The Rule of 100
A few years ago, I came across the Rule of 40 – the principle that for a software company, it’s revenue growth rate and profit margin should exceed 40%. Here is what it means in practice:
- If a business is growing at 100%, it can have a profit margin of -60%
- If a business is growing at 60%, the profit margin can be -20%
- If a business is growing at 20%, the profit margin should be +20%
Bain has more on the Rule of 40:
The Rule of 40…has gained momentum as a high-level gauge of performance for software businesses in recent years, especially in the realms of venture capital and growth equity. Increasingly, software industry executives are embracing the Rule of 40 as an important metric to help measure the trade-offs of balancing growth and profitability.
Software companies that can balance growth and profitability to outperform the Rule of 40 have valuations (measured by the ratio of enterprise value to revenue) double that of companies that fall “below the line,” and they achieve returns as much as 15% higher than the S&P 500. Companies whose growth slows and that fail to improve profitability often find themselves the target of activist investors and private equity acquirers.
I was thinking recently about proficorns, the profits generated and the trade-offs between profits and growth. What is a good-sized proficorn? Since proficorns do not have external investors, there is no benchmark valuation being set. How can proficorn entrepreneur’s benchmark themselves?
While my approach is not scientific or backed up by a study of proficorns, I came up with two key metrics:
- Profits (EBIDTA): this is important because it can measure the cash being generated each year. Profits are the oxygen for a proficorn’s growth, since there is no external capital. Profits help the entrepreneur invest in new areas, expand geographies or even acquire other businesses. Profit after tax (PAT) can have many other accounting elements factored in, so EBIDTA is a better metric to use. For our purposes, we can measure EBIDTA in millions of dollars. If the entrepreneur chooses, one-off investments / gains / write-offs can be excluded from this number.
- EBIDTA Growth percentage: Stagnation can be the death knell for a business. So, growth is important, especially in tech. Measuring growth in EBIDTA gives a glimpse into the future health of the business.
So, take these two numbers (EBIDTA in millions of dollars and EBIDTA percentage growth) and multiply them. The first goal for an entrepreneur should be to get the result to be more than 100 – for the business to have a healthy valuation (let’s say, $100 million or more). Thus, if a business is generating $5 million EBIDTA, it must have a growth rate of 20% or more to get a valuation of $100 million or more. If the business is generating $10 million in EBIDTA, growth can be lower at 10% to achieve the same benchmark valuation.
Admittedly, this is not backed by deep analysis – it is just a simple rule of 100 to guide entrepreneurs towards the magic marker of crossing $100 million in valuation. In today’s world, growth is being valued even more highly. But in my thinking, growth cannot come at the cost of profits. The Rule of 100 can help proficorn entrepreneurs balance the two – ensure the right mix of cash generation to invest in the future, and maintain a steady growth trajectory.
Tomorrow: Part 63
Technology in the 2020s: “Collectively, these technologies add up to a lot of possibility. If we cure a bunch of diseases, slow down aspects of aging, realize cheap and emissions-free baseload energy, and deploy new modes of transportation and better construction technologies, we will almost certainly exceed 2 percent TFP growth. But we might not do these things. It all depends on execution. The underlying science is there. The engineers are willing. Even the funding is available in most cases. But, as a society, how much urgency do we feel? Our culture does not prioritize progress—it fights, destructively, for status. And our politics reflects our culture.”
Movie I watched recently: Citizen Kane
A newsletter to subscribe: Anticipating the Unintended. “This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?”
Return on Capital: 10-20-30
As an entrepreneur who has been successful once, I am asked a question by many people – Why do I want to work hard again? Why go through all the ups and downs of running a business? Why not retire and enjoy life? Besides the answer that I do love running a business and that is life, there is another answer to these questions. Building and owning a successful business is the best path to wealth creation.
Let’s say you have some money. Where do you deploy it? One obvious answer is to invest it in the markets – maybe a mix of equity and debt. Since an entrepreneur is not necessarily an expert in investing, this will be done via portfolio managers or mutual funds. Long-term returns from such investments will be 10% per annum. Luck aside, it is hard to do passive investing that will give high returns.
One could then move to active investing – studying industries and stocks, and making long-term bets on specific companies. One could also invest in private companies – as an angel or via other venture capital funds. Given that this is likely to be in a basket of companies, some will succeed and others not. The ones which succeed will give very good returns. Long-term, one could perhaps hope for returns of about 20% per annum. Not easy but doable.
The third approach, which I favour, is to grow a proficorn. Once one has got past the initial stages of a business (where the mortality rate is highest), the odds of success improve dramatically with each passing year. Over a period of time, an entrepreneur should be able to deliver growth and returns of about 30% per annum. If dilution is limited, the upside is captured by the entrepreneur.
While a 10% difference may not seem much, apply the power of compounding over a decade and see the difference:
- 10% growth for 10 years will see Rs 100 become Rs 260 (2.6X)
- 20% growth for 10 years will see Rs 100 become Rs 650 (6.5X)
- 30% growth for 10 years will see Rs 100 become Rs 1,400 (14X)
For an entrepreneur, investing capital at 10% returns will yield less than a fifth of the returns than owning a successful and growing business growing at 30%. The decision to therefore keep running a proficorn is a no-brainer! Why would I sell (if I can see sustainable high future growth), convert it into cash and reduce my financial returns by 80%? A proficorn entrepreneur should therefore only sell if the prospects of growth diminish or the value paid by the buyer is extremely high.
Tomorrow: Part 62
A beautiful story on my favourite Mumbai book store, Kitab Khana. I hope it can re-open soon. My best wishes.
Reading: Agatha Christie short stories.
James Buchanan: “[Government] spending rates would be lower if all programs were required to be tax-financed. Government, however, may have access to both debt issue and money creation as alternative revenue sources. These allow the government to spend without taxing, which is almost the ideal setting for elected politicians. By creating deficits, government is allowed to finance desired programs that provide benefits to potential voters without overt increases in rates of tax.” Via CafeHayek.
An Indian Agenda
What we have in today’s India is one-way Talk TV – where the anchor holds sway, where the same political faces are seen, where rational discussion and debate gives way to emotionally charged rhetoric outbursts and rhetoric. A symbiotic relationship has developed between the BJP and some of the leading TV (and print) channels. Traditional media no longer holds the government and the political leadership to account; they are all on the same side, acting as amplifiers and mouthpieces of the government. It is almost like India has spawned dozens of clones of Doordarshan and the Press Information Bureau. In their studios, there is no discussion on why India needed the world’s most stringent lockdown, why migrant workers had to suffer, why is China still occupying Indian territory, why the independence of institutions is being trampled, why jobs have gone missing, and why cronyism is on the rise. In return for its loyalty, media gets the oxygen it needs – advertising rupees and survival.
My belief is that this still caters to a small audience, and there is an opening for talk radio – where the listeners are as engaged and there is more information, analysis and education, rather than misinformation, entertainment and conspiracy theories. If there is a hope for holding leaders to account and changing minds, it can come from new independent voices. Talk radio hosts can be India’s salvation.
Here is an agenda for future Indian talk radio hosts:
- Focus on the future, not the past
- Make freedom and prosperity as the twin pillars for content
- Lay out the choice Indians have – stagnation or upward mobility, past or future, kakistocracy or democracy, serfdom or freedom, cronyism or fairness, wealth redistribution or wealth creation, poverty or prosperity
- Ask the hard questions: Why are Indians not rich? What will make them rich?
- Encourage debate, not diatribes
- Hold the governments (Centre and States) to account on economic matters
- Focus on the rules, not rulers
- Discuss the right role for government in our lives, business and society
- Given the lack of experts in government, articulate an alternative roadmap
- Help foster the growth of a new generation of political entrepreneurs
I think there are many people in India who want betterment for their families and children as their primary agenda. They do not want to get caught into civilisational debates about the past, but genuinely want a tomorrow that has more opportunities than today. They need their voices heard. They need a megaphone for their aspirations. Talk radio can be their voice and platform. The listeners can in turn provide the political entrepreneurs and foot soldiers for the revolution India needs. Talk radio can take up the responsibility that Indian media has abdicated. What India’s talk radio movement needs are pioneers willing to create a new industry.
Fred Wilson on 2020 and 2021.
Vitalik Buterin: “What we see in 2020 is this: Big Government is as powerful as ever, but Big Business is also as powerful as ever.”
Pratap Bhanu Mehta on Supreme Court’s order putting on hold the farm bills: “The Supreme Court is increasingly looking like one of those fantasy creatures with disjointed shapes, where nothing is what it appears to be. The forms keep mysteriously changing, with benign faces masking more ominous fangs, and shapes shifting as the need arises. So this is a constitutional court that does not pronounce on the constitutionality of laws. Instead, it wades into political and administrative management without the imprimatur of any law. It positions itself as a saviour of democracy only to make a mockery of the parliamentary process. It wades into conflict management, only to hide behind the façade of some expert committee. It pretends that distributive conflicts are technical ones. It finds ruses to defuse genuine democratic protest. Yet it will not facilitate the orderly and law-bound expression of protest.”
A 2011 paper by Jeffrey M. Berry and Sarah Sobieraj explained the growing popularity of talk radio in the US:
The number of radio stations airing political talk shows—predominantly conservative talk radio—has surged in the past few years. This massive change in the radio industry says something about the demand for such shows, but attributing the rise of talk radio to a corresponding rise in conservative popular opinion is misleading. We argue that this remarkable growth is better explained by the collision of two changes that have transformed the radio business: deregulation and the mainstreaming of digital music technologies. Regulatory changes have shifted much of radio production and control from local to mass production (managed by industry giants such as Clear Channel Communications) and created a context ripe for nationally syndicated hosts such as Rush Limbaugh, Glenn Beck, and Mark Levin. Meanwhile, rapid technological changes have given consumers more control over the way they listen to music. Technologies such as MP3 players, Internet radio, smart phones, and Pandora Radio have made it more difficult for stations with a music format to be profitable. As music programming has become more problematic, many stations have developed a highly successful business model by converting to talk formats airing nationally syndicated shows.
A recent New York Times article by Paul Matzko wrote about the size, scale and impact of talk radio in the US (with a focus on conservatives):
Talk radio’s power is rooted in the sheer volume of content being produced each week. The typical major talk radio show is produced every weekday and runs three hours, so just the top 15 shows are putting out around 45 hours of content every day. Even setting aside hundreds of additional local shows, the dedicated fan can listen to nothing but conservative talk radio all day, every day of the week, and never catch up.
Each show has its own long-running inside jokes and references, a kind of linguistic shorthand that unites fans and repels outside examination.
As Jim Derych, the author of “Confessions of a Former Dittohead,” put it, Rush Limbaugh “makes you feel like an insider — like you know what’s going on politically, and everyone else is an idiot.” There is power in that feeling, the proposition that you and the radio elect have been awakened to a hidden truth about the real way the world works while the rest of the American “sheeple” slumber.
Like single-issue voters, talk radio fans are able to exercise outsize influence on the political landscape by the intensity of their ideological commitment.
Talk radio is not bounded by physical space. It can follow listeners wherever they go, from the car radio while commuting to the radio resting on the workbench to a radio app on a smartphone. It has the potential to dominate the construction of a person’s worldview in a way that other media simply cannot (until, perhaps, the advent of its white-collar cousin, the podcast).
What can Indian talk radio do? Can talk radio help drive the political and economic revolution India needs for freedom and prosperity?
Tomorrow: Part 7
The Art of Doing Nothing: “The idea that “doing nothing” is actually an event in and of itself. The idea that we no longer run on a treadmill of activity from getting the kids ready for school, to brushing our teeth, to conference calls, to picking up kids, fixing dinner, and bed- only to start over again. The idea that our actions day to day become influenced by our instincts and no longer by routines, shoulds, and musts.”
Payments in a Subscription Economy: “Transactions are never going to go away. Money will always have to move from one place to another. But what happens to payments in the Subscription Economy? I’ve heard arguments on both sides: in a world of subscriptions, payments don’t matter anymore; and when you run a subscription business model, payments are a bigger challenge than ever.”
Inside India’s Great Digital Reset: “Digital was in favour before the virus. Now we have a divide—the digital, and the dying.”
Changing Minds, Channelling Votes
In his book, “Talk Radio’s America”, Brian Rosenwald writes about how talk radio, led by the likes of Rush Limbaugh, led to Donald Trump’s takeover (and makeover) of the Republican Party in the US:
[The book chronicles how] talk radio blazed a path that would later be followed by cable news and digital media with dramatic consequences for the media in general. Talk radio became the first of a new wave of ideologically driven niche media that revised how Americans consumed information and how they viewed journalism, in some respects returning us to the partisan press of the nineteenth century, albeit one more focused on entertaining than informing. When hosts spotlighted salacious, often-unverified stories that made for great radio, they forced the mainstream media to address these same stories, thereby damaging journalists’ capacity to serve as gatekeepers who determined newsworthiness. The newsworthiness standard would crumble further with the rise of digital and social media, helping to blur the line between fact and fiction and spread mistruths, exaggerations, and distortions. At the same time, conservative media’s relentless denigration of the mainstream press discredited journalism itself in the eyes of a large segment of the population.
With the traditional media no longer an arbiter of truth, extremist politicians were free to make outlandish claims that no one could effectively dispute. These claims were music to the ears of a scorned segment of the population that felt like its values were under siege. The lure of conservative media stardom pushed politicians down this path. When they followed it, they found their power augmented. They didn’t have to be backbenchers in Congress, on the party fringe. The backing of conservative media protected them from Republican leaders trying to maintain party discipline, inverting traditional political and congressional power structures.
… The relationship between talk radio and the Republican Party was a Faustian bargain. Hosts provided substantial aid to Republican candidates and frequently labored to advance the Republican agenda. But, with time, the synergy of purpose between conservative media personalities and Republicans waned. As hosts and outlets proliferated, competition stiffened, and many conservative media figures guarded their flanks by lacerating Republicans. Hosts demanded from elected Republicans a level of ideological purity—and a warfare mentality—that made it far more difficult to be a nationally competitive party and to advance an agenda that would attract broad support. These demands increasingly imperiled moderate Republicans and hamstrung governance.
..The result was a negative feedback loop: by expelling party moderates, the inflamed conservative airwaves forced Republicans to reach farther across the aisle for compromise during divided government, leading to still more inflamed conservative airwaves. Conservative media responded by calling for even more combative Republicans willing to fight for listeners’ values at any cost.
What are the learnings for the future in India? Is there an opportunity for talk radio – targeting not the extremes, but the silent moderates who pine for a freer and richer India.
Tomorrow: Part 6
The Barry Diller Playbook: About IAC. “Diller’s anti-conglomerate is an uncommon and (often) unwieldy beast, but it has a clear focus, a singular purpose. It exists not in service of a particular market or technology, but a process, a playbook.”
17 Investing Lessons: By . One of the lessons: “It is possible to overpay for a company’s shares. This is why we need to think about the valuation of a business. But I think it is far more important to focus on the quality of a business – such as its growth prospects and the capability of the management team – than on its valuation.”
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