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Learning from Failure in Two Acts

March 30, 2007

Fred Wilson blogged about the lessons he learned from his (Flatiron Partners) investment in The Industry Standard (the Web 1.0 bible).

ACT I: Only build in costs that can be paid for by sustainable revenues.

This may seem obvious, but I assure you it is very difficult to get it right.  When John Battelle was building The Industry Standard from $9MM in revenue the first year to $25MM in the second year; had he assumed $25MM was his sustainable revenue and built costs in line with that number he would haver never hit $200MM a year later.

In the case of The Industry Standard the sustainable revenues were between $25MM and $50MM, but John and his team had built in $120MM in fixed costs per year.  Fred explains, "the gap between costs and revenues was too large."  

We have the very same problem in our own startups.  I will admit we are far too conservative.  The Architel business could easily reach $10MM in revenue next year, but based on the amount of money we are not reinvesting in the business will will only reach $7MM.  Why?  The answer is simple, with almost no risk (i.e. without increasing our cost basis) we can grow the business $2MM over the next twelves months.  To grow the business by $5MM over that same period of time would require a cost basis closer to $7MM (i.e. if it turned out that $7MM was the sustainable revenue level, we would not make any money until we reduced our cost structure).  Again, it is hard to know the right answer...

ACT II: Never invest in a deal if you are a minority investor.  

Of course, Fred wouldn’t agree with me on this point, but he is a professional investor and I am just an operator (as it turns out).  Fred specified, "Don’t invest as a minority investor in a company controlled by a corporate entity."  His point was that a corporate entity might have a different agenda than that of a typical investor.  In the case of The Industry Standard IDG (the majority investor) didn’t want to sell the magazine to Time Warner or Hearst due to the fact that they were competitors.  Even though the sale price would have been between $400MM and $500MM (a fantastic return for a financial investor).  Of course, if you have lots of dry powder (i.e. available cash) being a minority investor can be a good idea (you just need to keep paying to play).   

 

Written by Alexander Muse · Filed Under Blog 

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