There are certain “truths” in life that are immutable whether one wants to believe them or not. In order for the motion of an object to change, a force must act upon it (Newton’s First Law of Motion). The total energy in a closed or isolated system is constant (Conservation of Mass-Energy). If you need n items of anything, you will have n – 1 in stock (Seuker’s Note).
In the domain of building businesses there are immutable laws as well and trying to violate them rarely ends well. If you don’t have money you can’t pay for anything (The Law of Empty Pockets). Owning 5% of a successful company is better than owning 100% of a bankrupt entity (The Law of Greed). A good idea that never sees the light of day makes for a bad business (The Law of Pot Sitting).
What surprises me is that recently I’ve had what I feel is the same discussion over and over again with various Entrepreneurs and Investors regarding what I think of as an “immutable truth”. I think of it as “The Unfortunate Law of Building Complex Businesses” and it can be described simply by the following “truth”:
You Can’t Accelerate Time
Most complex businesses can’t be cracked overnight and this is especially true if they require today’s investments to result in a stream of cash that trickles in over time. The return profile of money invested in originating customers today might take months, quarters, or even years to understand and for some reason I’ve found myself in the middle of some pretty confusing conversations about this concept recently. As much as everyone involved with a business always likes to show quick progress and results that resemble a 45-degree angle straight up, the cadence of growing certain types of businesses doesn’t fit this profile.
Patience seems to have been lost in the investment community and the drivers are obvious. Every day cash is being burned which puts pressure on start-ups to produce results now. The cash-out date of a business is always known and burned into a Founder’s brain. Founders typically work backwards from cash-out minus 3-5 months (to give time for a fundraise) and put plans together that make their company look attractive to the next round investor. Unfortunately, this typically manifests itself as priority being given to growth of the top line at all costs. They want to show that the dogs are eating the dogfood and that the business can originate customers at a reasonable cost.
But, for many businesses on-boarding the customer is only the beginning. Complex, annuity oriented products require time to understand. If a business’s financial model suggests that the economics at month 12 or month 24 post-acquisition matters, then the business needs to gather data over 12 or 24 months to gain confidence in its projections. For some products there are ways of analyzing early performance results as a method for gaining comfort with out-month/out-year performance estimates, but there are times that these estimates are inherently flawed. And for the most complex products, there is no substitute for real data.
You Can’t Accelerate Time. Full Stop.
Backing these businesses requires patient Investors, a well-established learning agenda that outlines what will be learned by when, and enough capital to prove out the critical assumptions that make or break the business. The alternative is to move quickly and recognize that levers might need to be pulled at a later date if the results aren’t coming in as anticipated. Moving quickly can work if the business is fungible and customers are understanding, but it’s important to internalize that most decisions aren’t reversible. Growing a business that requires making irreversible decisions before performance is well understood is equivalent to gambling with investor money.
My recommendations are simple:
Before you become a steward of Investors’ money make sure you and your investors understand what the business will have learned before the money runs out. If it isn’t enough, adjust the model accordingly or raise enough money to prove out the next series of critical assumptions. If you can’t do either then you’re likely dead before you start so don’t start.
Before you invest in a complex, annuity oriented business, identify the critical assumptions that need to be proved out before the business is at “the next stage” and ask the Founder to pull together a plan that proves out these assumptions. If you’re willing to fund this plan, great. If not, ask for the plan to be refined accordingly. But, at all costs you should avoid funding a business to get part-way to the next stage without expecting to write the next check yourself. It’s better to just move on because a half-funded business will typically be managed very poorly for all the obvious reasons.
Tick Tock, respect the clock!