It always comes down to math

By Francisco Dao , written on May 14, 2013

From The News Desk

About a year ago, a 20-something rising star product guy at a hot startup turned to me and asked, “So are you a startup guy too?” As someone who has started several businesses but not in the Internet space, I answered, “I’m not really sure what that means to be a startup guy. I’ve been a brick and mortar entrepreneur for years but not really on the internet.” Without any hint of irony, he replied, “Yeah, the internet is just a different skill set than brick and mortar.” And with that dismissal, he lost interest in having any further conversation with me.

When I tell this story to my friends who have been around the block a few times, including the ones who have started successful Internet companies, they always shake their heads in disbelief. Of course there are different technology requirements and some of the techniques used for things such as user acquisition are different, but at the end of the day, regardless of what business you’re in, everything comes down to the same math problem. Revenue minus expenses must equal a positive number. Anyone who tells you business works in some other way or the rules are different on the Internet or any other claim of exceptionalism is an idiot.

Yet so much of the venture-fueled startup environment is based on questionable or even nonexistent math. The problem extends far beyond simply calling out individual startups for not having viable business models. With so many VCs and angels writing checks to startups without the slightest clue as to how they’ll ever make the math work, it is literally the entire ecosystem that has lost sight of the basic math equation.

I saw a great example of this “no math” startup thinking at a dinner a few months ago. The group got into a discussion about what defines a startup, when a founder whose startup had failed explained, “A startup stops being a startup when they figure out how they’re going to make money.” My friend Ben Nelson exclaimed, “That’s the most ridiculous thing I’ve ever heard! By that definition Snapfish was never a startup, because we always knew how we were going to make money, and yet clearly we were a startup at some point!”

I thought the entire scene was hysterical and it’s probably worth noting that the guy who understood the importance of math sold Snapfish to HP for $300 million.

As bad as it is that both VCs and founders are willing to ignore the realities of math, I wonder how many entrepreneurs even know how to do basic math. The most egregious example of an entrepreneur who didn’t understand math can be found in the tragic story of Ecomom.

As the details of its failure came to light, its former controller Philip Prentiss described a conversation he had with its CEO, Jody Sherman, as the company was collapsing. Prentiss explained, “At the end of December when things were getting truly desperate, he said to me, 'Phil, just bring me a forecast that shows how much we need to sell to break even.' He did not understand, after three years of negative margin, that increased sales resulted in increased losses.”

Contrary to popular belief, raising venture capital is not a business model and the rules of math aren’t different on the Internet. You may have a little more running room because of VC funding, and you might get lucky with an exit before the reality of math comes calling, but if you’re trying to build an actual business and not a house of cards, I can assure you the math is always the same.

As Brian Lee, co-founder of ShoeDazzle, The Honest Company, and LegalZoom explained at last week’s PandoMonthly event, “Business is business.” While this statement seems blatantly obvious, it’s a concept that is often lost in the world of venture-funded Internet startups.