Very True by Verissimo

Alex (00:02.232)
Hey everybody, welcome back to another episode of Very True by Verisimo. I'm here today solo and I'm discussing why companies fail and why I started this podcast in the first place. As many of you know, I've been writing for a long time. I've been working with founders for even longer and I've noticed two major trends and one of them is actually a little bit of a criticism on podcasts in general. The first is that there's just a handful of

core reasons why companies fail. Sometimes it's a combination of those reasons and they stack up, but sometimes it's just one and sometimes it's avoidable and sometimes it's not. On the other hand, a company that's super, super successful usually has a really unique special set of circumstances. I call it like a snowflake. It's so unique that allowed them what allowed them to really meaningfully beat the odds. The problem is that most podcasts

feature founders who fall into that really, really special category because most podcasts frankly are clout farming as we call it. Now, the reality is that it's nice to hear stories, but I'm here because I want to founders improve their chances of success. I want to help my founders. I want to help all founders. I want to make capital move more efficiently. And I want to help investors actually make better decisions as well.

to make the market move a little bit more sanely, I guess you could say. So rather than talk about why there are successes and why there's failures, I'm just going to bucket companies into three main categories. The first is the massively successful companies. Cool stories, really, really interesting, but really hard to repeat, almost to the point that it's really even not useful to hear their stories. It might be fun, but I don't think it's necessarily useful.

Then there's the companies that fail. And often they achieve some level of success and then they fail. I'm actually leaving out the fourth category, which is stuff that just never had a chance. That's just total garbage that no one should have ever wasted their time on. But then there's this middle category, which is the middling success. The stories you don't hear that much about. The stories that don't make the VCs rich, but they often actually make the founders rich. I always say there's three levels. The first level is the founder gets rich.

Alex (02:28.653)
The second level is the VC gets rich. And the third level is that the LPs actually get rich on a deal. And the LPs getting rich is super, super rare. VCs getting rich, except off fees, is somewhat common. Now, on a single deal, usually VCs get rich because they're in a handful of deals over long periods of time. But founders getting rich can happen pretty often. I've written talk before about founder-investor alignment and expectations management. I'm not going to dive into that today.

What I'm going to try to talk about is the dynamic that if you can avoid just the avoidable mistakes, you may bring yourself from a category three company that fails despite achieving some level of success along the way to a category two company which achieves founder wealth creation success. We'll call it eight figure wealth creation for founders. And then what I would like to put forward is that

Once you achieve that level of success, you actually open yourself up to the opportunity to achieve that massive success. Often companies that achieve that massive success, it's usually Act 2 or Act 3. So if you can successfully get through Act 1 by avoiding issues, then you open yourself up to Act 2 and Act 3, which is usually where the 11-figure opportunities live in.

I wrote before and I talked before about the bifurcation of the asset class. There's a lot of investors and several founders who've earned the right to say, want 10 billion, 50 billion or bust. And that's great. Good for them. I'm not really talking about those folks and those funds right now. I'm talking about kind of the rest of us, the smaller funds, the founders that aren't already massively successful and don't achieve that level of attention, whether it's warranted or not. And so again,

My philosophy here and my point of what I'm going through today is to talk about how we can not necessarily manifest success when it was never going to be there, but help avoid the pitfalls along the way to achieving that success. And that's very much in line with how I view my job as an early stage investor. Step one is identify massive potential before it's realized. And then step two is help those founders achieve their potential.

Alex (04:52.146)
Usually when investors are doing that, it's not actually by pushing them forward. It's just by helping them see around corners and avoid potholes and pitfalls and all the issues and mistakes that you can make along the way. And one interesting thing I've experienced is oftentimes repeat founders, whether they were successful or not, but usually if they had some level of success, are more open to hearing those, ooh, what might be around this corner and what might I be missing here than...

founders who are first-time founders. And again, there's a whole other subject matter there we can go into about founder psychology and how kind of confident is healthy, like what's the right level. Not the main point of what we're talking about today. But philosophically, again, my view is that the role of an investor is to be involved with a bunch of companies. Not in the weeds, not in the ground, on the ground, but rather seeing things at a high enough level that they're maybe not

emotionally or tactically involved in the problems, but they see them. And they might not know the answer, but they probably know who the founder that's sitting in front of them should talk to, who probably has that answer. the more open founders are, which I pause because I dare say that so many investors are just brutal and burn founder trust so many times that, I don't know.

You got to know your investors. I don't know what else I can say about that. But that they're open to, hey, I don't really know what I don't know. I'm happy to listen. I won't get distracted from the goals I have at hand. But I'm happy to listen to the 10,000 foot view of like, hey, maybe this is something you should just think about. I'm not going to tell you how to do it. But I'm just going to put this little drop of, hey, maybe spend a minute on this.

That is a long-winded way of expressing my philosophy of what role an investor plays in the startup journey and in the startup market. And the job is simple. I'm a big fan of Howard Marks. He talks about risk management. We don't actually have a metric to manage risk. We just know when it's there. He made a great point recently that risk is not volatility. Again, subject for another time. It's a great piece. You should listen to him as well.

Alex (07:16.181)
with both feet on the ground. ultimately, we're trying to maximize upside, and we're trying to minimize downside. And that's the goal. That's the job. That's why the asset class exists. So before I get into this list of why companies fail, I'll make two important caveats. The first is that every situation in every company is unique. don't mean I'm not, my goal here is not to blend everything together, oversimplify.

and make it about this is what everyone should do and everyone has this issue. It's obviously not the case. But if we can't find patterns, then what are we even doing here? You've got to look for commonalities and, again, try to avoid the pitfalls. The second is that the list I'm giving here is by no means exhaustive. But my goal is to provide a couple examples and frameworks. And hopefully, the goal is to improve

chances of success of founders, of investors, and of their employees and all their stakeholders. So now I'm going to jump in to a handful of reasons why startups fail. So the first one is the company never achieves product market fit. Now, I'm going to call this out because I think it's a great example of this is not actually a reason that companies fail. It is evidence of a company failing.

So anytime you're doing a cause and effect, you've always got to isolate the two and figure out what's the root cause and then what's the effect. So if a company doesn't achieve product market fit, again, another subject, what the heck even is product market fit? How do you know when you have it? How do you keep it? How do you make the most of it? That's a whole another subject, but never achieving it means no one wants your stuff or they wanted it and they don't want it anymore. They're not willing to pay for it. Whatever it may be, it's

It's actually, I would argue, a symptom and an effect more than it is a cause. But if we take that and split it into its two pieces, which is product and market, we can actually start to understand a little bit more. product is, you could argue, in the hands of the team. Their job is to build a product. Either it works or it doesn't. Either it's possible to build or it isn't possible. And either it hits the mark or it doesn't hit the mark. Maybe it's up to snuff. Maybe it's not.

Alex (09:45.598)
But that is the goal of a company is to build a product or service that customers will actually want. Now, the market on the other hand, the customers here, is usually completely out of your control. One of the famous lines that I really like is that being early is just another way of being wrong. There are so many companies I've seen over the years that they didn't work then, but now someone's doing the exact same thing eight years later and it's like the hottest thing ever. And it's actually working really well.

And that's part of it. Market timing is one of the most important things that successful companies get right, but it's nearly impossible to predict. And when you're an early stage founder and when you're an early stage investor, you've got to help create markets. You don't just feed markets. You've got to see what's coming. You have to predict it, and there's not 100 % certainty there. And by the way, even if you're Microsoft releasing a new product, there's also not complete certainty there.

But I will point out that there's two ways that you can actually, or there's more than two ways that you can actually hedge market timing. The first is you raise a bunch of money so that you can survive until the market is ready for your solution. And or the technology actually makes your solution work. The second is, which I'm a bigger fan of, is that you burn as little casters possible until you see that the market is actually ready for your solution or product. What I always say is that the pre-seed stage

is survive to iterate, meaning it's the whole trajectory of the company is just going down as you burn cash until you figure out what works. so hiring a bunch of people, whatever it may be, adding inertia to your business is not what you want to be doing when you want to be iterating. You want to be as agile as possible and doing that as efficiently as possible. And then the third option is you actually raise like a monumental amount of cash and try to force the market even if it's not ready. This also

often doesn't work and just creates a huge mess. But it has worked a few times, sometimes better than others. Sometimes it means changing the business model, actually, which we'll get into a little bit more later. But one example is in vertical software. Company starts, they want to build a tool to help some archaic industry come into the 21st century. And they can make their business a lot more efficient, whatever it may be. But the market's just not ready to buy it.

Alex (12:09.661)
Sometimes the stakeholders are just Luddites. Sometimes people don't care. Sometimes you can't get their attention. There's other priorities in the industry. These things can all be the case. So what you do is you change your business model. And instead of trying to sell into that market, you actually make that market your competition. So it might be a roll up strategy. It might be a private equity style strategy. But instead of just trying to sell software into the market, you actually

become a competitor and compete with the people that you were actually just trying to sell to. Because if you're saying, hey, if they're not ready for this solution and to come into the modern era, we're just going to do it ourselves and we're going to have a better business that's tech enabled, that's higher margin, that grows faster, that moves faster, that serves clients needs better. And we're just going to compete with all these people who wouldn't buy our software solution. You got to be careful with these.

Because the margin profile changes massively from when you raise money as a software business and maybe you got some level of traction and now you're pivoting a great example of this would be Flexport Flexport started as freight forwarding software Flexport is now a freight forwarder. They have warehouses. They have airplanes. They have boats and That's what they needed to do at the time to make that work. There are other companies now selling to freight forwarders. So again, that's just one example of

The market and the product, that's kind of the product market fit thing split into its elemental pieces. Second big, big reason is that the team doesn't scale or just doesn't work. So often the reason we invest in founders is two main things. The first is their superpower and the second is their charisma. Their superpowers might be product, sales, engineering, marketing, market access, or even just the charisma itself. Some people you're just like,

hey, whatever they're selling, I'm buying. Whatever they're hiring for, I'm joining. And this is often a key reason to invest or at least be interested enough to like meet the company and take it seriously and really dig in. But it's not the full picture of how you build a successful business. You've got to actually build the business. Company building is a key thing and it's not trivial. Money doesn't solve it. It takes

Alex (14:31.569)
certain personalities and true grit and intensity and finesse. And it's a real art. So I would argue that the reason that repeat founders, whether they've, again, been successful or not or had some level of success, trade at such a premium in the early stage market is because they've taken those steps and they've seen where the challenges are and they've shown that they can begin to scale as a

as a manager, as a person, as a leader. And it's important to recognize that all startups are grow or die. That is the game that you're signing up for when you decide, again, not to be a startup, but if you want to enter the VC world and raise venture capital. The prices and the models and everything really only works if you're growing and if you're going to grow fast and hopefully get big. With that in mind, growth is

a form of volatility. And the muscles it takes to change your job function constantly as the business develops and grows super, super quick is hard to develop. It's a reason that CEOs make a lot of money because being dynamic, being multidisciplinary is really, really hard. It's not for everybody. You could be the most amazing software engineering architect ever that can design this amazing product. But that may mean that you're that

But you may not be able to manage a team effectively. You may not be able to sell properly. And there's a strong argument that the CEO role is the only one that is independent of every other, meaning every other role, whether it's a CFO, a COO, a CRO, a CHRO, whatever it may be, depends on the key skills of that CEO. And the CEO's job becomes to manage those other functions. So.

when a company starts, the CEO has to do everything themselves. And then the art of hiring those correct people and interacting with them and managing them successfully is super, super important.

Alex (16:42.406)
There's another really interesting case that I've seen before kind of on the other end of the spectrum, which is sometimes founders are just so special and so inspiring and so, I don't mean to demean it, but salesy that they actually can't teach anyone else how to sell their product. I've seen this before. It's wild. It was actually a company that had three founders and I was in their CRM and no one was doing anything on their sales team. And then the founder would come back from a trip and be like,

I just signed a seven figure deal. And then boom, they had another year of life. And that can be a problem. It can be really hard to scale when you're relying on these large scale miracles every time. You also have to ask yourself, why do I really have a sales team? So I've got another framework that's important on the team side, which is, I mentioned briefly, is that early days CEO means handling everything. It's not pretending that, I don't need a CFO yet.

No, you got to be the CFO. I don't need a head of sales. No, you are the head of sales. So yes, you've got to focus, but you've also got to be able to not focus. That's, think, a key thing that founders do really well is context switching. It's skill switching. I'm not saying be totally ADHD and not be able to sit down and write or do whatever you need to do for an hour at a time. That's critical for, I think, pretty much any professional to achieve.

meaningful success in knowledge work, but trying to just focus for long periods of time on things, I mean, talking like months and be a CEO of an early stage company, I think is just antithetical. Like, yes, you've got to focus, but CEOs need to keep their head on a swivel and see all the challenges and all the opportunities early and deal with them accordingly. And the best CEOs that I've worked with are ones that just, they've got their finger on the pulse. They see, it's almost like a surfer.

They just have that instinct of like, what's the right wave? What wave am I going to skip? And then how am I going to catch that right wave when it's coming? And when do I need to paddle out and paddle back in? And that really is what a CEO needs to be able to do. And I believe that that's the case from the early stage to being a superscale company, is being able to do that. Now, what level of detail you have to interact with, I would argue, is

Alex (19:08.591)
harder at the early stage, even if maybe the stakes are lower, you might say. Maybe they're actually higher because the business has less inertia, so every decision you make could completely derail it. Whereas even if you're a Fortune 100 company, you miss a quarter, maybe you get fired for missing a quarter, but probably not. And you can get things back in line. Missing a quarter as a startup, and I'll talk about this a little later, could be the end. Hopefully it's not. Hopefully you've planned accordingly financially. So if you're a founder,

and you don't have the chops to be dynamic, look up, look down, look left, look right, be cross-functional, be able to focus on nitty gritty details and deal with customers and bugs in software and then think about what's the vision and where this market's going. That is the core competence. super, super important. The other thing with founders is you gotta have the fire. I use this framework where I say you gotta have good mazel.

I only want to work with you have good middos which means character traits. Mazel means luck. Again, good middos, like good character traits. Again, you don't need that. I prefer it. there's plenty of examples that show you don't need it to be successful. And then the last thing I talk about, the Hebrew word is ratzon But that translates to willpower, desire. And if you don't got it, it's just way too difficult and unlikely to be able to run through the walls.

that you need to run through to make it happen. On the other hand, someone used this term lately. They were talking about someone we knew, and they said, you know, he's great, and he'll run through walls even if there's a door right there, which isn't the best thing, right? You want someone who can intelligently figure out what mountain to climb, what wall to run through, and do that. And again, it's a little bit of that extra instinct, that ability to prioritize.

That is the founder's job, is to prioritize. Early stage, it's very instinctual. Later stage, it becomes very, very quantitative. Now, sometimes they never really had the fire. Sometimes they're just kind of acting at the beginning, and they raise money on that or start a company on that. Sometimes they just lose the fire on whatever problem they started on. And that's a bummer. You hope that doesn't happen, but you can check that. I'll always ask founders, like,

Alex (21:31.839)
Why did you start this company? Why are you going to care about this in 10 years? Interestingly enough, a very close friend of mine became the founder and CEO. I he started the company in a space that another friend of mine decided that, you he was like, what connection do you have to this problem in this industry? Like, I can't invest because I don't see you as so deeply entwined. Well, you know, I think we're nine years later.

He's pretty deeply entwined in it and he's he's a special kind of person that has Just the intrinsic fire that he's gonna do something because he needs he's gonna see it through and he's gonna do right by his co-founders his employees his investors his customers and everyone else and that's a unique thing and I would argue that it comes in a large part into into middos another reason maybe is just that like Maybe they had just like a massive windfall in something else. They're doing I actually had this happen with a

with a company where like the founder, the technical founder had been the original technical founder of this other company that they left after like maybe a year or two. But then that other company became like this massive smashing success. And so their equity was worth so much that it was like, why are they working so hard anymore? They should just become a real estate investor and live off cash flows. Sometimes it's like that their spouse makes a ton of money or they inherit something. Like you never know, but you can...

you know, maybe judge for that. can ask people, like, what would you do, you know, if all of a sudden tomorrow you, you know, made 30 million dollars, would you still be grinding it out, working on this or not? And you can usually see, you know, what's there. So, again, sometimes the flame just goes out, you did everything right, the drive was there. This isn't always knowable, but it's something to have in mind. Another thing is obviously the founder conflict.

I always say when we're evaluating companies, how do you quantify that awkward moment that you observed between a CEO and a CTO? It's super hard, but it matters a lot. And my advice there is these are not marriages. Marriages are meant to last forever. These companies probably won't. Maybe they'll get acquired, maybe they go public, maybe people retire. So doing a prenup,

Alex (23:56.14)
Having the awkward conversation upfront of what this might look like, it's not like a bad omen. It's not, I think it's responsible. And I think in life in general, it's often better to have that awkward conversation upfront. I always say like five minutes of awkwardness now to save a ton of potential heartache down the road is usually worth it. You can have a successful breakup. You can have an unsuccessful breakup. Sometimes it never stood a chance. Sometimes you invested in people that you knew were relatively volatile and you thought that was just great upside and it might have been.

and it just blows up in your face, that can work, that can happen. So one solution is that founders are not equals. That can be the case. You just clarify that power dynamic upfront that either the CTO or the CEO, who are usually the two main founders, one of them is just the boss and the other one, it's like, look, we both know that if we fundamentally disagree, founder B is leaving, not founder A.

And just that unspoken agreement can actually make the dynamic a bit healthier. Having everything split 50-50 means that it actually goes back to an example of...

King Solomon, these two women said, oh, they both were claiming that this baby was theirs. There's more to this story, but they were both claiming that a baby was theirs. And so in his wisdom, King Solomon said, okay, we'll cut the baby in half and each of you will get. And the woman who said, no, no, like she can just have the baby then, that was the mother.

And again, it's like this other woman was like, yeah, fine, cut the baby in half because it wasn't really her baby. That's crazy. That's sick. I'm sorry if that's too weird. It is a little biblical. But it's easier if it's just clear who's in that driver's seat. It makes these things a lot simpler and really, I think, survivability.

Alex (25:57.672)
Another big reason is competition. Now, there's an argument that this is rarely the case that companies fail. I'll give an example of a market dynamic that you can't control that can happen that no one sees coming, but usually other people doing what you're doing should not be the reason that your company dies. It's usually more of an excuse why things don't work out.

Alex (26:22.88)
To put it simply, if a market exists, if a product is good, you should be able to find some success. It doesn't mean you're going to be the king or queen of that industry. It doesn't mean that you're automatic massive success, but you should be able to find some success. And it's important to remember that any good market is going to attract competition. So being able to navigate that is really, important. One of my pet peeves, sometimes it's in my own portfolio, sometimes it's when I just meet founders.

I don't think obsessing over competition is good, but you gotta at least be aware of it. So one of my pet peeves is just that founders didn't do a Google search on, you haven't seen this product that Microsoft has? You haven't seen this other startup that Sequoia just announced they invested $100 million in doing this? You gotta be aware of it. I don't think that it should be an obsession and everything should be like Harvey Balls trying to compare products and what are they doing?

It's worth a little bit of time, shouldn't be an obsession, but if you're totally ignorant to it and you're sitting with an investor or a customer and you're not aware of your competition, it's not a good sign for what bodes. So there is a case though that I think is out of your control when it comes to competition, which is when someone just sinks the market, meaning either it's some big company that comes in or it's a startup that raises like an obscene amount of money.

and they just sell at a loss. like, they're just, it's just uncompetitive business dynamics, which I don't know, maybe it's illegal, maybe it's not, but like, something costs $20,000 to deliver and they're selling it for $10,000 just to try to like, sink everyone, all their competitors, and then they're gonna come back and raise their pricing later. I think this is illegal. Like, I think it's called anti-competitive, but you know, startups are a little bit of the Wild West.

There's a lot of ways around it, but this can happen and it can also result in everyone losing. There doesn't always need to be a winner, but everyone could lose. That can happen. And it sucks when it does, when you're in that market. I just had a company that was in a busy market and I think they saw where things were going with a couple of their competitors and they exited. And again, they made money and they were aware of their competition.

Alex (28:47.487)
They understood how they needed to navigate that and they made the best decision going forward.

Alex (28:56.318)
So.

Alex (29:04.126)
In the example where a big company, I'm talking Microsoft, Google, Facebook, Amazon, comes in and says, we're going to do this, and kind of pulls the rug out from under view, that segues really well into the next reason, which is what we call platform risk, which is a lot of great companies have been built on some of these big platforms, whether it's the Apple App Store or Shopify or whatever it may be.

Sometimes those partners, those players change something and either they release a competitive product or they change something about their system that just kills your business. Now often there is a way to pull it out and figure it out. I had a company where this happened. We knew it going in. We knew it was a risk and we didn't think they had any reason to change one of their processes and then they did and the story just ended. And that can happen.

That's a reason companies fail. It's something to be aware of. It's something to at least do a risk assessment on. But oftentimes, you can't see it coming, and it hits you. And it's a reason that companies fail. Another reason which has a really similar dynamic is regulatory. Either regulation gets introduced that kills a company, regulation that you're expecting to get lifted.

doesn't get lifted and it kills a company. Sometimes it's just bad luck with a judge or a municipality. But we saw with Uber and Lyft and a lot of these other consumer companies that if you will it, you can do it. And look, Tusk Ventures built their entire business around this. How do you navigate regulatory and how do you change regulation? It's possible, but sometimes, again, it's unavoidable.

Sometimes it's one of these things that you've got to be aware of. Sometimes you really can't be aware of it, unlike a platform risk where if you're using someone's platform, yes, they could change something. You're at that risk. regulatory, again, if something gets introduced that just makes what you do either illegal or irrelevant. This happened to my friend recently where legislation was coming down and then.

Alex (31:22.118)
like one tweet from Elon Musk and it was gone and it was like maybe this will happen in two years and he had set up this whole business and like that's how it goes nothing you can do. So now I'll get into one of my favorites which is bad business model. I'm a business model guy this is where I focus this is where I spend my time with my founders this is where I spend my time in diligence is figuring out if a business has a good model. This is one of my five key things my five key dimensions that I analyze which

You'll see we'll map to these, I'll say them now, which are team, market, technology and product, business model, and traction and metrics. Those are my five key evaluation criteria for any company at any stage in any market. But business model for me is public enemy number one. Well, it's also my favorite thing in the world. So it's hard to call it a public enemy. But I take everything back to fundamentals. I bring it back to the basics.

Can we sell something for more than it costs us to build and deliver it? Very simple. And, and by the way, are there like a ton of people who want it? If there aren't a ton of people who want it, it still could be a good business, but you probably shouldn't be raising venture capital unless the only person who wants it is like the US government, then like maybe that could work, or like Walmart, I don't know, or the Chinese government. But...

Simply put, like, you gotta have that fundamental thing there. Now, I'm gonna do a whole post on, and a whole session on unit economics and how to actually then calculate that. But really what it comes down to is, I'll say it again, which is, if your product, what you can charge for it, does not cover the cost of billing, building and selling it, then you never had a business. now,

Some people say, this happened. I ran into an investor. He told me, we invested in this company. People want our product, but they can't pay us as much as it costs us to make it. Sounds like you could have figured that out earlier, probably. So my philosophy and what I do is I just do a 30 minute modeling exercise. Right at the beginning, when I'm sitting with founders, I do it when they're starting the company or I invest, like in the investment process.

Alex (33:49.561)
And the output of it is what I call the one column model in Excel. So the first step, and I always say this, is that great business models start in PowerPoint or on a whiteboard, whatever you want. But you've got to identify the process and the stakeholders in the business in each step. What do you need to do to make a sale? What's the process of that happening? How much can you charge? What are the mechanics through each of those pieces? What like?

That is what it takes to just lay out and figure out clearly, what is our business? What are we doing? I always say businesses fundamentally do two things. They make stuff and they sell stuff. So what are we making? What are we selling it for? And who are we selling it to? How much money can we charge? And what's the process of building it and making it and delivering it? Do we need service? Do we need implementation? Is it a one-time cost? It is a recurring cost? All these things are...

They're mappable. We might not have all the answers, but they're at least mappable. so great models start as flowcharts. Start with the flowchart. Once you get the flowchart clear, building that one column model in Excel is usually fairly straightforward. And the goal of that is to isolate the inputs and the outputs, make sure that the mechanics of the model accurately represent what the business will do based on your understanding. And if you don't understand it, then you got to go understand it.

Then it allows you to validate those assumptions and figure out what can actually work on paper before you write a single line of code, build a single product, talk to a single customer. Now, you might need to figure out, talk to customers and figure out their willingness to pay on the front end, but that's a good place to start. I always say, do this exercise before you quit your job, before you incorporate.

and definitely before you raise money. I'll do it with anyone who asks. you email me and say, I want to do a one column model, you know what? I'll set up 15 minute slots or 20 minute slots and I'll do them with founders who ask to validate if the business can actually work. There are so many companies that just never stood a chance. mean, one of the craziest ones is WeWork. WeWork was selling a dollar for 75 cents.

Alex (36:11.599)
They had long-term liabilities. had short-term assets and choppy cashflow, volatile choppy cashflow. Like it should have never worked. And again, it's this, this fundraising mechanic in the market of perpetuating it and like, once they cross over into this, then it will work. like, no, it's actually just a real estate business that you're operating at a huge loss that's subsidized by venture capital dollars. You got to look yourself in the eye and be like, what is it really? And Hey, maybe there is a dream like,

know, Uber is a great example. And I think this was done by design with Uber is that they just undercharged. They undercut the market. They made it cheaper than taxis. Not only was it a better, you know, experience, but it was cheaper. And then once they got the entire world addicted to their product, they went ahead and raised all the prices. if that's, that's a really aggressive strategy. Travis pulled it off. You probably can't pull it off.

You probably can't raise the $5 billion of equity capital to wait out the whole market, which again goes back to the competition thing. But it is a thing.

Anyway, once you've isolated these key variables in the one column model, you can figure out like, what do we need to believe for this to work? We need to believe that there's this many customers. We need to believe that the sales cycle will be this. We need to believe that they're willing to pay us this. And once you vet those assumptions with yourself and what you know about the market, you can ask other people, run it through their filters, right? Then you come back to this big idea, which is I think supports

the entire venture ecosystem, which is that gross margin is margin for error. And what I mean by that is if you have a big enough buffer between what something costs you and what you're getting paid for it, you can make mistakes. And this is why SaaS companies are so VC backable. It's because the margins are big. The gross margins are big. Contribution margins are where the rubber meets the road. But the difference between

Alex (38:21.487)
gross margin and contribution margin. And notice I'm saying contribution and not operating margin because they're different things. Again, it goes back to the unit economics point. But if you mess up your sales and marketing for a quarter, or you go after the wrong end market for three, five months, you can actually recover from that if your gross margins are strong enough. If your gross margins aren't strong, you're playing a very, very dangerous game. And an example I would give is a restaurant.

Right? Restaurants do not have good margins. And as a result, a single bad month can just kill a restaurant. It can be game over. So, you know, if that's the case, you better know exactly what you're doing if you're playing within margins. Otherwise, try to aim for markets with big margin opportunity. And again, this is why digital tools are so powerful and why there are so many VC dollars have been poured into them because, when things are moving fast, when you're growing, you can mess up. And...

you can still be successful even if you mess up. So the main takeaway here on the business model portion is manage your variables, understand the mechanics of your business, know what can work, what you need to believe, what can't work, what the bounds are of what's reasonable, how those variables work with each other, and you'll really optimize your chances of success. And avoid a lot of silly, painful, expensive mistakes. And that leads me to

one more category. And this will be my final category for today. Maybe we'll come up with more later. But the last is financial mistakes. And I'm making this distinct from business model mistakes because maybe it's related to business model, maybe it's related to founder issues, but I think it deserves its own headline because usually what it means for a company to fail is that it runs out of money. So

There are good reasons to run out of money and there are bad reasons to run out of money, right? An unavoidable change, whatever it be, the market, like things out of your control, fine. This is how companies die. But sometimes everything's working well and the company still runs out of money. So that's what a startup is basically though. I heard this definition years ago, a startup is a company that is always almost going out of business. And that's because it loses money. I have this line that I've said, which is, know, sustainable revenue growth sets you free.

Alex (40:49.419)
It is the only way to control your own destiny, I think, in any business. If you're growing and you can sustain that, meaning you control the ability to continue to grow, then you really write your own story. Because people will want to fund you, which can allow you to go into the negative. But if you don't control that and you're stuck in the negative, you have no leverage on people funding you. again, running out of money usually is the result of financial mistakes. But I'll get into.

some of the financial mistakes people make. So first and foremost is that the job of a CEO is resource allocation. That doesn't matter if you're a solopreneur just dividing up your time or a Fortune 100 CEO figuring out which country you should open up or which $10 billion M&A deal you need to be doing. But resource allocation is the job of the CEO.

The tool and the language of resource allocation is money. And the language of money is finance. And those are the tools we have. The original data team inside a company was the finance team. Now, getting your financial numbers to accurately represent what's going on in the business is actually not trivial these days. And the reason is that accounting metrics were

like the GAAP, Generally Accepted Accounting Principles metrics that everyone's required to file in 10Ks, 10Qs, S1s, financial reports, whatever it may be, audits, may not actually tell the whole story of what's going on in a business. Now, oftentimes you can suss it out. You can figure out how net working capital is changing and then cash dynamics and all these things. And you can figure out where something's going. And this is what great stock analysts do for like technology companies with innovative business models. But sometimes,

Again, that's a great stock analyst. We're talking about founders right now and CEOs. Now, sometimes one of the founders of a company has a background in private equity. And so great, they've got the tool set already to make sure this is working. In the absence of that, be careful because a lot of mistakes get made because people just outsource things to an outsourced CFO, accounting firm, whatever, and they take everything at face value.

Alex (43:16.445)
I remember I was advising a friend's company and I was like, hey man, we need more detail in your accounting than just one line that says payroll. Can you tell the accounting firm to split it out into sales and marketing, R &D, and G &A for payroll? And they're like, sure, yeah. The accounting firm, though, they sent us all these questions. So some of this comes down to a bookkeeping issue, which is that expenses come in, salaries get paid.

The outsourced accounting firm doesn't know if John Smith, who's getting a paycheck, is an engineer, or if they're a salesperson, or if they're the janitor. They've got no idea. Now, if someone's in the company, you'd hope they'd be connected into the payroll system, the HR system, and they know what people's roles are. But sometimes, early stage, people just don't even have it. Also, as a little bit of an aside, founders often

don't represent their own time properly. And they're like, yeah, our CAC is zero because I do all the sales. I'm like, and your time is worth nothing? I think your time is worth infinity if you're the founder CEO of a company. Your CAC is infinity right now. So what I always recommend doing, which is I say this kind of casually, but I understand it's confusing for a non-financially oriented founder. Again, if you want to reach out and ask me,

how to do it what do I look like. I've written up a lot of things on this for a lot of different types of businesses and I can very efficiently help you figure it out. basically you've got to figure out what your economic metrics are. So now what does economic mean? Again, it comes back to this idea of resource allocation. What's really going on in the business? Is there economic value being derived in this company operation? do we have a set of numbers?

that appropriately represent that. Now, you've generally got three sets of numbers inside a company. The first is, like I mentioned, the gaap accounting metrics, which I'll say a little bit on after I finish the list. The second is the customized company-specific metrics, which they could be your own made-up, it could be your own LTV calculation, or it could be a, I don't know, a renewal model, or

Alex (45:31.911)
any operating metrics that you're pulling from your customer behavior and your sales operation and things like that. like those are really, really useful. They should be really well thought out and designed. And then the third is, don't forget, cash. You run out of money, your startup story ends. It's very simple. So cash always matters. Understanding the cash dynamics. Some people overly focus on it and it may not tell the whole story. And here's where I'll talk a little bit about, you know, gaap accounting and the gaap metrics.

It used to be, a thousand years ago, for all of history, people did everything on a cash basis. You sold something to someone, they gave you a pile of gold or cash or another item to barter with, and that's all that it was. And then the accounting principles kind of came into being, I think it was in the late 1800s, maybe more recently. And they invented two key concepts.

which the first is revenue, which is an invented idea. And the second is depreciation and amortization. So on the revenue side, that's the earning side and the depreciation and amortization is on the cost side. So what does it mean? It means that we want to find the number that represents the economic activity of the business. so revenue is, the verb is earned and then recognized and revenue is earned and then recognized.

at the moment when goods or services are delivered to the customer.

That might be very different from when the customer pays you. They might pay you before, they might pay you at that moment, and they might pay you after. I've run into this with companies. You go from being a credit card swipe sort of thing, where the booking, the billing, and the rev rec all are at the very same moment. A lot of companies don't work that way. Bigger companies, SaaS companies that charge a year upfront, companies with accounts receivable.

Alex (47:36.269)
meaning they basically are giving their customers loans. And so this concept of revenue was effectively invented to better, more accurately represent how companies earn and create economic value. Innovative idea, super helpful, absolutely critical to business. But with all these new business models and different technologies and things like, sometimes it doesn't tell the whole story of what the relatively archaic, slow moving legal definition of gaap revenue is.

Depreciation and amortization, same thing on the cost side. Typical example is you buy a truck for your company, it costs $50,000. Well, we didn't lose $50,000. We like bought this thing. Even though all the cash went out this year, we actually want to recognize the cost over 10 years. So it's $5,000 per year that we're recognizing the cost, even though the cash all went out upfront. Again, more economically aligned with what's going on in a business.

defining those economic metrics, at least again, just give it a minute, think about it early, like how are we gonna know we're being successful? And some businesses are really straightforward, they're well understood. If you're an enterprise software company, maybe you wanna work more on what is your sales cycle and can it work? If you're inventing a new business model that's never existed before, you probably just need to think about what are the metrics that really matter for us and are gonna tell us as leading indicators and lagging indicators what is the health of our business?

Ultimately, startups raise money and then immediately start to die. That's how it works. Again, they haven't achieved sustainable revenue growth. If you want to talk about EBITDA positive growth equity, that's not what I'm referring to here. I'm talking about companies that burn cash, right? So until you've reached that cashflow break even, that freedom of sustainable revenue growth, then you're just trying to stay in the black.

You're just trying not to dip below that zero. Because like I said, ultimately cash is king. You go below zero, your story ends. That's all that matters.

Alex (49:46.973)
Everything needs to be driven by these ideas inside a business, either explicitly or implicitly. I would recommend for an early stage company where the CEO is in charge of the financial decisions, that it should be implicit. They should spend some time thinking about these things. They should seek expert advice, not from an accountant, but someone who actually understands finance, which is distinct from accounting. Accounting is the language of finance, but finance is forward looking and accounting is backward looking.

to really understand what that might look like. And it's not a big time investment. making sure that each business decision roots back to, is this accruing value to the company, even if it's costing money? It's fine, it doesn't cost money, that's fine, you're investing, that's whole point. But it's gotta ultimately derive some value. So last main point here, which is that startups have bumpy journeys.

There's never a smooth curve up into the right. Has it ever happened? I don't think so. Every story's got ups and downs and questions and challenges. And that's the whole point. You're in a non-consensus disruptive mode. It's rarely just straight up and ti the right. And sometimes you hear founders on podcasts, they talk about how things were hard, but sometimes the way they tell the story...

And I've seen examples like this because I've been inside some of these boardrooms and then you hear the stories on podcasts and it's like, that's not exactly what happened. But if that's how they wanna remember it, good for them. That's totally fine, they're successful. They live their version of history, it's great. But the question is, why I do this, is what's useful for founders? What's useful for investors? How do we avoid issues? And so remembering that those hard times come.

They probably will, and you know what? Even if they don't, it's like buying insurance. Insurance is usually a good investment. And what that means typically is don't over-optimize for dilution, don't optimize for valuation. Valuation becomes a hurdle. Give yourself margin of error so that you can win. Again, like I said before, gross margin is margin for error. Create a margin of error for yourself, a safety factor, whatever you want to call it, so that...

Alex (52:03.251)
If there's a bump in the business, one of these challenges that we just went through that's totally out of your control, the market crashes, there's no VC dollars, Google invades your market space and you got to pivot to something else, have a rainy day fund. Again, some people say, oh, it's all or nothing in startups. That middle case, if you're a founder of making 25 million bucks, that's pretty awesome. And I wouldn't throw that out the window to just shoot the moon.

Unless that's the position you're in, and if that's the position you're in because you already made $25 million, then by all means, go for it. Shoot the moon. Call me. Let me know what you're working on. But also, if you're a founder who wants to go for the gold but is also satisfied and reasonable about making $25 million, let's say, personally, you can also call me and tell me about what you're working on. markets change. Hiccups happen.

It's better to have a slightly smaller piece of something than a slightly larger piece of nothing. So I'll end here with one quick note, which is that obviously there's more reasons that companies fail. There's details, there's nuances, there's tons more examples. My hope is and my dream is that founders take a few minutes at the beginning of their journeys, think about how to set themselves up for success. Who are the people that they can

call to help them avoid mistakes. Again, I don't believe in leading by committee, but usually you know who those people are who tend to give that sage advice, who you can rely on, who are on your team, who are ride or die with you, and who can help you. And then focus on what makes you great. Focus on your superpower. Get the most out of that. Keep your head on a swivel. Again, it's like focus, but don't focus. That's the job. Learn how to focus on a bunch of different things all at the same time.

That's why we launched our program. That was the inception of this podcast. It's all about everything. You've got to do everything. You've to know when it matters. You have to learn to prioritize. Skill of prioritizing. Maybe it's a skill. Maybe it's a talent. Maybe it's both. I'm not sure. We'll talk about more of this stuff in the future. To be continued, plenty more to share on the frameworks, on specific examples. Subscribe and stay tuned for more. And stay true.