1.4: Chapter 3 Business Rationale

Business Rationale

THE PERSONAL BENEFITS I DESCRIBED could apply to having just one additional income stream. But I’m arguing for more than that. Let’s consider why it’s best not to stop at just one. Entrepreneurs and solo founders these days should have several.

You might already be thinking, “Wait a second, I’m supposed to focus on one, maybe two things, and get those to work before doing anything else. And one of those things is my day job.”

Sure, a day job and some stocks is a fine way to do things. You can focus on investing and you may get rich, but it won’t happen very quickly and your gains could get wiped out during a down market. You could also work hard every day, toiling away for a promotion while you build someone else’s generational wealth and you get what’s left over.

I’m not saying it’s a bad thing. In fact that’s how most people do it. But there is another way.

Instead of tying your wagon to someone else’s company (via the stock market and your day job) you can invest in yourself (via new skills) and get equity in your own business at the same time.

Instead of hoping that your first idea turns out to be the best idea, you can test multiple ideas at once, build them, launch them, and even run them for a while. I’ll describe this process in much greater detail in the second half of the book.

Instead of banking on one business replacing your day job salary and falling short, you can stack the revenues of multiple businesses until in aggregate you’re making more than your old paycheck.

This is ultimately why you should run multiple side businesses at once. It increases the likelihood of success and each new business you add takes less additional time than the last one.

Why Growth Plateaus Happen in SaaS

There is a natural limit on how much money you can make as a solo founder without outside capital.

Given that there is a cap on the income stream from any one business, in order to continue your growth, you’ll need to start more businesses. If you can’t grow up, you have to grow out.

I’ve found this to be especially true in the software-as-a-service (SaaS) industry. There are growth plateaus that you hit along the way and they are notoriously difficult to break out of. In fact, you may never break out of them. You may hit one and be stuck there for months or even years.

When that happens you have two options: sell the business or keep it and start a new one.

This has happened to me several times throughout my career in SaaS, both with Scripted and Toofr. In fact, I’m experiencing it right now. Toofr’s revenue has plateaued for the last several months and I’m actively working to break through it. It gets harder and harder.

The logic behind why this happens goes like this.

Your subscription software business grows when the increase in new revenue exceeds the decrease in churned revenue. New revenue is just what it sounds like: a new customer signing up for a monthly subscription of your product. They’re coming in and paying you for the first time. Churned revenue is the opposite. It’s an existing customer cancelling their subscription.

There are also the forces of upgrades and downgrades, but for most businesses those movements are a fraction of the volume, 15% at most, of new and churned revenue amounts. So let’s just focus on acquisition and churn.

If you get $1,000 of new subscriptions and lose $250 of existing subscriptions, then you grow $750 in monthly recurring revenue. I’m intentionally not saying how many customers those revenue numbers represent. It could be four customers paying you $250 each or 1,000 customers each paying you $1. For the purposes of sheer revenue growth, it doesn’t matter. (I’d argue it’s safer to have more customers paying a smaller amount, but let’s table that for later.)

The problem every SaaS business eventually runs into is when churn catches up to acquisition. If you keep acquiring $1,000 of new revenue each month, then inevitably, and I do mean inevitably, churn will reach $1,000. And there you’ll sit, in limbo land, not growing, not shrinking, until you can do something to reduce that churn (better customer support, fewer bugs) or acquire more revenue (advertisements and promotions, new features).

The reason every business eventually hits this plateau can be explained with basic math. Churn is a relatively constant percentage of revenue. It’s very difficult to dramatically change your churn rate and it is influenced by two main factors: the industry you’re in (e.g. marketing vs healthcare) and the average customer size (e.g. small business vs enterprise).

Most B2B entrepreneurs will sell to small businesses. Both of my companies sold primarily to small businesses. The nice thing is there are literally millions of them in the United States alone, and millions more worldwide. The bad thing is they churn pretty fast and prefer to be on monthly rather than annual contracts. When you charge someone every month instead of every twelve months, your customer gets twelve more opportunities to churn. Therefore, monthly contracts will always churn at higher rates than annual contracts.

So why not just do annual contracts? Because annual deals have longer sales cycles and involve more paperwork. Your customers will want more diligence, they’ll want to try before they buy, and they’ll want to customize your contract every time. As solopreneurs, we don’t have time for all of that.

That’s why I take the higher churn and a faster sale every time.

Here’s what higher churn looks like. This chart represents the net monthly growth of a business that adds $1,000 of new revenue every month and churns 10% of existing revenue every month. You can see the drop-off in net new revenue. Within twelve months it falls 75% and drops at the same rate after that.

Within two years if you’re still just adding $1,000 of new customers your churn, still at 10% of existing revenue, is $920. You’re working harder to get that $1,000 of new revenue (because it always gets harder to acquire new revenue over time) and keeping less than 10% of it.

Ouch. It hurts.

On the bottom line revenue side, here’s what it looks like. This is what we call a plateau. You’re capping out at $10,000 of monthly recurring revenue (MRR). In fact, there’s a pretty simple formula you can use to quickly get at this revenue cap:

New revenue / Churn rate = MRR. In this example, that’s $1,000 / 10% = $10,000.

So $10K per month is your upper bound on how much money you’ll make with this business. Not bad, but not great. If you want to break past a $120K salary you’ll need to think outside the box and either lower your churn or increase revenue.

You have two choices: Go from good to great, which I’ll discuss shortly, or build another new box and stack your plateaus.

Stacking Your Plateaus

Parallel entrepreneurship means stacking your plateaus on top of each other. It’s admitting that SaaS businesses have an upper bound in MRR and to break out of it you need to hire more people, which may mean taking on debt or equity financing and spending more money on marketing.

You may decide not to do that.

Doubling down on your business means greater risk for an unknown reward. I would assume that at the plateau you’re not working very hard. The business is humming along, it’s just not really going anywhere. Like I said, not growing, but not shrinking. You’re making $10,000 per month and doing very little work.

That’s great, congrats! Why mess with that? You have an ATM machine spitting out $330 every day into your pockets. Don’t risk losing it. Leave it be. If you want more money, start another business and stack the plateaus.

If you followed this advice and started your second business one year after your first one and it had the same growth parameters of $1,000/mo of new revenue and 10% churn, your combined MRR chart will look like this:

Whether that base plateau is your own business or the salary from your day job, the stacking plateaus concept still applies. That’s the business rationale for parallel entrepreneurship.

From Good to Great

If you can get your business up to $10,000 in monthly recurring revenue (MRR), then that’s really good. Most entrepreneurs never get there.

It’s good but not great.

Jonathan Siegel gave me advice that I’ll never forget. I use this bit of wisdom to fire up my drive. He says, “Any $10,000 per month business can be a $100,000 per month business.” These are crumbs, he says, compared to what the larger companies are earning. The hard growth steps, he argues, happen beyond that first $100,000 per month. Less than that is just discipline and some creativity.

He also argues that if your monthly churn is 3% and your net monthly growth is 4% then you will have a phenomenal business. This Rule of 34 (I’ll name this rule on his behalf) is what we should all strive for. You may only get there once in your entrepreneurial career, so to increase the likelihood of doing this, you have multiple businesses running at once.

Finally, a great business has what’s known as “net negative churn.” This is the holy grail of SaaS businesses, when revenue growth from your retained customer base consistently offsets the revenue lost from cancellations.

To make this point clearer, let’s look at this table.

Let’s say you’re adding $1,000 of new customers every month. You’re also getting another $1,000 from upgrades and $500 reactivations (customers who canceled and then came back). That’s bringing $2,000 of new monthly revenue into your business.

On the flipside, let’s say you’re losing $500 from cancellations and downgrades each month. This means on net you’re adding $1,500 of revenue to your business each month.

Net negative churn is when, setting new customer revenue aside, you’re still adding revenue every month. In this case, you would be making $1,500 from upgrades and reactivations and losing $1,000 from cancellations and downgrades. You’re adding $500 each month from existing customers.

If you’re able to grow a business before you’ve added a single new customer then you’re in great shape. You can stop reading now, shut your other businesses down, and focus on that one.

I haven’t experienced this yet myself, but I’m working on it. It’s why I still have multiple businesses running today.

Exploiting Synergies

Nobody can run a pizza parlor, a nail salon, and a grocery store at the same time. Even the most ambitious local businessperson couldn’t do that.

But can you open more than one restaurant? Sure, it happens all the time. I think of Tyler Florence and his restaurants El Paseo in Mill Valley and Wayfare Tavern in San Francisco. Same chef, two different restaurants within a few miles of each other.

Can you open multiple cafes? Absolutely. Look no further than the dominance of Philz Coffee, which began in San Francisco’s Mission District and spread throughout the city and then to every corner of the San Francisco Bay Area. (By the way, here’s a fun fact: Phil Jaber spent seven years perfecting his first blend, Tesora, which means “treasure” in Italian.)

I was delighted when a Philz popped up within walking distance of my house in the suburbs 20 miles outside of the city. It’s a perfect example of parallel entrepreneurship applied to brick and mortar businesses.

So what’s the difference between running a chain of cafes and running a slough of disparate shops?

It’s this word: synergy.

Synergy is one of those cliche business terms that gets mocked because it shows up on corporate HR posters and is said around the table in boardrooms. I think it gets an unfair rap. Synergy is a critical concept to embrace if you’re going to be a successful parallel entrepreneur.

As Andrej Danko, VP of product at an artificial intelligence studio that builds and runs multiple companies at once told me, “Doing completely mutually exclusive businesses is very hard. There are no economies of scale. You can’t leverage IP or operational skills across businesses.”

CASE STUDY: Philz Coffee

When you have a busy cafe, some name recognition, and a cult following like the founder of Philz Coffee did, opening the second cafe is a lot easier than opening the first one. Let’s take a high-level look at what’s required to open a new Philz cafe:

Financial needs

• Point of sale terminal
• Cash transfers and security
• Accountant and bookkeeping

Product needs

• Coffee supply and storage
• Coffee brewing devices
• Milk, sugar, honey, and other condiments
• Baked goods supply

Personnel needs

• Management
• Staff
• Hiring and training resources

Marketing needs

• Grand opening
• Ongoing local outreach

Facility

• Renovation
• Lease

Looking at the above list, there are both direct and indirect synergies with the existing cafes. The direct synergies are financial. Phil can use the same point of sale and accounting team. If the second cafe is in the same city then he can also use the same bank for cash deposits.

Product needs are the same. Since Phliz doesn’t bake its own muffins, he’ll need a new supplier unless they’ll distribute out of the city. Same with the coffee roasting. Philz wants only the best, freshest coffee beans (they grind their proprietary blends on the spot) so some supply chain logistics may also be required for coffee beans if the second cafe is too far away.

Indirect synergies are personnel, marketing, and facility needs. Although they won’t be exactly the same (they’ll need a new location, obviously, and new people) the playbook is the same. If it’s not written down then it can be transferred by Phil or one of his first employees at the Mission District cafe.

Let’s imagine, for a second, that Phil decided instead to open a pizza parlor. What synergies would he have then?

Very few.

It would be incredibly difficult if not impossible to launch and run a pizza parlor while simultaneously running a cafe. That kind of parallel entrepreneurship is destined to fail.

When you have a profitable and growing SaaS business, it’s like having one cafe. The nice thing about cafes is they can get more revenue simply by replicating themselves in another location. But you can’t do that on the web. You can’t clone a SaaS business in another location (by giving it a new domain name) and expect to double your revenue. That’s just not how the internet works.

The internet equivalent to opening that second cafe is to start another SaaS business that is separate from the first profitable one but still benefits from synergies.

CASE STUDY: Sheel Mohnot

Sheel Mohnot is another parallel entrepreneur par excellence. After selling his online payments business to Groupon, he started Thistle, a food company that delivers sustainable plant-based meals to homes in major cities throughout California. He also runs a podcast, an auction platform, and a financial technology fund within 500 Startups, a prestigious startup incubator with offices around the world.

He does this all in parallel because he’s found ways to exploit synergies across his projects, delegate his way out of daily management, and turn his cost centers into profit centers.

Let’s dive into Thistle to really see what I mean.

Thistle competes in a very difficult market. Blue Apron, the market leader, went public in June 2017 and its stock price has had a precipitous 70% decline since the public offering. Another major competitor, Plated, sold to Albertsons for $200 million. Other meal delivery services including Sprig, which raised $59 million and was valued at over $150 million, had to shut down.

So what did Sheel do differently? How has Thistle thrived while his well-heeled competitors failed or exited? He successfully approached the problem like a parallel entrepreneur.

First of all, he only raised $1 million for Thistle. He forced his business to run lean, operating profitably from the beginning. Even if you’re small, you won’t be forced to shut down while you’re minting money.

This profitability constraint in turn forced Sheel to be creative. Meal delivery is a complex business, and arguably the hardest part is packaging and delivering meals on time. This cost is often higher than the cost of the food itself. To keep costs down, Sheel found a commercial kitchen that someone else was paying $20,000 per month to use. He negotiated a deal to sublease the kitchen from 9pm to 5am for just $5,000 per month.

Startups that raise gobs of money usually don’t make smart decisions like this. Thistle now serves tens of thousands of customers each week and is profitable with 220 employees.

For Sheel personally, he is a co-founder of Thistle but is not the CEO. That gives him the flexibility to run his auction business, a fund in 500 Startups, and other personal investments that generate meaningful monthly revenue streams.