Thinking About Thinking

What Is Your Personal Profit Per Hour?

Posted in Pop Culture by larrycheng on December 30, 2009

Was thinking about some useful household finance metrics as the new year approaches…

From the day anyone starts working, we’re quickly educated on the concept of an hourly wage.  Whether we start at minimum wage or otherwise, we’re conditioned to the idea of compensation being denominated in the time interval of hours.  Even as many folks transition to being paid on a salaried basis, it’s not hard to calculate what you effectively make per hour.  For example, if Bob’s after-tax bi-weekly paycheck is $1,500 and Bob works 50 hours per week, then he makes $15.00 per hour.  This example presumes Bob has no other sources of income other than his paycheck. 

The household metric that is often missing from the equation is the flipside: spending per hour.  The most simple way to calculate this number is to take all of your expenses for a given period (say a month) – mortgage/rent, credit card charges, car payments, ATM withdrawals, utilities, insurance, interest payments, tuition, healthcare, charitable giving, etc. – and do the basic math to denominate that spending on an hourly basis presuming the same “spending hours” as “working hours”.  To use the same example, if Bob spends $3,000 per month and has the same 50 “spending hours” per week, then a little basic math says Bob spends $13.85 per hour. 

That takes us to the most important metric: profit per hour.  Bob makes $15.00 per hour and spends $13.85 per hour which means he makes $1.15 per hour in profit.  The reason I prefer the hourly denomination of profit more than a month or year is that it’s more practical for all of those little spending decisions we make every day.  Congratulations to Bob for being profitable!  Just knowing your hourly profit metric is an achievement in and of itself.  But, let’s go on to a couple second order ideas for those interested. 

First, you can say that spending hours and working hours are not the same in reality.  If Bob spent $13.85 every hour of every day (24 x 7), he would end up spending $10,000 per month instead of $3,000.  So, the key to making the math work is to limit your spending hours per week to the same as your working hours per week.  If you work 50 hours per week, pick the 50 hours per week where spending is allowed and fix them.  It might be 5 specific hours on each weekday and 12.5 hours on Saturday and Sunday.  Once that is selected, the question is how much can you spend per hour in those “spending hours”.

To determine how much you can spend in those spending hours, you have to determine how much you have already spent just by existing.  Take all of your “fixed costs” – all those costs that you bear whether you ever take your cash or credit card out of your wallet.  This could be things like car payments, rent/mortgage, insurance, tuition, etc.  Let’s say for a moment that of Bob’s $13.85 per hour of spending, $10.00 per hour is fixed.  That means in those 50 spending hours per week, Bob can spend $3.85 per hour and still maintain his profit margin of $1.15 per hour.  Now all of Bob’s discretionary spending decisions can be benchmarked against that $3.85 in hourly discretionary spend that he knows he is allowed.  That’s a useful metric whether Bob is looking to get that bagel sandwich for breakfast or that fancy steak for dinner.

Burn Rate Norms

Posted in Technology, Venture Capital by larrycheng on December 16, 2009

When investors and entrepreneurs talk about “burn rate”, they’re generally referring to the amount of cash a company consumes through its normal operations every month.  For many venture-backed companies, they have a negative burn rate meaning that they are expending more cash than they are collecting.  The obvious rationale to burn cash is that by spending more now, your company will be able to grow revenue faster, acquire market share and separate from the competition. 

Investors will talk about “high burn rate” companies, “capital efficient” companies, companies that are “burning too much”, etc.  But, how does this translate to hard numbers?  Here’s my rule of thumb:

  • Cash Flow Positive:  If the company is growing and cash flow positive – congratulations.  The model has been proven, you never have to raise capital again. 
  • $0–$250k burn rate:  This is still a “capital efficient” company – a $10M round could last 3–4 years which is an eternity.
  • $250k-$500k burn rate:  This is average.  Many young venture-backed companies are in this zone.  A $10M round lasts 1.5–2.0 years. 
  • $500k-$750k burn rate:  This is on the high side.  You could be accused of “burning too much”.  A $10M round lasts a 1.0–1.5 years.  That’s a tight timeframe to create value.
  • $750k-$1M burn rate:  This is a “high burn rate” company.  A $10M round doesn’t even last a year.  There’s no room for error.
  • $1M-$2M burn rate: Many investors won’t touch a company burning this much.  The exception is if the spend is due to aggressive marketing against a known acquisition model that is profitable against the lifetime value of a customer. 
  • $2M+ burn rate: Most investors will run like the wind. 

While some sectors such as biotech, cleantech and communications services don’t follow these norms – it’s a pretty good benchmark for most emerging technology companies.


Founder Liquidity

Posted in Venture Capital by larrycheng on December 15, 2009

The sentiment towards founder liquidity among investors seems to swing back and forth like a pendulum.  Founder liquidity refers to instances when an investor invests capital to buy shares directly from a founder rather than or in conjunction with investing capital that goes into the company for traditional working capital purposes.  When capital goes to a founder rather than into the company, there is typically neither an economic benefit or an economic cost to the company (though there may be non-economic benefits and costs). 

Why would an investor be willing to use their capital for founder liquidity?  Typically it’s because they want more ownership in a company that already has sufficient working capital.  By acquiring shares directly from the founder, they can increase their ownership without increasing the post-money value of the company.  Often times, founder liquidity is used for more mature companies that are profitable and hence the only opportunity for a new investor to gain an ownership stake is by providing the founder or other shareholders with liquidity. 

Why don’t investors want to use their capital for founder liquidity?  The drawback of using capital for founder liquidity is that the capital does not go into the company and therefore has no impact on helping the company to grow.  Using a limited resource like capital in a non-accretive way is viewed quite negatively in bad economic times when capital is scarce or in situations where the company might need more working capital in the future.  Another issue related to founder liquidity is whether it impacts the motivation of the founder or is viewed negatively by other employee/management shareholders who do not get liquidity themselves. 

Why do founders want liquidity?  The most common reason is that they have bootstrapped the company, taken on substantial personal debt, and have foregone all other forms of wealth accumulation to take the company to it’s current state.  By taking some liquidity, they can strengthen their personal balance sheet and “go for a bigger win” at the company.  Other times founders want liquidity because they are no longer actively involved with the company and are seeking to clearly separate from the company.  In this instance, it’s of value to the company and investors to not have any possible dissident shareholders involved as well. 

What’s my take on founder liquidity?  Using capital for founder liquidity is a viable use of proceeds for more mature companies but it has to be done in a disciplined way.  It has to be the right kind of company and, as importantly, the right type of founder.  The right kind of company is one that does not need additional working capital and is highly predictable in nature.  The right kind of founder is one whose focus, energy, and motivation will remain productive and positive despite a suddenly improved personal balance sheet.  The two must be in place: right company, right founder.   

I have seen a number of examples where founder liquidity has been a positive instrument for all parties involved.  So, I have and will continue to support using capital for founder liquidity in very specific instances.  That being said, I think a great predictor of success for a growth stage company is when a founder who could take liquidity – chooses not to.  There may be no more significant of a vote of confidence a founder can give his or her investors than to forego liquidity and press ahead.  While I don’t know for sure, I doubt that luminary founders like Steve Jobs (Apple), Jeff Bezos ( or Larry & Sergei (Google) took liquidity while their companies were private.  If true, it’s a fact pattern worth emulating because in their case, it turned out to be the best financial decision they could have possibly made. 

What’s Worse: Hyperinflation or Deep Recession?

Posted in Economy by larrycheng on November 25, 2009

I thought this was a poignant observation by Fareed Zakaria in his book, The Post-American World:

“Hyperinflation is the worst economic malady that can befall a nation.  It wipes out the value of money, savings, assets, and thus work.  It is worse even than a deep recession.  Hyperinflation robs you of what you have now (savings) whereas a recession robs you of what you might have had (higher standards of living if the economy had grown).  That’s why hyperinflation has so often toppled governments and produced revolution.  It was not the Great Depression that brought the Nazis to power in Germany but rather hyperinflation, which destroyed the middle class by making its savings worthless.” 

The Single Playbook Executive – What Venture-Backed Executives Can Learn From NFL Coaches

Posted in Technology, Venture Capital by larrycheng on November 22, 2009

There used to be a single playbook in the NFL built around a simple philosophy – running and defense wins championships.  The entire operating approach of teams was centered on this singular belief.  The prototypical example of this was the 1986 Chicago Bears – think Buddy Ryan-coached defense with Mike Singletary and William “The Refrigerator” Perry.  Think about a running game led by none other than Walter Payton.  That was a dominant team with the right playbook for that era.

But the rules of the NFL have changed – literally.  The rules have slowly been re-engineered in the league to preferentially protect wide receivers and quarterbacks.  Hit a quarterback the wrong way, and you’ll get a penalty.  Touch a wide receiver after 5 yards, and you’ll get a penalty.  Literally, the rules have changed, to support a more exciting brand of football that revolves around the passing game.  It’s no wonder that four of the best teams in the league – Indianapolis Colts, New Orleans Saints, New England Patriots and San Diego Chargers are pass first teams led by quarterbacks Peyton Manning, Drew Brees, Tom Brady, and Philip Rivers, respectively. 

Over the last several years, some NFL teams have learned a new playbook because the rules of the game have changed.  Others have not adapted.  I have always thought that this was a great analogy for the technology landscape and the executives that operate in this world.  I’d argue that in the world of venture-backed technology companies, the rules of the game change dramatically faster than in the NFL.  That puts a burden on executives living in this world to adapt. 

Beware of the “single playbook” executive.  They have one blueprint and they apply that blueprint for any situation they’re in.  They use that blueprint because they’ve had success with it – maybe great success with it.  They bring in the same people that were succesful with that blueprint.  But, it’s dangerous to be a single playbook executive if the rules of the game are changing all around you.  Therein lies the lesson I think that executives in venture-backed companies can learn from NFL coaches– your playbook has to take into account the changing rules of the game. 

Now, don’t get me wrong.  I, like many VCs, love to back successful executives who have a proven and successful playbook.  But, there is a reason that many new entrepreneurs are finding great success without a proven historical playbook– it’s because their playbooks are being built for the rules of the game as it stands today.  Successful venture-backed executives have to adapt their playbook or they should beware of the up and coming executives who don’t care how things were done before and only care about how to win today. 

Succeeding With A Potential Single Point Of Failure

Posted in Technology, Venture Capital by larrycheng on November 21, 2009

I’ve had the opportunity to invest in two companies that I’d describe as having a “potential single point of failure”.  I chose to invest in one – Verid.  And decided, unfortunately, to pass on another – Mint.  Verid was ultimately sold to EMC/RSA less than two years after our investment for several multiples of our capital.  And Mint was recently acquired by Intuit.  I thought it was interesting how they were both sold for similar exit values given that both had the uncommon distinction of having a point of single dependency.  Here are their stories and a couple thoughts:

Verid provides knowledge-based authentication services.  You’ve probably run into the service if you’ve ever tried to open an account online and been prompted to answer questions about yourself to prove that you are who you say you are.  Verid’s potential single point of failure?  Their entire authentication service was built leveraging a single data aggregator on the back-end.  If that data provider decided not to work with them one day, there would be no questions and no answers in this authentication service.  Verid’s entire service depended on a single data contract. 

Mint provides an online financial management service for consumers.  They help you manage and identify ways to save money through one online console that sees across all of your financial accounts.  Mint’s potential single point of failure?  They rely on Yodlee as the account aggregator to bring together all of the data from the different financial accounts for a consumer.  Absent Yodlee, there would be no data in Mint’s service, which means there would be no service at all.  Mint’s entire service depended on a single technology relationship.

While I don’t know Mint’s situation, I suspect both companies mitigated this risk by signing long-term deals with their respective partners.  I imagine both were among the largest customers for their respective partners and felt like they had some leverage in the other direction.  Nonetheless, I suspect both companies wanted to hedge their bets by cultivating other partners, but ultimately were growing too fast to seriously contemplate using another platform.  I also imagine that both sold to their respective acquirers with one eye looking at an attractive valuation and the other eye looking at a substantial unknown after the terminal year of their partner contracts. 

Verid and Mint both deliver superb products and ended up being great investments for their investors.  Both probably could not have been huge companies without mitigating that potential single point of failure.  But, both showed that despite that issue, with astute management, you can still have a very successful outcome. 

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The Case For Gold & The Case Against Gold

Posted in Economy, Pop Culture by larrycheng on November 19, 2009

I’ve been looking unsuccessfully for an article that succinctly lays out both sides of the debate on whether gold is a good asset to own.  So, I’m here to ask for your assistance in pulling together an article that outlines the key points on both sides of the debate.  I have some ideas, but I’m sure you have more.  Just leave any points of view, good articles or predictions in the comments an they will be added to the article.  I hope that this article proves to be useful to readers regardless of your current point of view on the topic.  If you’re formulating your own opinion on a given topic, hopefully it’s helpful to get the full spectrum of opinions on the topic.  And, if you already have a strongly held point of view, surely it’s good to pressure test your convictions with an opposing view every once in awhile.  So, here we go: 

The Case For Gold

  1. The devaluing of fiat currencies around the world through unprecedented fiscal stimulus will cause an increase in the price of gold.   
  2. Gold is a safe haven currency that tends to rise in precarious economic times like these.
  3. International governments will diversify out of their US dollar reserves and buy gold thereby driving demand.
  4. Hyperinflation is on the horizon – and that drives gold prices. 
  5. The growth of institutional and retail investment demand for gold. 
  6. Lack of growth in the supply of gold from mines. 
  7. Fiat currency has no intrinsic value.
  8. Others?

The Case Against Gold

  1. Gold doesn’t pay interest.
  2. Gold goes up when there’s inflation, and deflation is the far greater risk today.
  3. A safe haven asset like gold goes up when Armageddon hits, and we have avoided that. 
  4. Over the long run, history shows that gold is not an appreciating asset. 
  5. Asset prices are inflated by the dollar carry trade – gold will come crashing down
  6. Too much hype – sell high, buy low. 
  7. Gold has no intrinsic value.
  8. Others?

The Price of Gold/Oz.

  • $1,141.70 (11.19.09 – date of post)

Gold Articles

  1. Buy Gold, Not Miners: Jim Rogers
  2. What’s John Paulson Buying Now? Hint….Think Gold
  3. “I Don’t Believe In Gold,” Says Nouriel Roubini
  4. Others?

A Simulation Game: Cutting Your Losses

Posted in Pop Culture by larrycheng on November 16, 2009

One of my partners led an impromptu game in our team meeting today which illustrates the emotional tension of cutting your losses.  For any investor or operator who takes risk with capital, the concept of cutting your losses comes into play at some point.

The simulated game had these ground rules:

  1. Everyone would have the chance to make monetary bids for a prize. 
  2. You could always increase your bid after hearing other bids.  There is no limit to the number of revised bids you could make. 
  3. The highest bid after everyone had finalized their bids would get the prize – in this case my partner offered to pay $20 as the prize.
  4. The catch is if you are not the highest bid – you would have to pay him the amount of your highest bid.  So you could lose money. 
  5. He guaranteed he would theoretically make inordinate amounts of money through the simulation. 

So in a room of around ten folks, we started lobbing in hypothetical bids:

  1. I started with a bid of $5.00, just to see how things would go. 
  2. Another person bid $7.00. 
  3. Then another person offered $19.99 thinking that he could short circuit the whole process.
  4. Not wanting to lose my $5.00, it immediately occurred to me to offer $20.00 – which I did.   

Then all of us had the aha moment that for the person who bid $19.99, if he thought he could win the “auction” by bidding $20.01 – he would certainly rather lose 1 cent than lose $19.99.  And, then if he bid $20.01, I would have to decide if I was going to bid $20.02 for the chance to lose 2 cents rather than lose $20.00.  But, what if then the person who bid $7.00 decided to bid $20.03 for the chance to lose 3 cents instead of $7.00. And, eventually you could imagine a scenario where everyone in the room bids above $20.00 for what amounts to be a foregone conclusion where everyone loses money (except my partner of course). 

In a very simple way, this game illustrates the challenge of cutting your losses.  Investors face this in situations when they have to decide whether to invest more money behind a company that is decreasing in value.  Managers often have to face this when continuing to invest in business initiatives that are not tracking, but have taken substantial time and resources.  I think the lesson learned from the game is if you’re in a no-win situation, cut your losses immediately.  But, as the game illustrates, that is easier said than done.  And in the real world, it’s often hard to know if you’re truly in a no-win situation or not.

By the way, I would not have bid $20.02. 

Who Is The Best Looking U.S. President Of All Time?

Posted in Pop Culture by larrycheng on November 13, 2009

I was reminded today of the commonly held belief that since the advent of mass media – good looks is a critical advantage in winning the Presidency of the United States.  So out of sheer curiosity (a common refrain in this blog), I pulled together the images of all 42 Presidents courtesy of the White House website.  Are the Presidents of the mass media generation better looking?  Who is the best looking President of all-time?  Judge for yourself… 

1 - George Washington

2 - John Adams

3 - Thomas Jefferson

4 - James Madison

5 - James Monroe

6 - John Quincy Adams

7 - Andrew Jackson

8 - Martin Van Buren

9 - William Henry Harrison

10 - John Tyler

11 - James Polk

12 - Zachary Taylor

13 - Millard Fillmore

14 - Franklin Pierce

15 - James Buchanan

16 - Abraham Lincoln

17 - Andrew Johnson

18 - Ulysses Grant

19 - Rutherford Hayes

20 - James Garfield

21 - Chester Arthur

22 - Grover Cleveland

23 - Benjamin Harrison

24 - Grover Cleveland

25 - William McKinley

26 - Theodore Roosevelt

27 - William Taft

28 - Woodrow Wilson

29 - Warren Harding

30 - Calvin Coolidge

31 - Herbert Hoover

32 - Franklin Roosevelt

33 - Harry Truman

34 - Dwight Eisenhower

35 - John Kennedy

36 - Lyndon Johnson

37 - Richard Nixon

38 - Gerald Ford

39 - Jimmy Carter

40 - Ronald Reagen

41 - George H Bush

42 - Bill Clinton

43 - George W Bush

44 - Barack Obama

Give Me A Dollar and I’ll Give You 90 Cents Back

Posted in Economy, Pop Culture, Technology by larrycheng on November 11, 2009

This is the purest business idea of all time – give me a dollar and I’ll give you 90 cents (or something less) back.  Ridiculous, right?  Yet, it happens in so many different forms that it’s somewhat surprising.  Why would anyone in their right mind give someone a dollar just to get less money back?  And, I’m not talking about you giving someone a dollar so that they give someone else 90 cents back.  That’s money movement.  I’m talking about a direct trade – you give someone money just for the privilege of getting less money back.  It happens a lot and we’ve all participated in it.   

Here are some ways this model exists in business – and I’ll rank order them by the models that give you the most money back to the ones that give you the least.  I’m going to spend a little extra time on the last business which I think is the most onerous of them all.  Here we go:

1.  ATMs.  The most obvious model – you give the bank a dollar, and they give you 98%-100% of it back every time you withdraw it from the ATM.  Their service: accessibility and interest. 

2.  Travelers Checks.  We all know that companies like American Express have made a great business in taking your money, and giving you 96%-99% of the value back in the form of a less liquid travelers check.  What’s the embedded service?  Insurance. 

3.  Check Cashing.  Companies like Western Union will take your check and give you cash worth about 95%-99% of the value.  Their value: liquidity, especially to the unbanked.

4.  Currency Exchange.  Companies like Travelex have made a great living taking your money, and giving you 90%-98% of the value back in the form of another currency.  The implied service:  local purchasing power.

5.  Coinstar.  These guys own the kiosks you see at the grocery store where you put in a bag of coins and they give you 90% of the value back in the form of cash.  It’s an amazing business to say the least.  What’s their underlying service?  Money portability.

And last but certainly not least:

6.  Gold Buyers.  These companies allow you to trade in your gold jewelry, and they give you cash for the gold.  Not a fair example you say?  I think it’s very fair – gold is a currency and so are the dollars you’re getting in return.  Their true service: liquidity.

Here’s why I think the gold buying services are truly the worst economic deal of them all.  There are two compounding issues.  First, these companies are not giving you anywhere close to value of your gold, dollar for dollar.  While the above businesses give you 90%+ of the value of your dollar, some people who have used these gold buying services have calculated that they have received 17%-18% of the value of their gold.  That’s an 80%+ tax right there.  (UPDATE: This CNN report that came out today says gold buyers pay between 18%-60% of face.)  But, let’s not stop with that.  There’s a second compounding issue that can be material.  Gold is an appreciating asset.  The US Dollar is a declining asset. 

Here’s the historical price of gold:


Here’s the strength of the US Dollar over the same time period:


[UPDATE: Just a note – past performance is not indicative of future returns.  Either currency could go up or down from here.  It’s unlikely that any currency fluctuation up or down would make up for the initial 80% tax though.]

Here are the real economics:  let’s just say you sold your gold jewelry in 2003 where the actual gold value is $100.  Let’s say you got $18 for that $100 of gold.  And then let’s just say you held that cash until now.  The purchasing power of that $18 has declined to ~$14 since 2003.  Meanwhile, if you just held the $100 of gold in the form of the jewelry, it would now be worth over $350.  I’m not exactly sure how to properly index two bifurcating currencies, but in a nominal sense, you traded something worth $350 for $14.  You got paid 4 cents for your dollar.  Instead of saying “We Pay Top Dollar” – these companies should say we pay you cents on the dollar. 

[UPDATE: This is what happens when you whip together a blog post late at night.  Since the gold is priced in dollars, the depreciation of the dollar is embedded in the gold price.  So, I didn’t need the second chart so I double counted the impact of the dollar depreciation.]

Now to be fair – most gold sellers probably don’t hold their cash so the separation from gold’s appreciation and the dollar’s depreciation may not actually have time to play out.  The seller gets the value of instant liquidity and they probably use it.  In addition, the gold buyers do need to have infrastructure to appraise, melt, and monetize gold if they do it themselves.  Nonetheless, the tax these companies charge to give you your money back is pretty onerous no matter how you cut it.  But, it just goes to show, there’s always ways to get people to give you money in exchange for less money back.