The more apt framing of this article would be something along the lines, of "The Agency Trap." The author grew his marketing agency to $1M quickly. That might sound great for HNers here, but there are reasons why such businesses don't attract handsome valuations. You always have to keep grinding to keep the inflow of customers, you're never free, and growth is directly tied to the number of employees. Additionally, such business can have severe ups and downs depending upon market conditions.
Building a product, on the other hand, is slow at the start but after a point, the rewards start showing up. The inflow of cash is consistent and keeps growing while the costs remain the same.
There's nothing wrong with the agency business, but it'd be a smart bet to use at least some of the proceeds into building something long-term. Some agencies, notably 37signals, have been quite successful doing that. Most, though, never do it.
If you run an "agency" business then you should always be promoting junior employees to full partner. They start our doing work that you find for them, but after a few years of training from you they are now bringing in their own work and should be treated like an independent business owner in your space that you agree not to compete with (which would be against monopoly laws if you were not the same company) and once in a while one covers for the other for vacations/sick. Lawyers regularly change the name of their company to reflect changes in who is partner.
Not all employees become full partners. Most do not, but it should be clear to everyone what hard work is required to become a partner and they should see examples of it happening.
This is an interesting idea. I started in agencies and this is indeed a problem.
It’s a good start for junior people to get experience but they tend not to stay long.
It also attracts people who can do it all - design, programming, animation, etc who become stars, and then wonder why they aren’t working for themselves.
Generalists like that also tend to navigate poor management well (also very common) because they remove the need to be managed.
The agencies I was at came to the opposite conclusion - why do we even have employees instead of contractors? Which never really worked out.
> It also attracts people who can do it all - design, programming, animation, etc who become stars, and then wonder why they aren’t working for themselves.
This is why you promote to full partner all the time. The people who wonder why they aren't working for themselves should answer "I will have all the advantages of working for myself, plus the advantages of partners for the few places that matter". If you don't promote to partner you lose all the effort you put into training that person if you did you get someone who can help you once in a while.
Most B2B firms live in the grey area between consultancy and product for most of their lives. I’ve known of more than one database company with greater than 50% of their HC tied to bespoke asks from top clients.
In my opinion, the difference is really in whether the core founders can scale super-linearly with HC, and whether you can maintain a wide enough spread of clients that you can afford to lose a few of your biggest and not care beyond the signal you get on how your product is doing in the market. Practically, every top B2B startup fails the latter test to some degree.
Yes—lots of good examples of marketing agencies building themselves into product companies, most notably Moz, HubSpot and Semrush. This is the way.
In order to scale past $1M in profit, you need to professionalize the management of the agency and scale the workforce, probably using offshore/nearshore help. I've found that a lot of agency owners just don't want the hassle, and are fine taking home $1M/year (fair!)
There's a hidden glimmer of wisdom in here, which is to let your (cash) customers contribute to funding your (equity) business growth.
My theory is a niche consulting firm can perform services to make enough money to build out a product, and better yet, they're being paid to learn about user requirements along the way.
I'm on a similar journey right now, and it's always difficult balancing the dopamine and temptation of a short-term cash injection at the expense of development time spent on the core product we're scaling.
This is exactly how we built viaForensics in 2009. For the first five years, we performed mobile forensic investigations and gave trainings based on the Android and iOS forensic books we wrote. We were able to self fund software development for the first five years. When we moved from forensics to mobile app security, we required more capital to build our automated software which led to our Series A.
Having an established business with customers in revenue, obviously significantly helps in the fundraising process and evaluation. The other huge advantage is you can benefit significantly from the Qualified Small Business Stock statute which provide an exemption/shield on federal taxes when you sell that is the _greater of_ either $10m or 10x times your valuation at the time of funding.
Yes, but it takes strong leadership. Service and Product companies have important structural differences in many areas, including finance, culture, technology infrastructure, and project management. I’ve seen many companies start on one side, try to add the other, and fail hard.
I think better advice here is to say that you should plan to spend time learning enough about the field you're trying to enter that you can see whether you are working toward fit or whether you're working away from it. In other words everything that you should do when building a new product should be geared toward quickly validating whether what you're building is what people want. If you don't have a plan for market validation you don't have a business yet.
Not exactly the same but this reminds me of Joel's Strategy Letter I [0] regarding knowing what kind of business you operate, and consequently how you should grow it.
He references Amazon as a land grab play - sure - but it was also a cash generation machine - I don't think Amazon raised a huge amount of capital - didn't it mostly funded growth via revenue?
The usual value of equity is the cash it can generate. This is a wordy way of saying:
1) that some businesses will be profitable short term, and some in the long term and it can be worth sacrificing one for the other as you end up with a more valuable business, and,
2) sometimes you sell a business for a lot more than its value as a standalone business, for various reasons - for example it lets a big business fill in a gap in their product line, or remove a potential future competitor, or remove a low cost alternative to their existing services/products, or help them sell more of something related, or gather more data..... or are just irrational at times.
The phenomenon in two is common in technology businesses, but is not common elsewhere. its most common during bubbles.
that's a good point about the strategic value exceeding the standalone business value... i think a lot of acquisitions are driven by that, especially in tech. it's interesting how much "potential" gets priced in, even if it's not immediately obvious how that potential will be realized.
It is usually the justification trotted out to justify acquisitions.
In general (not tech in particular) it turns out to be false more often than it turns out to be true. Large acquisitions tend to lose shareholders money but benefit management (because they profit more from running a bigger business).
A cash business can have quick linear growth, whereas an equity business will have slower but exponential growth.
...or not. Businesses do fail. A cash business and an equity business are just as likely to fail as one another. Working in the cash business means you're realising the value when it happens, rather than 'banking' it to realise a compounded value later. If the business fails for any reason you'll have been much better off working in the cash business. This is the downside risk of working for equity.
An investment strategy focusing on cash flow versus equity growth is also an important difference between most people who invest in businesses and venture capital.
I think a good chunk of services I receive from small businesses are underpriced due to people not realising the business they're starting has an upside similar to being an employee but with much greater personal financial risk and working stress. There's really not that much scalability to something without franchise potential.
Perhaps the personal financial risk and working stress isn't as great as it might seem?
Imagine I'm a qualified plumber. I've got my own tools, vehicle, and insurance.
I can work as a subcontractor for a local plumbing business. They'll pay me $250 per day when they have work for me. I get no income when there's no demand, and I get no holidays or sick pay.
Or I can start my own plumbing business, and charge customers $100 per hour. Sure, I've got to pick up the marketing and giving quotes and sending out invoices - but if I can get the work coming in, I get a lot more money.
It never fails. If someone mentions “selling courses” as one of the best examples of a business they can think of, their line of business is “self-help guru/grifter”.
He even has the “how to have better sex” book out there for you to buy.
What are some indicators of the type of business one is running? Consider that in a short period’s assessment both styles (cash and equity) might generate cash, both might grow over the interval… But what matters is what happens 5 years or 10 years or 20 years later. What indicates, in the first few months, whether or not you are planting a tree or planting perennials?
You can also have fast equity and slow cash. This is kind of oversimplifying business accounting. Learning some basic accounting may quite literally pay dividends for any project.
Equity business is thoroughly inaccessible to the vast majority of people, especially the IT people. It requires being an insider at least to a degree, and it requires apart from knowledge and skills, at least some luck.
I've seen a lot of extremely bright, talented and hardworking people trying to play that game - all failed, some ruined their entire lives simply for refusing to give up for too long. While those who went into cash business - as simple as an outsourcing shop - are almost all doing fine.
Nudging people to try for "equity business" is a dangerous advice to give.
I don't understand why people are so opposed to starting a bootstrapped consulting company. You can start as a single man shop and then hire people and expand.
I'm running a consultancy in a LCOL area. Last year we made 400k revenue, 150k profit and 40% growth. We already have verbal agreements for around 400k worth of sales for this year. We have the employees for 600k revenue and if we manage to bring in more sales we can grow the team to meet demand. 600k revenue would mean 250k profit for us.
I can easily see us growing the company to a few million revenue in the coming years. Making lots of profit while having the option of selling the company for a lot of money if a nice offer comes along. Sure it won't be making me a billionaire, but I can easily see myself building generational wealth here.
My country has public tax records for all companies over 250k revenue. The story is very often with product companies that they have burnt 2, 5, 10 million to achieve 2-3m ARR while still making a loss.
That's because most people apparently grow their spending in sync with their income. The people who grow their income and not their spending are "an extreme edge case".
Someone who does things not because he read about them on the Internet, but because they were invented or co-invented, or owned by people he went to school with, or family connections. When "system" is not something you fight with, but it's YOU and people who are your family or treat you as a family. Elizabeth Holmes is a prime example but only because she was caught.
The article kind of conflates multiple factors and oversimplifies. Equity is great, but it's only as good as the EV (enterprise value) of the company. All things being equal, a company that generates free cash flow is worth more than one that doesn't—regardless of whether it's a software business or not.
Taking a long time to get to "break even" is not inherently a smart or long-term business play. It could just ruin you. In business, cash is oxygen.
Some businesses (especially platforms and marketplaces like Kit) simply take longer, because it takes time to build brand awareness, develop network effects, and basically hit critical mass.
However, the upside of a platform is that the growth is naturally exponential—the more people on the platform, the more valuable it is to its users.
Because this is so time-consuming and difficult, a platform business commands a premium over a more straightforward SaaS product.
One path isn't inherently better than another path—there are just tradeoffs. And hopefully you go into it with eyes open and make those tradeoffs deliberately.
The more apt framing of this article would be something along the lines, of "The Agency Trap." The author grew his marketing agency to $1M quickly. That might sound great for HNers here, but there are reasons why such businesses don't attract handsome valuations. You always have to keep grinding to keep the inflow of customers, you're never free, and growth is directly tied to the number of employees. Additionally, such business can have severe ups and downs depending upon market conditions.
Building a product, on the other hand, is slow at the start but after a point, the rewards start showing up. The inflow of cash is consistent and keeps growing while the costs remain the same.
There's nothing wrong with the agency business, but it'd be a smart bet to use at least some of the proceeds into building something long-term. Some agencies, notably 37signals, have been quite successful doing that. Most, though, never do it.
If you run an "agency" business then you should always be promoting junior employees to full partner. They start our doing work that you find for them, but after a few years of training from you they are now bringing in their own work and should be treated like an independent business owner in your space that you agree not to compete with (which would be against monopoly laws if you were not the same company) and once in a while one covers for the other for vacations/sick. Lawyers regularly change the name of their company to reflect changes in who is partner.
Not all employees become full partners. Most do not, but it should be clear to everyone what hard work is required to become a partner and they should see examples of it happening.
I think you make, in miniature, a good example of the case for why most businesses should be making most employees into equity stakeholders.
This is an interesting idea. I started in agencies and this is indeed a problem.
It’s a good start for junior people to get experience but they tend not to stay long.
It also attracts people who can do it all - design, programming, animation, etc who become stars, and then wonder why they aren’t working for themselves.
Generalists like that also tend to navigate poor management well (also very common) because they remove the need to be managed.
The agencies I was at came to the opposite conclusion - why do we even have employees instead of contractors? Which never really worked out.
> It also attracts people who can do it all - design, programming, animation, etc who become stars, and then wonder why they aren’t working for themselves.
This is why you promote to full partner all the time. The people who wonder why they aren't working for themselves should answer "I will have all the advantages of working for myself, plus the advantages of partners for the few places that matter". If you don't promote to partner you lose all the effort you put into training that person if you did you get someone who can help you once in a while.
Most B2B firms live in the grey area between consultancy and product for most of their lives. I’ve known of more than one database company with greater than 50% of their HC tied to bespoke asks from top clients.
In my opinion, the difference is really in whether the core founders can scale super-linearly with HC, and whether you can maintain a wide enough spread of clients that you can afford to lose a few of your biggest and not care beyond the signal you get on how your product is doing in the market. Practically, every top B2B startup fails the latter test to some degree.
Yes—lots of good examples of marketing agencies building themselves into product companies, most notably Moz, HubSpot and Semrush. This is the way.
In order to scale past $1M in profit, you need to professionalize the management of the agency and scale the workforce, probably using offshore/nearshore help. I've found that a lot of agency owners just don't want the hassle, and are fine taking home $1M/year (fair!)
There's a hidden glimmer of wisdom in here, which is to let your (cash) customers contribute to funding your (equity) business growth.
My theory is a niche consulting firm can perform services to make enough money to build out a product, and better yet, they're being paid to learn about user requirements along the way.
I'm on a similar journey right now, and it's always difficult balancing the dopamine and temptation of a short-term cash injection at the expense of development time spent on the core product we're scaling.
This is exactly how we built viaForensics in 2009. For the first five years, we performed mobile forensic investigations and gave trainings based on the Android and iOS forensic books we wrote. We were able to self fund software development for the first five years. When we moved from forensics to mobile app security, we required more capital to build our automated software which led to our Series A.
Having an established business with customers in revenue, obviously significantly helps in the fundraising process and evaluation. The other huge advantage is you can benefit significantly from the Qualified Small Business Stock statute which provide an exemption/shield on federal taxes when you sell that is the _greater of_ either $10m or 10x times your valuation at the time of funding.
Yes, but it takes strong leadership. Service and Product companies have important structural differences in many areas, including finance, culture, technology infrastructure, and project management. I’ve seen many companies start on one side, try to add the other, and fail hard.
I'm convinced it can only happen if the company is laser-focused, or really small.
I also believe resource constraints create innovation, which these companies are particularly poised to do.
Or just … enjoy your cash business? Be your own boss, make a good amount of money, do it as long as you can.
Seems aggressive to look at a 5-6 person agency pulling in $1M a year and give the advice “now it’s time to start your _real_ business”
Do not read this as- If you have slow growth you have an equity business. It's more likely you just have a shitty business.
Or you haven't found product market fit yet, which sounds like what happened in the Kit.com example referenced in the article.
I think better advice here is to say that you should plan to spend time learning enough about the field you're trying to enter that you can see whether you are working toward fit or whether you're working away from it. In other words everything that you should do when building a new product should be geared toward quickly validating whether what you're building is what people want. If you don't have a plan for market validation you don't have a business yet.
Not exactly the same but this reminds me of Joel's Strategy Letter I [0] regarding knowing what kind of business you operate, and consequently how you should grow it.
[0] https://www.joelonsoftware.com/2000/05/12/strategy-letter-i-...
He references Amazon as a land grab play - sure - but it was also a cash generation machine - I don't think Amazon raised a huge amount of capital - didn't it mostly funded growth via revenue?
At first, Amazon was exactly the kind of Equity business OP is writing about. And it was hugely criticized about it [1, for example]
[1]:https://www.computerworld.com/article/1377261/bezos-says-ama...
The usual value of equity is the cash it can generate. This is a wordy way of saying:
1) that some businesses will be profitable short term, and some in the long term and it can be worth sacrificing one for the other as you end up with a more valuable business, and, 2) sometimes you sell a business for a lot more than its value as a standalone business, for various reasons - for example it lets a big business fill in a gap in their product line, or remove a potential future competitor, or remove a low cost alternative to their existing services/products, or help them sell more of something related, or gather more data..... or are just irrational at times.
The phenomenon in two is common in technology businesses, but is not common elsewhere. its most common during bubbles.
that's a good point about the strategic value exceeding the standalone business value... i think a lot of acquisitions are driven by that, especially in tech. it's interesting how much "potential" gets priced in, even if it's not immediately obvious how that potential will be realized.
It is usually the justification trotted out to justify acquisitions.
In general (not tech in particular) it turns out to be false more often than it turns out to be true. Large acquisitions tend to lose shareholders money but benefit management (because they profit more from running a bigger business).
A cash business can have quick linear growth, whereas an equity business will have slower but exponential growth.
...or not. Businesses do fail. A cash business and an equity business are just as likely to fail as one another. Working in the cash business means you're realising the value when it happens, rather than 'banking' it to realise a compounded value later. If the business fails for any reason you'll have been much better off working in the cash business. This is the downside risk of working for equity.
An investment strategy focusing on cash flow versus equity growth is also an important difference between most people who invest in businesses and venture capital.
I think a good chunk of services I receive from small businesses are underpriced due to people not realising the business they're starting has an upside similar to being an employee but with much greater personal financial risk and working stress. There's really not that much scalability to something without franchise potential.
Perhaps the personal financial risk and working stress isn't as great as it might seem?
Imagine I'm a qualified plumber. I've got my own tools, vehicle, and insurance.
I can work as a subcontractor for a local plumbing business. They'll pay me $250 per day when they have work for me. I get no income when there's no demand, and I get no holidays or sick pay.
Or I can start my own plumbing business, and charge customers $100 per hour. Sure, I've got to pick up the marketing and giving quotes and sending out invoices - but if I can get the work coming in, I get a lot more money.
It never fails. If someone mentions “selling courses” as one of the best examples of a business they can think of, their line of business is “self-help guru/grifter”.
He even has the “how to have better sex” book out there for you to buy.
What are some indicators of the type of business one is running? Consider that in a short period’s assessment both styles (cash and equity) might generate cash, both might grow over the interval… But what matters is what happens 5 years or 10 years or 20 years later. What indicates, in the first few months, whether or not you are planting a tree or planting perennials?
You can also have fast equity and slow cash. This is kind of oversimplifying business accounting. Learning some basic accounting may quite literally pay dividends for any project.
Any suggestions for good basic accounting learning resources?
I have no association with the author but this site has been a good search result source for me over the last few years when I've had questions:
https://www.accountingcoach.com/
Equity business is thoroughly inaccessible to the vast majority of people, especially the IT people. It requires being an insider at least to a degree, and it requires apart from knowledge and skills, at least some luck.
I've seen a lot of extremely bright, talented and hardworking people trying to play that game - all failed, some ruined their entire lives simply for refusing to give up for too long. While those who went into cash business - as simple as an outsourcing shop - are almost all doing fine.
Nudging people to try for "equity business" is a dangerous advice to give.
I don't understand why people are so opposed to starting a bootstrapped consulting company. You can start as a single man shop and then hire people and expand.
I'm running a consultancy in a LCOL area. Last year we made 400k revenue, 150k profit and 40% growth. We already have verbal agreements for around 400k worth of sales for this year. We have the employees for 600k revenue and if we manage to bring in more sales we can grow the team to meet demand. 600k revenue would mean 250k profit for us.
I can easily see us growing the company to a few million revenue in the coming years. Making lots of profit while having the option of selling the company for a lot of money if a nice offer comes along. Sure it won't be making me a billionaire, but I can easily see myself building generational wealth here.
My country has public tax records for all companies over 250k revenue. The story is very often with product companies that they have burnt 2, 5, 10 million to achieve 2-3m ARR while still making a loss.
This works in your situation. It does not for most Americans. Your current total profit would barely support a small family.
It also requires you already have enough money to not need any returns for a few years.
That is a much smaller problem, most people in IT have it.
Citation needed. From my experience, being able to go two years without income is an extreme edge case.
That's because most people apparently grow their spending in sync with their income. The people who grow their income and not their spending are "an extreme edge case".
Could you elaborate on that? How come it requires being an insider? What constitutes an insider?
Someone who does things not because he read about them on the Internet, but because they were invented or co-invented, or owned by people he went to school with, or family connections. When "system" is not something you fight with, but it's YOU and people who are your family or treat you as a family. Elizabeth Holmes is a prime example but only because she was caught.
The article kind of conflates multiple factors and oversimplifies. Equity is great, but it's only as good as the EV (enterprise value) of the company. All things being equal, a company that generates free cash flow is worth more than one that doesn't—regardless of whether it's a software business or not.
Taking a long time to get to "break even" is not inherently a smart or long-term business play. It could just ruin you. In business, cash is oxygen.
Some businesses (especially platforms and marketplaces like Kit) simply take longer, because it takes time to build brand awareness, develop network effects, and basically hit critical mass.
However, the upside of a platform is that the growth is naturally exponential—the more people on the platform, the more valuable it is to its users.
Because this is so time-consuming and difficult, a platform business commands a premium over a more straightforward SaaS product.
One path isn't inherently better than another path—there are just tradeoffs. And hopefully you go into it with eyes open and make those tradeoffs deliberately.