Games people play with cash flow(commoncog.com)
commoncog.com
Games people play with cash flow
https://commoncog.com/cash-flow-games/
138 comments
You're both getting what you want, but you are different businesses, so you are optimizing for different things.
In other words, you have a business of a certain size with a certain set of constraints and goals. For most small businesses the constraint is not enough money, and the goal is to make more money.
Naturally you see your client as a "big version of your business" and therefore you think they are optimizing to the same goals as you. When interacting with corporates this is a really common mistake.
What's really happening is that to them they have all the cash in the world. The difference between 30k and 150k is nothing. Literally nothing.
However they likely have incomings and outgoings totally hundreds of millions, if not billions, each month. When you move that much money some jobs are likely to be _really_ big, and doing it right the first time I'd important.
So they have a buying, and paying, process. That process is optimised for say 50M and up. But the process applied to all purchasing, they want 1 process, not 3 or 5 or 10.
Your tiny rounding error if a job is therefore irrelevant. Money is not the limit. They want to use their process. Andif you are happy to wait 100 days, then they are happy to spend more.
Would you rather spend 30c now, with a bunch of hassle, or $1.50 in 3 months time with zero hassle. Since $1.50 is nothing, you're happy to pay more for no hassles.
Neither of you are getting a bad deal, and yes they are getting upside you can't see. You are playing to one set of rules, bug they have a very different rule book.
In other words, you have a business of a certain size with a certain set of constraints and goals. For most small businesses the constraint is not enough money, and the goal is to make more money.
Naturally you see your client as a "big version of your business" and therefore you think they are optimizing to the same goals as you. When interacting with corporates this is a really common mistake.
What's really happening is that to them they have all the cash in the world. The difference between 30k and 150k is nothing. Literally nothing.
However they likely have incomings and outgoings totally hundreds of millions, if not billions, each month. When you move that much money some jobs are likely to be _really_ big, and doing it right the first time I'd important.
So they have a buying, and paying, process. That process is optimised for say 50M and up. But the process applied to all purchasing, they want 1 process, not 3 or 5 or 10.
Your tiny rounding error if a job is therefore irrelevant. Money is not the limit. They want to use their process. Andif you are happy to wait 100 days, then they are happy to spend more.
Would you rather spend 30c now, with a bunch of hassle, or $1.50 in 3 months time with zero hassle. Since $1.50 is nothing, you're happy to pay more for no hassles.
Neither of you are getting a bad deal, and yes they are getting upside you can't see. You are playing to one set of rules, bug they have a very different rule book.
This is an incredibly realistic and pragmatic take on how large companies work.
> You're both getting what you want, but you are different businesses, so you are optimizing for different things. [...]
> The difference between 30k and 150k is nothing. Literally nothing. [...]
> Would you rather spend 30c now, with a bunch of hassle, or $1.50 in 3 months time with zero hassle.
Anyone who struggles to understand why corporations do what they do should internalize this thought process. It explains a lot.
> You're both getting what you want, but you are different businesses, so you are optimizing for different things. [...]
> The difference between 30k and 150k is nothing. Literally nothing. [...]
> Would you rather spend 30c now, with a bunch of hassle, or $1.50 in 3 months time with zero hassle.
Anyone who struggles to understand why corporations do what they do should internalize this thought process. It explains a lot.
So I assume if they hired someone cheap who’s only job is to manage OPs account payments, and they did this for perhaps 100 other accounts (manager per account), they’d still make millions profit extra, yearly? I indeed struggle to understand why anyone is leaving that on the table.
Because administrative structures are not about hiring one more body to do random job X.
Each body in the machine needs a reporting structure, training, tooling, a career path, and be plugged into other structures that have visibility to and alignment with, senior management. So it's about trying to maximize the size of your company while keeping the complexity manageable. In a big organization, management is struggling for simplicity and visibility, and one technique is standardization of processes and alignment on goals and processes so that you have more than just a big bureaucracy doing thousands of inscrutable things, but you have a bureaucracy that management can understand, measure, and steer as best they can. This is the biggest challenge.
So they tend not to do things like hire one off people to do random things at odds with what everyone else is doing.
That means you do not chase every possible thing which appears to have some upside but adds complexity. Because following the latter approach is the administrative equivalent of "yes, we are an autobody shop, but people often come here hungry, so let's also sell them some pancakes" -- a decade of these type of decisions and you have a huge unmanageable mess.
Clay Shirky once wrote a piece in which ATT reached out to him for a business discussion about getting into web hosting, and when he told them how little he paid for web hosting, they were absolutely stumped at how anyone could provide reliable webhosting for a profit, and Shirky replied that his webhosting just wasn't very reliable. He tells them there is no staging environment provided, no failure, no offsite backup, no redundant power -- how sometimes he'd just take the main site offline when he wanted to update, and other times it would go down when there was too much traffic. The ATT folks just stared at him in disbelief. And Shirky knew that they weren't going to get into the web hosting business because a company can't both be good at doing one thing and the opposite of that thing at the same time. A company that has reliability in its corporate DNA isn't going to "hire a few guys" to create a cheap, yet unreliable offering - even if it means they are leaving money on the table.
Each body in the machine needs a reporting structure, training, tooling, a career path, and be plugged into other structures that have visibility to and alignment with, senior management. So it's about trying to maximize the size of your company while keeping the complexity manageable. In a big organization, management is struggling for simplicity and visibility, and one technique is standardization of processes and alignment on goals and processes so that you have more than just a big bureaucracy doing thousands of inscrutable things, but you have a bureaucracy that management can understand, measure, and steer as best they can. This is the biggest challenge.
So they tend not to do things like hire one off people to do random things at odds with what everyone else is doing.
That means you do not chase every possible thing which appears to have some upside but adds complexity. Because following the latter approach is the administrative equivalent of "yes, we are an autobody shop, but people often come here hungry, so let's also sell them some pancakes" -- a decade of these type of decisions and you have a huge unmanageable mess.
Clay Shirky once wrote a piece in which ATT reached out to him for a business discussion about getting into web hosting, and when he told them how little he paid for web hosting, they were absolutely stumped at how anyone could provide reliable webhosting for a profit, and Shirky replied that his webhosting just wasn't very reliable. He tells them there is no staging environment provided, no failure, no offsite backup, no redundant power -- how sometimes he'd just take the main site offline when he wanted to update, and other times it would go down when there was too much traffic. The ATT folks just stared at him in disbelief. And Shirky knew that they weren't going to get into the web hosting business because a company can't both be good at doing one thing and the opposite of that thing at the same time. A company that has reliability in its corporate DNA isn't going to "hire a few guys" to create a cheap, yet unreliable offering - even if it means they are leaving money on the table.
There are 2 kinds of businesses...one extremely profitable and another on dying path. If the company you're dealing with not dime nickel you sooner or later they will be the on the dying path. You can readup Nokia outrageous expenditure in Europe. Heck if they are dying or extremely profitable, just take advantage of it. It is business. Nothing personal.
2 logical options:
1) They aren’t as fiscally sound as you think.
2) They’ve sub optimized and someone is looking very good for stretching payment terms at the expense of the rest of the company. Once they do this it can be hard to walk back as someone centrally has to justify more working capital.
1) They aren’t as fiscally sound as you think.
2) They’ve sub optimized and someone is looking very good for stretching payment terms at the expense of the rest of the company. Once they do this it can be hard to walk back as someone centrally has to justify more working capital.
I'm pretty confident on their soundness, they're publicly traded and I check up on clients lodgings when I can, to manage my exposure, they claim to be sitting on $400M in cash and $200M in minerals as of a few months ago.
Option 2 seems plausible, a couple years ago they had a bit of internal politics that we were caught in the middle of, the end result was changing the engineering requirements going forward over purely cosmetic issues, doubling the price of materials. One particular job we did in 2019 for $30k, was $150k in 2022, for the same exact end result for the workers, at the same site, right next to the previous one. The site manager complained, and I said if he got it in writing that they wanted to use the old engineering and disregard the cosmetics, it'd be $30k and take 2 days less, and he said they needed it done ASAP, it'd be faster to convince capex to pay the $150k than it would be to start another round of discussions on the engineering.
Option 2 seems plausible, a couple years ago they had a bit of internal politics that we were caught in the middle of, the end result was changing the engineering requirements going forward over purely cosmetic issues, doubling the price of materials. One particular job we did in 2019 for $30k, was $150k in 2022, for the same exact end result for the workers, at the same site, right next to the previous one. The site manager complained, and I said if he got it in writing that they wanted to use the old engineering and disregard the cosmetics, it'd be $30k and take 2 days less, and he said they needed it done ASAP, it'd be faster to convince capex to pay the $150k than it would be to start another round of discussions on the engineering.
This is business process dysfunction, and I bet their AP/AR spend management software was setup wrong.
They can try to spin it as a free loan from you or the ROI gain of running a leaning team, but they're paying 400% more (150k v. 30k) in a current reporting period.
Nothing clever.
You're also sticking around and not getting burned out of repeat business. I like increasing prices to compensate and being upfront.
They can try to spin it as a free loan from you or the ROI gain of running a leaning team, but they're paying 400% more (150k v. 30k) in a current reporting period.
Nothing clever.
You're also sticking around and not getting burned out of repeat business. I like increasing prices to compensate and being upfront.
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> it'd be $30k and take 2 days less, and he said they needed it done ASAP, it'd be faster to convince capex to pay the $150k than it would be to start another round of discussions on the engineering.
ouch. This kind of situation could benefit from a cost savings program at that company.
ouch. This kind of situation could benefit from a cost savings program at that company.
I'm genuinely curious at how a top-down initiative could succeed at rooting out this type of waste. Without empowering the cost savings to speak directly to the vendor, it's hard to imagine them being able to discover that paying a month or two sooner could get them non-FU pricing.
Running an RFP and benchmarking versus competitors would address this.
The problem is empowerment to question the officer who signed the deal and has the vendor relationship.
The problem is empowerment to question the officer who signed the deal and has the vendor relationship.
Sometimes the cost and energy of the RFP means it’s only done for $500K or higher. An understaffed sourcing team has to focus on the huge deals.
> Sometimes the cost and energy of the RFP means it’s only done for $500K or higher.
Fair point, but that's for a different discussion.
The question was how to "root" it out, not business priorities.
If you're unable to flag and audit an easily identifiable 400% cost increase year over year and +$100k in savings, then let's be honest about the value creation of your AP/Procurement teams.
Fair point, but that's for a different discussion.
The question was how to "root" it out, not business priorities.
If you're unable to flag and audit an easily identifiable 400% cost increase year over year and +$100k in savings, then let's be honest about the value creation of your AP/Procurement teams.
Does "lodgings" mean something like "filings" in Australian English? As in documents lodged with the official somebody or other? Or are you snooping on their houses?
No idea about the original post, but property real estate values for customer addresses can be an invaluable signal for confirming potential fraud, in the presence of other yellow flags on a high-end consumer transaction!
Yes, you lodge tax returns with the ATO.
There are a lot of things within (2) that are still reasonable.
For instance, the contracting officer may have to fill out one form for a $500,000 project that they can approve, but approving any kind of different payment terms requires more levels of approval. Sure, it doesn't make sense in this instance, but maybe the rule makes a lot of sense with a far bigger contractor. As the OP said, they are a blip. Making rules that work well for 95% of the time and end up doubling the cost of the 5% is rational.
More options:
3) There are tax advantages to higher costs of services and lower costs of debt servicing that make it advantageous to pay more for a good with better terms.
4) It's literally not worth the time to optimize. They planned for this cost and it's a blip so who cares if it's double the cost. I mean, someone should care, but who actually gets the benefit. Think about it like not cancelling a subscription or not renegotiating every time a contract is up in personal life.
For instance, the contracting officer may have to fill out one form for a $500,000 project that they can approve, but approving any kind of different payment terms requires more levels of approval. Sure, it doesn't make sense in this instance, but maybe the rule makes a lot of sense with a far bigger contractor. As the OP said, they are a blip. Making rules that work well for 95% of the time and end up doubling the cost of the 5% is rational.
More options:
3) There are tax advantages to higher costs of services and lower costs of debt servicing that make it advantageous to pay more for a good with better terms.
4) It's literally not worth the time to optimize. They planned for this cost and it's a blip so who cares if it's double the cost. I mean, someone should care, but who actually gets the benefit. Think about it like not cancelling a subscription or not renegotiating every time a contract is up in personal life.
Both of these are reasonable guesses. A slight variant on 2 is that they are actually just a mess; lots of big companies have bad accounts payable teams. It’s typically not something where the CFO is measuring team efficacy based on supplier/vendor satisfaction. You could say this is another way of putting “sun optimized”, but it doesn’t even need someone to be actively trying to stretch terms (though that absolutely happens too).
Is there a #3? Investors are paying for this inefficiency and the money is still coming in/there "for now"?
Or their accounting department is not great. Most accounting departments I have worked with were not great.
> I keep assuming they must have some massive upside I'm not seeing
My default assumption would not be that there's an upside in this for them, but that they're a disfunctional organization. The people procuring your services and authorizing the expense are not in contact with or unable to influence the people planning and authorizing the payment. They might not even share a superior all the way up to the board, with the procurement people reporting to the COO and the payment people to the CFO. If it's easier to spend the company's money than to save it, people will spend it. Corporate seldom rewards saving money anyway.
My default assumption would not be that there's an upside in this for them, but that they're a disfunctional organization. The people procuring your services and authorizing the expense are not in contact with or unable to influence the people planning and authorizing the payment. They might not even share a superior all the way up to the board, with the procurement people reporting to the COO and the payment people to the CFO. If it's easier to spend the company's money than to save it, people will spend it. Corporate seldom rewards saving money anyway.
Based on previous experience, I concur. There are businesses with a culture of 'pay late no matter what' and this becomes the norm, regardless of logic.
I had a manager who could buy just about anything he wanted with no checks as to why he needed this stuff or where it went. The only control was the time period between delivery and payment.
I had a manager who could buy just about anything he wanted with no checks as to why he needed this stuff or where it went. The only control was the time period between delivery and payment.
If you can swing the cash flow, keep billing them at a rate that makes sense for your business. So many AP departments are incentivized on payment delays. Let them “win” their stupid game and just build the cost plus some extra into your rates.
Yeah thankfully we can swing it, but we've actually turned down some work for other clients here and there because I've done the math and figured there was too much overlap/risk with this particular clients jobs.
>I keep assuming they must have some massive upside I'm not seeing ¯\_(ツ)_/¯
There is a massive upside for the person you're talking to in accounts payable.
By making the whole tender process ridiculous, they get to hold onto their bullshit job.
I've found similar things when dealing with corporates. They'll never try to negotiate the price down, but they'll be damned if they don't get to rack up their Amex points. :)
The golden rule I keep in mind is that you're never speaking to a company - instead, you're dealing with a human.
There is a massive upside for the person you're talking to in accounts payable.
By making the whole tender process ridiculous, they get to hold onto their bullshit job.
I've found similar things when dealing with corporates. They'll never try to negotiate the price down, but they'll be damned if they don't get to rack up their Amex points. :)
The golden rule I keep in mind is that you're never speaking to a company - instead, you're dealing with a human.
This is an area where banks can help. A bank can loan you the money immediately after the job is done with a low-ish interest rate (since your client is publicly traded and reputable and presumably highly creditworthy) and then ask for repayment only when the 45 days EOM is up. Alternatively you just ask the bank for a fraction of the invoice amount upfront and not think about paying interest to the bank any more. It's called invoice factoring.
That sounds like some good practical advice, but also slightly vomit inducing.
>> Economists such as Lord Adair Turner, the former chair of the British Financial Services Authority, have argued that innovation in the financial industry is often a form of rent-seeking.[24][25]
source: https://en.wikipedia.org/wiki/Rent-seeking
Do they not teach this stuff in an undergraduate business classes any more? "Float" was BIZ101 and in BIZ102 you learn how to read financial statements...
The "genius restaurateur" in the article rediscovered the art of not paying your bills with a credit card, i.e., the "debt trap".
>> Economists such as Lord Adair Turner, the former chair of the British Financial Services Authority, have argued that innovation in the financial industry is often a form of rent-seeking.[24][25]
source: https://en.wikipedia.org/wiki/Rent-seeking
Do they not teach this stuff in an undergraduate business classes any more? "Float" was BIZ101 and in BIZ102 you learn how to read financial statements...
The "genius restaurateur" in the article rediscovered the art of not paying your bills with a credit card, i.e., the "debt trap".
> but also slightly vomit inducing.
It's similar to a payday loan, except for businesses. Maybe that's why the bad rep comes from. Of course with my personal experience the interest rate is nowhere as high.
It's similar to a payday loan, except for businesses. Maybe that's why the bad rep comes from. Of course with my personal experience the interest rate is nowhere as high.
Business payment terms, and more importantly their handling (read: usually ignoring) seem bonkers to me. I understand why net-something makes sense, but the apparently universal tendency to agree to a term then routinely pay an arbitrary time later seems crazy. I just don't understand how it became so normalized.
I suspect that it happens because of the asymmetrical power relationships between the customer and supplier. The suppliers are typically too small to have the option to sue. Perhaps the solution is to make this kind of breach of contract a strict liability criminal offence!
A better solution is to negotiate the late payment penalty in the contract itself, then just add the late payment penalty as a line item on future invoices.
Don’t put it on the invoice of payment is close to on time, and waive the first late payment (if the other payments are close to on time). When waiving it, put the late payment fee in the invoice and and another line item waiving it. In whatever communication channel you send the invoice, note that they had a late payment, and that since it’s the first time you’ve waived it.
Don’t put it on the invoice of payment is close to on time, and waive the first late payment (if the other payments are close to on time). When waiving it, put the late payment fee in the invoice and and another line item waiving it. In whatever communication channel you send the invoice, note that they had a late payment, and that since it’s the first time you’ve waived it.
That sounds like a neat solution. Much less confrontational than taking it to court or a collections agency.
"some jobs would be up to 50% less if they paid quicker"
Why would you give someone a 50% discount for faster payment? Is your cost of capital so high?
Maybe I can pay you advance (with the 50% discount) and then, 100 days later, collect 100% from the customer?
Why would you give someone a 50% discount for faster payment? Is your cost of capital so high?
Maybe I can pay you advance (with the 50% discount) and then, 100 days later, collect 100% from the customer?
It makes no sense when you frame it that way of course haha, but it's only possible to look at it that way now that we've been working for them for several years.
When I started raising prices, taking a medium/large sized job from them was an huge risk. If I hadn't started hiking the prices when I did, We probably would have folded later that year when we did a much larger job for them, if I hadn't been stockpiling the extra cash from their smaller jobs.
It was an enormous existential risk early on when I had less capital to play with, now in a weird way I can look at it how you say: The company is loaning itself 50% to make 100% later.
That said, fair's fair so I'd still honor the offer if they asked: I don't/can't quote other clients that much, so if they wanted to pay on reasonable terms I would charge them reasonable prices.
When I started raising prices, taking a medium/large sized job from them was an huge risk. If I hadn't started hiking the prices when I did, We probably would have folded later that year when we did a much larger job for them, if I hadn't been stockpiling the extra cash from their smaller jobs.
It was an enormous existential risk early on when I had less capital to play with, now in a weird way I can look at it how you say: The company is loaning itself 50% to make 100% later.
That said, fair's fair so I'd still honor the offer if they asked: I don't/can't quote other clients that much, so if they wanted to pay on reasonable terms I would charge them reasonable prices.
So you are financing your client. Same thing happens in the construction industry. Client pays 30 days after invoice (which can only be issued after an IPC is signed), then the main contractor pays all subcontractors 30 to 60 days after and their IPCs must VE proportionally to the Main Client approved IPC, in turn subcontractors pay material suppliers and equipment rentals after that. The only payment “on-time” are taxes and salaries, freelancers are treated as suppliers of course. In the Iberian Peninsula it wasn’t unheard of 180 days after invoice. And there is only so much you can blame on SAP.
Cash can be both capital and operating funds. They may want to keep certain debt ratios and are not worried about impact on net income.
I really enjoyed the article.
The only thing that stood out was that the argument the author set out to dispel had a much simpler flaw. In the original argument, point number 3 (having less skin in the game leads to bad decisions) is the weakest one.
That statement isn’t really a first principles fact, but at best a hypothesis. IMO, not even a good one. For all we know, having less extreme exposure may lead to better decisions, as the founder may be open to more calculated risks. And even IF true that statement doesn’t address the tradeoffs: maybe bad decisions are outweighed by the ability to outrun the competitors due to influx of extra cash.
While there is certainly some correlation in such arguments, the bar for proving causation needs to be much higher than a pithy statement.
All that being said, I really enjoyed the rest of the argument.
The only thing that stood out was that the argument the author set out to dispel had a much simpler flaw. In the original argument, point number 3 (having less skin in the game leads to bad decisions) is the weakest one.
That statement isn’t really a first principles fact, but at best a hypothesis. IMO, not even a good one. For all we know, having less extreme exposure may lead to better decisions, as the founder may be open to more calculated risks. And even IF true that statement doesn’t address the tradeoffs: maybe bad decisions are outweighed by the ability to outrun the competitors due to influx of extra cash.
While there is certainly some correlation in such arguments, the bar for proving causation needs to be much higher than a pithy statement.
All that being said, I really enjoyed the rest of the argument.
I agree. 1) because the company took outside money does not decrease your skin in the game (if substantially all of your net worth was in the company before a funding round, and it was all primary capital raised, then you’re still “all in”). 2) when people are over invested exposed, their risk tolerance typically goes down not up (even if the payoffs have high expected returns)
I think there is a much bigger flaw in the version of the argument stated in the article.
The argument boils down to "here is a bad thing about raising capital, here is a good thing about not raising capital, therefore not raising capital is better".
But there are other pros and cons that this argument is ignoring, so it is not logically correct.
I also think the version in the article is an unfair representation of the original blog post (https://ensorial.com/2020/dont-raise-money/), which explicitly says
> I’m not suggesting that there are never reasons to take outside investment. Obviously there are. But, we should recognise that doing so comes with significant trade-offs and difficulties that mean it shouldn’t necessarily be the default.
(I see that @ilyt already posted this exact quote.)
The argument boils down to "here is a bad thing about raising capital, here is a good thing about not raising capital, therefore not raising capital is better".
But there are other pros and cons that this argument is ignoring, so it is not logically correct.
I also think the version in the article is an unfair representation of the original blog post (https://ensorial.com/2020/dont-raise-money/), which explicitly says
> I’m not suggesting that there are never reasons to take outside investment. Obviously there are. But, we should recognise that doing so comes with significant trade-offs and difficulties that mean it shouldn’t necessarily be the default.
(I see that @ilyt already posted this exact quote.)
Great read. The real problem with "the skin in the game argument" is that it's a matter of opinion, but one opinion is more likely to be right.
>> Raising capital to do a startup reduces skin in the game (you’re spending other people’s money, after all).
The more likely correct take is as follows. Note that I am changing just one word.
The right version:
>> Raising capital to do a startup INCREASES skin in the game (you’re spending other people’s money, after all).
The naïve take seems to place no value on reputation (ability to get more financing in the future).
>> Raising capital to do a startup reduces skin in the game (you’re spending other people’s money, after all).
The more likely correct take is as follows. Note that I am changing just one word.
The right version:
>> Raising capital to do a startup INCREASES skin in the game (you’re spending other people’s money, after all).
The naïve take seems to place no value on reputation (ability to get more financing in the future).
An insight I've found very useful in many areas is to separate cases where you're satisfying requirements versus optimizing.
If you're satisfying, a single logical argument for a decision is enough. If you're answering the question of "How to add 10M of new revenue to this business?" there are many valid answers and you just want to test a few and land on one that's well supported by an argument. Then go execute that and do it all over again later.
If you're maximizing though it's much trickier. If you're answering the question of "What's the ideal way to raise capital for this business?" a single logical argument is not enough because you often misrepresent the search space and end up doing very precise optimization of a tiny subset of options for example.
A good option is to turn optimization problems into satisfying problems by specifying them more. "How can I raise capital at cost below X, amount above Y, in under Z months?" gives you most of the value of the optimization problem. It doesn't give you a general insight but it may even give you more value than that by forcing you to define your constraints properly. It's common to find that once you try to fill in X/Y/Z to even start working on hypothesis you find out not everyone has the same view. Having that discussion is often more valuable than any fancy generic optimization you could do to the problem.
If you're satisfying, a single logical argument for a decision is enough. If you're answering the question of "How to add 10M of new revenue to this business?" there are many valid answers and you just want to test a few and land on one that's well supported by an argument. Then go execute that and do it all over again later.
If you're maximizing though it's much trickier. If you're answering the question of "What's the ideal way to raise capital for this business?" a single logical argument is not enough because you often misrepresent the search space and end up doing very precise optimization of a tiny subset of options for example.
A good option is to turn optimization problems into satisfying problems by specifying them more. "How can I raise capital at cost below X, amount above Y, in under Z months?" gives you most of the value of the optimization problem. It doesn't give you a general insight but it may even give you more value than that by forcing you to define your constraints properly. It's common to find that once you try to fill in X/Y/Z to even start working on hypothesis you find out not everyone has the same view. Having that discussion is often more valuable than any fancy generic optimization you could do to the problem.
Thank you for sharing that insight! I've often found myself doing something like that.
When my natural inclination is to optimize, and the smart decision is to satisfy, having it as explicit words will help me make a decision faster.
When my natural inclination is to optimize, and the smart decision is to satisfy, having it as explicit words will help me make a decision faster.
I couldn't make it through this (rather long) article, in part because a lot of it seemed to take as a given that you could predict interest rate movements. There are, probably, a large # of companies out there right now who have made keeping a large debt load part of their way of doing business, who are right now starting to find out that this makes them fragile.
Nassim Nicholas Taleb, a grumpy guy who nonetheless makes some good points sometimes, said debt was a way to "fragilize". Like Just-In-Time manufacturing, it can make sense up to a point, but is often taken way further, to the point of being a bet that nothing in your environment will change.
Nassim Nicholas Taleb, a grumpy guy who nonetheless makes some good points sometimes, said debt was a way to "fragilize". Like Just-In-Time manufacturing, it can make sense up to a point, but is often taken way further, to the point of being a bet that nothing in your environment will change.
At least for bigger companies that doesn't appear to hold (if I understand the point)? - they can borrow at a fixed rate by issuing bonds or they can enter into a swap to pay fixed and receive floating to hedge out their interest rate exposure.
> At first glance, there doesn’t seem to be anything that’s explicitly wrong with this argument. I agree with all the base ideas, and I found myself nodding to the intermediate propositions. The logical correctness of the argument wasn’t a problem. No, my unease stemmed from experience: I knew this wasn’t the right way to think about raising capital. But I couldn’t begin to construct an argument that went against it.
The original argument could be very easily argued - you just might not have enough money to get your foot in target market in the first place and not every business can be stared by single person and some savings anymore.
I don't see why author of article didn't just do that instead of pages of arrogant faffing because he got offended he couldn't invent a counter-argument to a (not only one, just one) way to make sensible business that many people succeeded just fine utilizing
The original argument could be very easily argued - you just might not have enough money to get your foot in target market in the first place and not every business can be stared by single person and some savings anymore.
I don't see why author of article didn't just do that instead of pages of arrogant faffing because he got offended he couldn't invent a counter-argument to a (not only one, just one) way to make sensible business that many people succeeded just fine utilizing
If you read the original article, the author says right at the beginning that of course some startups should raise money.
The original argument was just that it shouldn’t be the default position.
The original argument was just that it shouldn’t be the default position.
Right but that makes this rambling even more pointless.
It's as if author just doesn't have any sensible reasoning for his gut feeling that "startups should raise money by default" then is annoyed that he can't produce anything sensible on the topic but someone else can produce reasonable argumentation for opposite, then started giving up random examples of how not-startups companies use cash flow, and nothing there was really related to original topic on how to start and grow your startup.
And all of the examples fit nicely into hard to get/expensive to get markets that need a bunch of money upfront
> I’m not suggesting that there are never reasons to take outside investment. Obviously there are. But, we should recognise that doing so comes with significant trade-offs and difficulties that mean it shouldn’t necessarily be the default.
that the original article suggested.
It's as if author just doesn't have any sensible reasoning for his gut feeling that "startups should raise money by default" then is annoyed that he can't produce anything sensible on the topic but someone else can produce reasonable argumentation for opposite, then started giving up random examples of how not-startups companies use cash flow, and nothing there was really related to original topic on how to start and grow your startup.
And all of the examples fit nicely into hard to get/expensive to get markets that need a bunch of money upfront
> I’m not suggesting that there are never reasons to take outside investment. Obviously there are. But, we should recognise that doing so comes with significant trade-offs and difficulties that mean it shouldn’t necessarily be the default.
that the original article suggested.
> pages of arrogant faffing
Good description. If you have a point to make, make it!
Good description. If you have a point to make, make it!
The author states that the incriminated blog post is perfectly logically constructed. That is not the case. The argument:
Once you have less skin in the game, it is easier to make bad decisions
Doesn't quantify how much it's easier, and nothing follows from this. It may be ok that some startups (maybe even 99%) fail because not having skin in the game is not right for them. This may filter out, globally, bad startups.
But let's allow the argument to be true and that the rest follows. Still it's all conditional to a specific startup making those mistakes, being easier to make doesn't mean they are made consistently.
Once you have less skin in the game, it is easier to make bad decisions
Doesn't quantify how much it's easier, and nothing follows from this. It may be ok that some startups (maybe even 99%) fail because not having skin in the game is not right for them. This may filter out, globally, bad startups.
But let's allow the argument to be true and that the rest follows. Still it's all conditional to a specific startup making those mistakes, being easier to make doesn't mean they are made consistently.
The other way to think about it is that investors pitching in doesn’t reduce your own investment. If you take out a second mortgage and pour all your money into your business, you’ve got the same skin in the game regardless of what investor money your business takes from then on out.
> Once you have less skin in the game, it is easier to make bad decisions
Ye. It is quite ofent I am winning, get nervous, and lose. When playing competitions.
Less skin in the game makes you cooler.
Ye. It is quite ofent I am winning, get nervous, and lose. When playing competitions.
Less skin in the game makes you cooler.
Previously (2020) : https://news.ycombinator.com/item?id=25357669
The other side of the cash flow game is that you can be cash flow positive most of the time... but go out of business if you face occasional, large often complicated fixed costs. A robust accounting and pricing model is needed to plan for those fixed costs. It's like picking up pennies in front of a steamrolller if you only focus on short term cash flow.
The other interesting example of cash flow games is Warren Buffet's focus on insurance. He really likes picking up people's premium payments and collecting interest on them until the claims hit. My limited understanding is that Buffet looks for those situations specifically.
The other interesting example of cash flow games is Warren Buffet's focus on insurance. He really likes picking up people's premium payments and collecting interest on them until the claims hit. My limited understanding is that Buffet looks for those situations specifically.
Buffet uses the held premiums - called _float_ - to invest in assets which generate a higher than required return for the eventual insurance claims.
The way he sees it, the float is an interest free loan that you never have to pay back, as long as your incoming premiums each year are roughly equivalent to your outgoing claims each year. His strategy is to use this interest free loan to generate as high a return as possible, which he can then cream off the top for shareholders.
The way he sees it, the float is an interest free loan that you never have to pay back, as long as your incoming premiums each year are roughly equivalent to your outgoing claims each year. His strategy is to use this interest free loan to generate as high a return as possible, which he can then cream off the top for shareholders.
But it's only possible when you're well-capitalised and not as dependent on cash flows. See also the Kelly criterion, which makes it logical for one actor to offer and another to pay for insurance, despite the fact that both sides cannot have positive EV.
> despite the fact that both sides cannot have positive EV
Maybe for the thing insured, but dependencies can cause ripple effect costs which can be very high, so both sides can have positive EV when considering the whole (not just the insurance). I think you are assuming all transactions are zero-sum? Not something I know much about, so quite probably I just misunderstand your comment.
Maybe for the thing insured, but dependencies can cause ripple effect costs which can be very high, so both sides can have positive EV when considering the whole (not just the insurance). I think you are assuming all transactions are zero-sum? Not something I know much about, so quite probably I just misunderstand your comment.
> Once you have less skin in the game, it is easier to make bad decisions. The author argues this is due to a) having a capital buffer to cushion you, and b) having more time to waste.
I don’t see how it follows. People may make worse “penny-wise pound-foolish” decisions when it is their own money. Using done by hand SEO instead of ads to save money for example and it taking longer to get customers, as a made up example.
I don’t see how it follows. People may make worse “penny-wise pound-foolish” decisions when it is their own money. Using done by hand SEO instead of ads to save money for example and it taking longer to get customers, as a made up example.
In your made-up example, though, the SEO may build a long-term pipeline whereas the ads are one-and-done. That’s without mentioning the mentality foisted on companies to “just show user growth in the next quarter, don’t worry about profitability”.
The devil’s in the details.
The devil’s in the details.
It sure is, and that is really my point: I don’t think you can say people make worse decisions on “OPM” (other peoples money). It might even be a forcing function that you have to explain what you have been doing to a “boss” of sorts.
Yes the original premise he’s trying to refute can be dismissed far more easily.
That argument has as a premise that taking on investment increases risk. For the most part that’s simply not true, having more money in hand reduces risk for a business.
That argument has as a premise that taking on investment increases risk. For the most part that’s simply not true, having more money in hand reduces risk for a business.
> taking on investment
Also means (generally) finding someone to invest, which (generally) means getting your head around your business what you do, what you are going to do next, and what you are going to do with the money, a plan one might say. This plan is then considered by the investing party and if it is total nonsense, no investment.
Also means (generally) finding someone to invest, which (generally) means getting your head around your business what you do, what you are going to do next, and what you are going to do with the money, a plan one might say. This plan is then considered by the investing party and if it is total nonsense, no investment.
There are upsides to raising capital which haven't been addressed by the article that argues against raising capital.
The posted article argues against (or exposes) faulty logic, and to do this talks about cashflows but misses the simpler flaw in the argument it critiques.
It follows, if nothing else, by selection bias. The organisations that did not take on investment and subsequently made bad decisions based on flawed assumptions don't stick around for as long to make further mistakes on the same assumptions.
During my college course on accounting cash flow was by far the most difficult to understand and I still find it difficult in light of the cable company example.
As an owner you still want money to spend. How do you get that if not from the profits?
As an owner you still want money to spend. How do you get that if not from the profits?
Well in the cable example it was from capital investors. But also, since the business was pulling in cash flow it could use its present customer revenue to immediately reinvest in expanding the business. So on paper the business would show little to no profit, probably even negative in some years, while the business was actually growing at 30% a year.
It's a riskier model for non-cash flow based businesses though, in my opinion. If you don't have a stable source of cash flow from something like a subscription model it's harder to count on revenue being consistent (unless you're dominating a particular market).
Also can be risky if you only have one or a few clients providing the cash flow. If they pull out or go belly up, your business can be decimated with whatever overhead you added to provide for them.
It's a riskier model for non-cash flow based businesses though, in my opinion. If you don't have a stable source of cash flow from something like a subscription model it's harder to count on revenue being consistent (unless you're dominating a particular market).
Also can be risky if you only have one or a few clients providing the cash flow. If they pull out or go belly up, your business can be decimated with whatever overhead you added to provide for them.
As an owner you still want money to spend. How do you get that if not from the profits?
In the cable company example, from taxes (not paid) and accelerated depreciation (a big part of the taxes not paid). Money is fungible and cash is the ultimately fungible form of money. Tax money (not paid) is better than money taken as taxed profits.
By running the business at a loss (from a profit/loss point of view), the cable company paid little or no taxes. You can take $100 in profit and pay $30 in taxes (net $70 in your pocket), or you can show $0 profit and roll that $130 into your business expecting $130 + growth in the future. Note that, with the cable company example, the cable company "was unprofitable" every year yet paid a compound return of 30% to its shareholders.
In the cable company example, from taxes (not paid) and accelerated depreciation (a big part of the taxes not paid). Money is fungible and cash is the ultimately fungible form of money. Tax money (not paid) is better than money taken as taxed profits.
By running the business at a loss (from a profit/loss point of view), the cable company paid little or no taxes. You can take $100 in profit and pay $30 in taxes (net $70 in your pocket), or you can show $0 profit and roll that $130 into your business expecting $130 + growth in the future. Note that, with the cable company example, the cable company "was unprofitable" every year yet paid a compound return of 30% to its shareholders.
Sure. But if I roll all revenues into the business where are the money to pay my personal rent and groceries as the owner?
You pay yourself a salary. That's the business investing revenue back into its employees. And yes, you'll pay income tax on that, but that may only be a small part of the value you've created.
Or you sell some shares, or borrow against your equity. Perhaps you can roll it forward indefinitely and you're in a jurisdiction where your heirs get favorable tax treatment by inheriting the business.
Or you sell some shares, or borrow against your equity. Perhaps you can roll it forward indefinitely and you're in a jurisdiction where your heirs get favorable tax treatment by inheriting the business.
You pay yourself a salary.
The whole setup probably requires operating at a much larger scale than that of a sole trader or small family business.
The whole setup probably requires operating at a much larger scale than that of a sole trader or small family business.
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I had the same question while reading. It's probably obvious to the startup crowd, which is why it wasn't made explicit, but I think the trick is this: a company which will never make a profit is (should be) worth zero, but a company that has the ability to make a profit in the future is valuable, even if current profits are zero. So rather than making a profit and paying it to yourself, it's better to make the company as valuable as possible to other people by reinvesting everything, and then sell stock or borrow against it for your own consumption. That definitely seems true for the most prominent outliers, but no idea whether it's actually true for the average or median owner / founder.
I guess this why EBITDA is important: if you have positive EBITDA and stop growing the business, you can pay off your loans, finish depreciating your existing equipment, and with I=D=0 you have real profits.
I guess this why EBITDA is important: if you have positive EBITDA and stop growing the business, you can pay off your loans, finish depreciating your existing equipment, and with I=D=0 you have real profits.
If you have growing cash flow, and can plausibly show that you will be making profit in the next 5 years, or even better that you could be making profit right now if you stopped reinvesting, you won't have a problem getting either investors or a bank loan.
It is funny how many old and traditional companies fail to see the importance of cash flow as well. Especially those with traditionally high profit margins and long lead times, as the matgin allowed them to finance thr necessary cash flow through banks. All fine and well, until margin break away.
A former coworker mentioned a prior job at a major food manufacturer. Apparently somebody realized they could mail the checks from across the country and still adhere to their payment terms. The extra day or two in the mail was worth pretty big money for the minimal effort required.
I understand the rationale behind cash flow management, but I've always been a bit annoyed at the games around payment terms. It just feels like a chain of all companies lagging payment to suppliers while expecting (or hoping) for prompt payment from their customers. I'm curious what the world would look like if everyone was expected/required to pay within 2 weeks of services rendered?
You might have payment terms agreed upon, but a megacorp has no issue delaying payment an extra 60 days and will cut a check for the original amount without agreed upon late fees included. Then a smaller company is left trying to manage the relationship after their margins are arbitrarily slashed.
I understand the rationale behind cash flow management, but I've always been a bit annoyed at the games around payment terms. It just feels like a chain of all companies lagging payment to suppliers while expecting (or hoping) for prompt payment from their customers. I'm curious what the world would look like if everyone was expected/required to pay within 2 weeks of services rendered?
You might have payment terms agreed upon, but a megacorp has no issue delaying payment an extra 60 days and will cut a check for the original amount without agreed upon late fees included. Then a smaller company is left trying to manage the relationship after their margins are arbitrarily slashed.
This was a painful learning for me when I worked for a megacorp: the bigger the customer, the less likely to pay on time.
For me as an engineering manager at the “big customer” it was a constant embarrassment. We worked with small scrappy vendors who I was on a first-name basis with. Megacorp would just never cut the checks. They would negotiate super aggressive terms to start with and then still intentionally not meet the agreed terms. I had close collaborators telling me they really needed the $$ to meet their own bills and all I could say was “I’ll send another email to purchasing and hope for the best!” Hated that so much.
For me as an engineering manager at the “big customer” it was a constant embarrassment. We worked with small scrappy vendors who I was on a first-name basis with. Megacorp would just never cut the checks. They would negotiate super aggressive terms to start with and then still intentionally not meet the agreed terms. I had close collaborators telling me they really needed the $$ to meet their own bills and all I could say was “I’ll send another email to purchasing and hope for the best!” Hated that so much.
I had a similar experience at a mid-sized nonprofit. We would get generous pricing from vendors with reasonable terms, then the next time around I would find we were 5 months late paying them. The internal answer was "cash flow" and "well we wouldn't want to pay them too quickly", or worse "they shouldn't be complaining, they got their check much faster than X"
Clever use of your payment terms is a valid strategy. Not respecting the agreed upon payment terms is bad business behavior, using cash flow as an excuse is just lazy. Or worse, a clear sign of financial trouble.
Why not charge $big-customer more to compensate? Or avoid them altogether?
I was the big customer, I was just powerless as a cog in the machine to make my employer pay on time.
As the scrappy vendor, landing those big accounts is so important that you will take the risk even if it kills your business :(
As the scrappy vendor, landing those big accounts is so important that you will take the risk even if it kills your business :(
This is standard practice, but some vendors are inexperienced.
The common answer to this is to break the project up into a series of milestones, and then put tools down whenever payment for a milestone is late.
Generally large customers do actually have the cash, and simply have no incentive to pay on time, so why bother?
Meanwhile, their internal deadlines are very strong incentives, and can get managers in serious trouble if repeatedly missed, especially by a year or more.
Generally large customers do actually have the cash, and simply have no incentive to pay on time, so why bother?
Meanwhile, their internal deadlines are very strong incentives, and can get managers in serious trouble if repeatedly missed, especially by a year or more.
I've literally had contractors working for certain BigCos tell me the companies insist on a 90 day due date on all invoices (at the end of the month of services rendered, ofc) and will still always be late on payments because they know that they can get away with it.
> curious what the world would look like if everyone was expected/required to pay within 2 weeks of services rendered?
You’d need to generate credit through the financial system versus trade at some nodes.
Consider a diner. It orders ingredients. Adds value to them. Serves and collects payment. Let’s enforce instantaneous payment on this system. Now the diner has to borrow to buy ingredients. Or maybe it pre-sells “tickets.” The way some high-end restaurants do. Now the customer is financing them. If they don’t have credit, maybe this encourages their employee to pay them earlier. Et cetera.
You’d need to generate credit through the financial system versus trade at some nodes.
Consider a diner. It orders ingredients. Adds value to them. Serves and collects payment. Let’s enforce instantaneous payment on this system. Now the diner has to borrow to buy ingredients. Or maybe it pre-sells “tickets.” The way some high-end restaurants do. Now the customer is financing them. If they don’t have credit, maybe this encourages their employee to pay them earlier. Et cetera.
Now you have me smiling while imagine a future where someone crashes the world economy by messing with the cash flow games.
Cash flow is so much more than just payment terms.
> I realised I didn’t have a good argument for why it was wrong. Every axiom and intermediate proposition were ideas that I agreed with. And it wasn’t so simple as the conclusion being flat out mistaken
So... its pretty clear that time is poorly understood in the axioms presented, and the author comes to that conclusion at the halfway mark. And frankly so is risk. But nobody--myself included-- wants to read an accurate axiomatic representation of probability distributions and discount rates.
But in so doing I expect that the bit about "skin in the game" would be hard to ground. The argument is that if you have 100 percent of your wealth tied up in one enterprise you are going to be very careful. Very risk averse. But what is the optimal level of risk taking? Zero? It's not a hypothetical. Especially in tech startups, projects can have wide error bars on completion time. Short runways mean you can really only pick from among the shortest options in the solution space, and longer implementation plans are discounted.
Maybe thats good. But it seems like a huge shortcut to say "the shortest path is optimal."
So... its pretty clear that time is poorly understood in the axioms presented, and the author comes to that conclusion at the halfway mark. And frankly so is risk. But nobody--myself included-- wants to read an accurate axiomatic representation of probability distributions and discount rates.
But in so doing I expect that the bit about "skin in the game" would be hard to ground. The argument is that if you have 100 percent of your wealth tied up in one enterprise you are going to be very careful. Very risk averse. But what is the optimal level of risk taking? Zero? It's not a hypothetical. Especially in tech startups, projects can have wide error bars on completion time. Short runways mean you can really only pick from among the shortest options in the solution space, and longer implementation plans are discounted.
Maybe thats good. But it seems like a huge shortcut to say "the shortest path is optimal."
> ...You could just as well bootstrap a tiny, successful internet business selling Wordpress plugins or Shopify themes, believing that ‘startups shouldn’t raise capital’. You would then never need to update your beliefs, because those are perfectly sufficient for a small, independently-run business.
At the scale of a one or two person show the up front costs for building and selling your software are pretty reasonable. This setup rearranges how much cash you need up front to 1. be competitive and 2. win over new business. True this has a cap on it of say... ~1-2M ARR but that's a very reasonable game for a lot of smart people to be playing. I didn't read the original article he's arguing against, but if that's the style business they are discussing then the "don't raise" argument holds up. Frankly given the original article's conclusion of "don't raise money" I suspect they weren't focusing a post-IPO cable business...
At the scale of a one or two person show the up front costs for building and selling your software are pretty reasonable. This setup rearranges how much cash you need up front to 1. be competitive and 2. win over new business. True this has a cap on it of say... ~1-2M ARR but that's a very reasonable game for a lot of smart people to be playing. I didn't read the original article he's arguing against, but if that's the style business they are discussing then the "don't raise" argument holds up. Frankly given the original article's conclusion of "don't raise money" I suspect they weren't focusing a post-IPO cable business...
The issue with the original article seems like it could be summed up pretty simply, startups, for their founders and investors, aren't meant to create profit, they are meant to increase equity. Therefore having the same business model as a cancerous tumor makes perfect sense, consume as much free resources (low interest debt) as possible to grow as large as possible in as short a time as possible, independent of any external effects or moral hazards that creates.
So in that way at least the original article does have a point, in a better world startups most likely shouldn't take as much funding as they do, but in the current world, the correct answer for any particular startup will always be to do exactly that.
So in that way at least the original article does have a point, in a better world startups most likely shouldn't take as much funding as they do, but in the current world, the correct answer for any particular startup will always be to do exactly that.
The most glaring and obvious problem with this model is that your customers are paying for all of your investment. If you can’t invest large or fast enough to provide benefits your customers need, they will most certainly leave. The second most glaring flaw is that the shortest path to what the customer wants does not lead to Macintosh or iPod or Watch. Big ideas need big investment before customers come around to the idea.
This articles wastes too much time on its appeal to personal incredulity when the answers are so obvious.
This articles wastes too much time on its appeal to personal incredulity when the answers are so obvious.
A fun "thought" experiment? Given the time of year (just after a fiscal quarter/year end) and given that I am a dual citizen (New Zealand and USA), I found the following demonstration particularly intriguing: a bank customer (friend) had some not insignificant funds in several personal accounts in their NZ banks as of December 31st. At 10 am on Sunday, January 1st (NZ time), it was "still" 3 pm Saturday, December 31st in the central time zone in the US. I watched as they withdrew a large amount of USD cash from multiple debit cards on their NZ accounts at some midwestern ATM machine(s), then turn around and deposit said cash into their US bank accounts.
Net effect: their net worth showed accumulated fiscal year-end bank balances of twice the "not insignificant amount of funds" (according to cash methods of GAAP).
They went on to hint at the fact there are 24 time zones on this planet (more actually). I asked about the legality of such antics. They said they were not sure other than any obvious fraud on using such financial statements for any fraudulent financial benefit. They explained how the daily batch processing of bank transactions hurt customers real time cash flow, and felt it was one way to rectify things to the customer advantage.
Hmmmm
Net effect: their net worth showed accumulated fiscal year-end bank balances of twice the "not insignificant amount of funds" (according to cash methods of GAAP).
They went on to hint at the fact there are 24 time zones on this planet (more actually). I asked about the legality of such antics. They said they were not sure other than any obvious fraud on using such financial statements for any fraudulent financial benefit. They explained how the daily batch processing of bank transactions hurt customers real time cash flow, and felt it was one way to rectify things to the customer advantage.
Hmmmm
Layman here: what are the consequences of having a net worth of accumulated fiscal year-end bank balances of twice the "not insignificant amount of funds"?
On the face of it, it looks like you have twice the liquid net worth than you actually have (or more with multiple countries). Often financial statements will be prepared by different accounting firms in different countries, and each set says you had the same amount of money on hand on the same date, even though you only had one. It is not so much a delusion of wealth as a delusion of time. When people refer to a date (such as a fiscal year end), they think that date is the same everywhere but of course midnight on December 31st happens in every one of the 24+ time zones.
Eye-opening essay. I think this should be essential reading for any investor or business owner.
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great insight, but one point I miss is that to play games with cash-flow you got to have it in the first place.
Some ideas really benefit from investment before a product is marketable (i.e. for research, production). Kickstarter etc. provide a great tool to generate that for consumer oriented products before the product is launched. There are many markets where this is not so simple or not possible.
Some ideas really benefit from investment before a product is marketable (i.e. for research, production). Kickstarter etc. provide a great tool to generate that for consumer oriented products before the product is launched. There are many markets where this is not so simple or not possible.
I love it that it concludes with what is called abduction in my field of academia. So in general you would have deduction, you reason from a set of principles, or induction, you reason from specific instances towards the principles. Abduction is like induction, but that you find a completely new type of principles, unknown before.
>>> Once the depreciation ran out on particular systems, they could then sell them to another operator, where the depreciation clock would start anew
ohhhhh!!!! Tell me that's not the reason there are so many sub-contractors around.
That seems a complex ut doable tax code fix
ohhhhh!!!! Tell me that's not the reason there are so many sub-contractors around.
That seems a complex ut doable tax code fix
There is no real fix here. The article is wrong. The effective tax erasure when you do that is not really significant. When you resell the depreciated asset, you make a profit which “erases” the depreciation and will have to pay taxes on that. You have actually just deferred your taxes. That can be advantageous cash flow wise but that’s pretty much it.
Bring advantageous for cash flow is the whole point, isn't it?
You are repeating exactly what the article said.
No, I fundamentally disagree with the idea that the clock is starting anew when you sell the asset. The buyer can start depreciating but the seller just paid taxes on the benefits it received from the sale which is an equivalent cash flow. You can in fine only depreciate once per asset. The whole reselling thing is bogus.
There is no real tax shielding coming from depreciation. If you just invest to replace existing depreciated asset, you just reach a steady state where you indefinetly write off real loss of value in infrastructure and pay taxes on real income which is things working as they should.
The real tax shielding actually comes from debts and means you can finance your investment in new infrastructure advantageously by using the tax write off. The interplay of debts and depreciation is not involved: that would remain true without any depreciation.
Anyway, the point of Malone through EBIDTA wasn't about cash flows anyway. It was to show that if you ignored how new investments were financed, the company was actually earning money and was profitable and these profits would materialise as soon as the company would stop expending which is indeed exactly what Amazon did again years later.
To get back to the article, I don't really understand what follows the part about Malone. If the point was that raising money through debts would be preferable to raising through capital, I would obviously have agreed but that's kind of obvious and startups wouldn't use VC money if they had access to debt anyway. Instead, he is somewhat talking about WCR without mentioning WCR which is weird before coming back to his initial argument about VC without having really at any point discussed the subject. What a mess.
There is no real tax shielding coming from depreciation. If you just invest to replace existing depreciated asset, you just reach a steady state where you indefinetly write off real loss of value in infrastructure and pay taxes on real income which is things working as they should.
The real tax shielding actually comes from debts and means you can finance your investment in new infrastructure advantageously by using the tax write off. The interplay of debts and depreciation is not involved: that would remain true without any depreciation.
Anyway, the point of Malone through EBIDTA wasn't about cash flows anyway. It was to show that if you ignored how new investments were financed, the company was actually earning money and was profitable and these profits would materialise as soon as the company would stop expending which is indeed exactly what Amazon did again years later.
To get back to the article, I don't really understand what follows the part about Malone. If the point was that raising money through debts would be preferable to raising through capital, I would obviously have agreed but that's kind of obvious and startups wouldn't use VC money if they had access to debt anyway. Instead, he is somewhat talking about WCR without mentioning WCR which is weird before coming back to his initial argument about VC without having really at any point discussed the subject. What a mess.
It’s not nearly as large a dodge as presented. Ideally the economic (tax) life would be similar to the practical life, but “depreciation allowed or allowable reduces your basis” in the asset, so when you sell it, you will have a gain on the sale if it’s for more than your basis. You will be taxed on a portion of that which is depreciation recapture at a higher rate than the capital gains rate and at the capital gain rate for any gains above the basis plus depreciation recapture.
So, the new operator gets to start depreciating from their basis (which is fair and right), but the old operator has a gain to have taxed (or delayed by a 1031 exchange). It’s a cash flow difference in taxes as well (making it fair to include in the article), but not a permanent avoidance of taxation.
So, the new operator gets to start depreciating from their basis (which is fair and right), but the old operator has a gain to have taxed (or delayed by a 1031 exchange). It’s a cash flow difference in taxes as well (making it fair to include in the article), but not a permanent avoidance of taxation.
I didn't follow the article closely, but I assume the author's alluding to resetting the accounting/tax/depreciable basis of the assets with an arm's length sale.
There is a tax concept using "leased employees" where you pre-pay for a vendor to work on-site, and it counts as an asset on the balance sheet. I don't think that applies to independent contractors.
Sub-contractors are popular because
1. They don't count in key performance metrics like revenues/employee or liabilities (paid vacation)
2. Their costs are buried further down the income statement and appear as non-recurring/variable.
3. They can ramp up/down with less approvals.
There is a tax concept using "leased employees" where you pre-pay for a vendor to work on-site, and it counts as an asset on the balance sheet. I don't think that applies to independent contractors.
Sub-contractors are popular because
1. They don't count in key performance metrics like revenues/employee or liabilities (paid vacation)
2. Their costs are buried further down the income statement and appear as non-recurring/variable.
3. They can ramp up/down with less approvals.
This makes sense to me. I am trying to build a house, and I have recently hit a funding issue. My cash flow is the problem. I want to take on more debt to get it done, but to do that makes me starve. So my solution is to get a better paying job so that my cash flow clears up and the debt is easier to manage. The debts are not huge, just lots of short term loans that clear up in a few months. Doing this without a mortgage but with lots of small temporary loans looks a lot like this. The end result is a house that should cost $300k for more like $100k.
Yes, and as I've learned the hard way, even a bootstrapped one-man-SaaS can use cashflow tricks to run a much more successful business.
It actually Makes the most sense to mess with cash flow when you are small and scrappy and your loan terms are unfavorable.
Megacorp can get a loan for significantly more favorable terms so the cost of financing is much lower on their end. As such it would be slightly advantageous for them to pay quickly and ask for a discount. Unfortunately the net benefit is small for mega corp and they usually can’t capture the savings
Megacorp can get a loan for significantly more favorable terms so the cost of financing is much lower on their end. As such it would be slightly advantageous for them to pay quickly and ask for a discount. Unfortunately the net benefit is small for mega corp and they usually can’t capture the savings
I'd find practical learnings from a bootstrapped one-man SaaS far more valuable than the examples used in the original post (all more large-scale companies with more room for refactoring).
Any specific insights you can share?
Any specific insights you can share?
This was a great essay. Does anyone subscribe to commoncog - is it worth it?
Compared to just getting books from libgen?
Compared to just getting books from libgen?
This is a long-winded refutation of an article [1] that ignores economies of scale.
[1] https://ensorial.com/2020/dont-raise-money/
[1] https://ensorial.com/2020/dont-raise-money/
Now I have the Spinners song Games People Play stuck in my head.
https://www.youtube.com/watch?v=vbkg1WXf594
At least it's not Holly Jolly Christmas.
https://www.youtube.com/watch?v=vbkg1WXf594
At least it's not Holly Jolly Christmas.
[deleted]
So, am I understood correctly that the endgame of cable or Amazon business is selling the company, as a whole or via IPO? And what the endgame for buyer(s) would be then?
I urge those interested in cash flow games to read "The Sovereign State of ITT" by Anthony Sampson.
[deleted]
The example in the article of how the restauranteur halved his food costs simply by pre-paying his supplier rather than paying Net-120 (120 days after goods are delivered) fascinated me. Where exactly does the value of cash flow come from?
Rehashing the example from the article: Why do restaurants pay Net-120? Suppose Restaurant R is buying 30-day dry-aged steak from Supplier S. R needs to buy the steak days in advance of cooking it to serve customer C. R receives money for the steak only after this point, and now R can pay back S.
Why is pre-payment better? S can now be more efficient about the number of cows they have to slaughter. If R pays by Net-120, S ends up with a lot of waste due to unsold dry-aged steak, because S cannot anticipate the true demand but must be prepared to capture it to earn money.
Analysis: In effect, S and R are pushing C to plan better. If C can just confirm that they want dry-aged steak ahead of time, which involves significant preparation, the entire supply chain can be more efficient. Sometimes, planning ahead is a benefit for C, as landing reservations at top restaurants can be difficult. Other times, C does want the ability to make last-minute decisions on where to go for food.
Meanwhile, S can do something better than slaughter the cows that would have gone to waste. In essence, S has more freedom because S has more cash flow. So does more cash flow == more freedom?
Cash is the most liquid asset. Supposedly, it represents the value that you can transfer immediately. I can have all the cash in the world, but if I am bound to pay a ton of debt with that cash, do I really have the ability to use the cash for something I value? That's why cash flow is a separate, and more useful, concept.
One argument against "cash flow == freedom" is that cash flow can be a function of effort. If I spend all of my waking hours working, I will generate cash flow, but I won't get to enjoy anything. What about landlords who don't have to do much to earn cash? Well, cash flow in strict $ terms doesn't capture everything. Businesses don't have this problem because they can simply capture the effort for producing cash flow in terms of wages. A simple trick is to pin a cash value for the amount of time I spend.
Cash flow represents freedom because cash flow = value in - value out at a given point of time. You don't even need to use USD for the "cash" part of cash flow, if that's not what you value. Then, to increase cash flow, you can 1) strictly increase "value in" (e.g. work more), 2) strictly decrease "value out" (e.g. delegate a task to free up your time), or 3) increase "value in" more than "value out" for a single transaction (e.g. take out a loan). Increasing cash flow doesn't need to be immediate: you can work on an asset and incur negative cash flow initially to establish better long-term cash flow. Worse "value in - value out" now for a better "value in - value out" in the future.
It's neat to see how to apply accounting principles to optimize my day-to-day.
Rehashing the example from the article: Why do restaurants pay Net-120? Suppose Restaurant R is buying 30-day dry-aged steak from Supplier S. R needs to buy the steak days in advance of cooking it to serve customer C. R receives money for the steak only after this point, and now R can pay back S.
Why is pre-payment better? S can now be more efficient about the number of cows they have to slaughter. If R pays by Net-120, S ends up with a lot of waste due to unsold dry-aged steak, because S cannot anticipate the true demand but must be prepared to capture it to earn money.
Analysis: In effect, S and R are pushing C to plan better. If C can just confirm that they want dry-aged steak ahead of time, which involves significant preparation, the entire supply chain can be more efficient. Sometimes, planning ahead is a benefit for C, as landing reservations at top restaurants can be difficult. Other times, C does want the ability to make last-minute decisions on where to go for food.
Meanwhile, S can do something better than slaughter the cows that would have gone to waste. In essence, S has more freedom because S has more cash flow. So does more cash flow == more freedom?
Cash is the most liquid asset. Supposedly, it represents the value that you can transfer immediately. I can have all the cash in the world, but if I am bound to pay a ton of debt with that cash, do I really have the ability to use the cash for something I value? That's why cash flow is a separate, and more useful, concept.
One argument against "cash flow == freedom" is that cash flow can be a function of effort. If I spend all of my waking hours working, I will generate cash flow, but I won't get to enjoy anything. What about landlords who don't have to do much to earn cash? Well, cash flow in strict $ terms doesn't capture everything. Businesses don't have this problem because they can simply capture the effort for producing cash flow in terms of wages. A simple trick is to pin a cash value for the amount of time I spend.
Cash flow represents freedom because cash flow = value in - value out at a given point of time. You don't even need to use USD for the "cash" part of cash flow, if that's not what you value. Then, to increase cash flow, you can 1) strictly increase "value in" (e.g. work more), 2) strictly decrease "value out" (e.g. delegate a task to free up your time), or 3) increase "value in" more than "value out" for a single transaction (e.g. take out a loan). Increasing cash flow doesn't need to be immediate: you can work on an asset and incur negative cash flow initially to establish better long-term cash flow. Worse "value in - value out" now for a better "value in - value out" in the future.
It's neat to see how to apply accounting principles to optimize my day-to-day.
This is a bunch of rhetoric dressed up as logic hidden by using long paragraphs. If you break it down and remove the repetition it is basically saying:
1. the other guy made some argument
2. but he was just too ignorant to understand why his argument was wrong
3. I am smart and I do SENSEMAKING
4. therefore other guy's argument is wrong
As far as I can tell, the actual first argument is something along the lines of
1. many founders raise capital and waste it because it's not "their money" so they part ways with it more easily
2. this leads to failed businesses
3. therefore founders should not raise money
and the counter argument is
1. some businesses need upfront capital and the returns only come later
2. some founders can raise capital and use it effectively, instead of wasting it, even though it isn't "their money"
3. therefore founders should raise money
which are both good arguments and in no way contradict each other. I have seen founders do both, and it's true that some money is raised when it was not needed, and some money is raised and then squandered, and some money is raised and used effectively to generate massive returns. That's why it's called "venture" capital.
1. the other guy made some argument
2. but he was just too ignorant to understand why his argument was wrong
3. I am smart and I do SENSEMAKING
4. therefore other guy's argument is wrong
As far as I can tell, the actual first argument is something along the lines of
1. many founders raise capital and waste it because it's not "their money" so they part ways with it more easily
2. this leads to failed businesses
3. therefore founders should not raise money
and the counter argument is
1. some businesses need upfront capital and the returns only come later
2. some founders can raise capital and use it effectively, instead of wasting it, even though it isn't "their money"
3. therefore founders should raise money
which are both good arguments and in no way contradict each other. I have seen founders do both, and it's true that some money is raised when it was not needed, and some money is raised and then squandered, and some money is raised and used effectively to generate massive returns. That's why it's called "venture" capital.
Thanks for writing this. This was my sentiment as well.
I feel that the anecdotes about cash flow are somewhat interesting, but the whole 'proving an argument' narrative is unsubstantiable fluff.
The cash flow strategies are things which can be leveraged in specific situations, but are generally not global truths that most early stage startups can action on.
I feel that the anecdotes about cash flow are somewhat interesting, but the whole 'proving an argument' narrative is unsubstantiable fluff.
The cash flow strategies are things which can be leveraged in specific situations, but are generally not global truths that most early stage startups can action on.
> This is a bunch of rhetoric dressed up as logic hidden by using long paragraphs
Rhetoric is the classical art of persuasion. Were you trying to say "empty rhetoric" or to describe the argument as being poor? Describing a poor argument as "rhetoric" is like calling an old unreliable car "engineered".
Logos is part of rhetoric, not aside it.
Rhetoric is the classical art of persuasion. Were you trying to say "empty rhetoric" or to describe the argument as being poor? Describing a poor argument as "rhetoric" is like calling an old unreliable car "engineered".
Logos is part of rhetoric, not aside it.
That might be what you think that word means, but it doesn't match the common usage (at least in my experience), nor the clear intent of the parent.
Rhetoric is commonly introduced this way in college composition courses. Here's a good approachable introduction:
https://pressbooks.ulib.csuohio.edu/csu-fyw-rhetoric/chapter...
Typically when I hear the word rhetoric used in the way you're defending, as a pejorative autoantonym, it's by political talking-heads trying to dismiss an argument of an opponent.
https://pressbooks.ulib.csuohio.edu/csu-fyw-rhetoric/chapter...
Typically when I hear the word rhetoric used in the way you're defending, as a pejorative autoantonym, it's by political talking-heads trying to dismiss an argument of an opponent.
What would you say is the ratio between usage in the official meaning and usage in the manner of the great grandparent? I would expect 1 to 10 at least.
No, his argument is that you should not say "new companies should not go into debt".
His financial advice is "don't think about the amount or the debt, but think about the cash flow analysis."
He goes on to state that many new companies won't need to go into debt to be successful along the terms the founds define them.
You are presenting a straw-man argument. He even says, it isn't that the argument is wrong, but that there are better (more complete) frames to examine this problem. Your point (4) is literally false.
His financial advice is "don't think about the amount or the debt, but think about the cash flow analysis."
He goes on to state that many new companies won't need to go into debt to be successful along the terms the founds define them.
You are presenting a straw-man argument. He even says, it isn't that the argument is wrong, but that there are better (more complete) frames to examine this problem. Your point (4) is literally false.
When I work with my own money, I’m often overly cautious. I’m currently agonizing over whether to drop 1k on cloud credits to see if something is viable.
If such a decision on 1k took a week in a real startup which blocked a whole team at 10k/head… then there wouldn’t be much startup in the future.
Founders waste money because they need to move fast. Sometimes the need for speed also means that they do seemingly foolish things, you can be right or fast - sometimes being slow is wrong.
If such a decision on 1k took a week in a real startup which blocked a whole team at 10k/head… then there wouldn’t be much startup in the future.
Founders waste money because they need to move fast. Sometimes the need for speed also means that they do seemingly foolish things, you can be right or fast - sometimes being slow is wrong.
I agree with you, got same feeling from reading. When i hear question should I raise only right answer is: it depends, what is your context?
But I guess it is hard to sound smart this way :)
But I guess it is hard to sound smart this way :)
Smart or not it's hard to make ad revenue (or get readers, whatever the author's going for) with a concise summary or a context heavy conversation.
The other weird part of this article is it's presented as the author's unique (or uncommon) business/startup insight, when cash flow analysis is the fundamental of finance.
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I dislike when people think incorrectly and then say “thinking doesn’t work”. In this case the final step of the 6 step argument chain is just incorrect thinking. The conclusion does not follow from the “axioms” / accepted “prepositions”.
It is difficult to detect auto-generated content, but it also does not preclude the possibility an author was having a stroke during composition.
By definition, one no longer fully owns a company when exchanging ownership for liquid capital (often at ridiculously discounted value), or lose future well-being through debt-financing issues/predatory-scams. Note, the often negligible incremental cost of scaling tech companies often offsets the expected value in investment risk. Every fist-year student learns Bayesian statistics, but Vegas was built on those who still can't assess risk.
In general, a small service site like Craigslist operates just fine with minimal overhead, and has remained functional much longer than most startups.
It was really sad seeing what Silicon Valley Bank did to startup culture, and naive investors that get FOMO.
Happy 2023 =)
By definition, one no longer fully owns a company when exchanging ownership for liquid capital (often at ridiculously discounted value), or lose future well-being through debt-financing issues/predatory-scams. Note, the often negligible incremental cost of scaling tech companies often offsets the expected value in investment risk. Every fist-year student learns Bayesian statistics, but Vegas was built on those who still can't assess risk.
In general, a small service site like Craigslist operates just fine with minimal overhead, and has remained functional much longer than most startups.
It was really sad seeing what Silicon Valley Bank did to startup culture, and naive investors that get FOMO.
Happy 2023 =)
The mysterious "receipting team" is not in the main office, and has no phone number or even names listed, emails are never directly replied to, instead site contacts will call to relay questions/answers from them, ref# come from an automated do-not-reply email. They will quite often be "backlogged" and fail to send a ref# before the the end of the month, and suddenly will be cleared up on the 1st of the month.
We've had jobs that finished in the first week of a month, been ignored for 25 days, received a ref# with an apology for the delay on the 1st of the following month, get paid 45 days end of that month. So up to 100 days from completing work to getting paid. All our accounts are POS, 7 days EOM, or 30 days EOM, and must be paid on time or we lose supply. So to do a job with $100k of materials and wages for them, we have to have $100k spare cash for up to 60-100 days
It's not a cashflow problem, they're sitting on reserves and we're a blip on their radar, less than 1/10th of a percent of their outgoings
So we quote them outrageously high, and they never blink. I've told them some jobs would be up to 50% less if they paid quicker, and they've outright said they'd rather hold the cash and pay more. For a sense of scale we've invoiced them about $500k a year for the last few years, they've told me to clear out a couple weeks for two jobs that are nearly that much each, in February and April this year. I can't figure out who's getting the bad deal, them or me, I keep assuming they must have some massive upside I'm not seeing ¯\_(ツ)_/¯