "we got X users and we didn't spend any money on marketing".
Really? So you don't know what your acquisition cost really is? You want me to think that your social network for accountants is going viral? When your user base is about the size I'd expect it to be when all the other "Social Network for X" founders from Angel.co show up to see what you're up to?
Back to the article-- I think he's spot on to point out the difference between ramen profitable and profitable enough to hire an employee who's getting a real salary. That is another milestone.
But I think "we're profitable from day one" is really not a bad thing, because many of the other companies out there have no path to profitability without a whole lot more funding (Eg: Facebook, which took a lot of money.) It did pay off for Facebook, but your social network for taxidermists is not another Facebook.
So, "we're profitable from day one, even though we're only covering operational expenses and not covering employee living expenses yet" is still a significant piece of information compared to the companies that will take another $5-$50M to get even to that point.
Also, FWIW, my startup, which will likely be "profitable from day one" (but not ramen profitable) will be requiring about $300 a month in hosting-- and that's getting a dirt cheap deal. Not all of us are just a website that can run on a single server... we're building a cluster of dedicated machines and we need to do that before we open the doors. Fortunately, $300 a month for ~5-6 dedicated machines is kinda amazing![1] This is also one way where "immediately profitable" is more achievable than it was a decade ago.
[1] Hetzner.de has dedicated machines for cheap. Our product is very amendable to a CDN, and our major partner is hosting a lot of the higher bandwidth stuff on their own global CDN anyway, so locating in germany is not nearly the issue it would be for us if we were doing a social network for philatelists.
I think this is a much better metric to seek than the "we've grown our user base by 1 million percent!" from a company that isn't taking in any money from its users, and whose users would never pay money to use the service (perfect example: Facebook) but has also gotten $1M+ in investment and has spent significant money. How do you tell the difference between that and buying users? The latest thing these days is to say "we got X users and we didn't spend any money on marketing".
Really? So you don't know what your acquisition cost really is? You want me to think that your social network for accountants is going viral? When your user base is about the size I'd expect it to be when all the other "Social Network for X" founders from Angel.co show up to see what you're up to?
Back to the article-- I think he's spot on to point out the difference between ramen profitable and profitable enough to hire an employee who's getting a real salary. That is another milestone.
But I think "we're profitable from day one" is really not a bad thing, because many of the other companies out there have no path to profitability without a whole lot more funding (Eg: Facebook, which took a lot of money.) It did pay off for Facebook, but your social network for taxidermists is not another Facebook.
So, "we're profitable from day one, even though we're only covering operational expenses and not covering employee living expenses yet" is still a significant piece of information compared to the companies that will take another $5-$50M to get even to that point.
Also, FWIW, my startup, which will likely be "profitable from day one" (but not ramen profitable) will be requiring about $300 a month in hosting-- and that's getting a dirt cheap deal. Not all of us are just a website that can run on a single server... we're building a cluster of dedicated machines and we need to do that before we open the doors. Fortunately, $300 a month for ~5-6 dedicated machines is kinda amazing![1] This is also one way where "immediately profitable" is more achievable than it was a decade ago.
[1] Hetzner.de has dedicated machines for cheap. Our product is very amendable to a CDN, and our major partner is hosting a lot of the higher bandwidth stuff on their own global CDN anyway, so locating in germany is not nearly the issue it would be for us if we were doing a social network for philatelists.
The key in any communication is accurately conveying the facts. So use words that will be understood in context by the audience. For example, my own friends would use the same standard as a professional investor to define the term "profitable". They would think I'd lost my marbles if I claimed I was profitable making just $200 a month.
But if you're a high school student, and you're talking to your Aunt Nelly, sure you can use the term "profitable" to describe making $200 a month above expenses. In fact, if you were making $200K a month you would have to say "WAAAY more than profitable", lest she assume that "profitable" meant $200 a month.
Just be clear so that you're understood, in context.