The 5 Things I Look For Before Starting Any Business | Ep 967

If I wanted to start the perfect business, these are the things that I would focus on. So I think these are like the five advantages to make any business easier to grow and weigh more profitable. And this is what's helped me build a portfolio of companies that generated over $250 million from revenue last year alone. And so for each one, I'll describe what it is. I'll give examples and I'll show you industries that excel in them and industries that suck. There are very few businesses that have all five. And even having one of these makes the business that you have better than others. And so just think this video is like an S tier ranking for opportunity vehicles. So if you've ever heard or thought, man, like, I feel like I've got a level 10 skill set in the level two opportunity than this video is for you. So let's get started with number one. Sticky. It's the most important thing. If you do not have what's called revenue retention, you have nothing. Revenue retention just means how much revenue from last year you retain to the next year. That's all it is. If you don't have that, you will always be in the sales business. So John Paul DeGiorio, who started Paul Mitchell, who started Patron, he says this quote that I always remember, he says, you want to be in the resale business, not in the sales business. And so there's two types of retention that people discuss. One is logo retention, which is if you had 100 customers in January, how many do you have now? And then the second is the revenue retention piece, which is if you made $100 from those customers in aggregate in January, how much do you make from that same cohort or group of customers today? And so logo retention, just to be clear, you almost never have 100% logo retention. Like you can't get more than 100%, you only have certain amount of customers and it only decays over time. And so some reasons for that is that there's something called structural term. So someone moves away, they die, they're, they're business dies, they fire the employee if you do a payroll thing, who use the subscription or the service. And this is called involuntary turn. It's because it's just structural to how business is operate, right? On the other hand, there's something called voluntary turn. And this is the one you really want to avoid. That's when people leave because they just think you suck. Right? And so those are kind of like from a logo retention perspective, how many of the number of people are still here? The revenue retention side, you absolutely can have over 100% net revenue retention. And so that means that even if you lose some of those customers, the ones who stay increase how much they spend enough to make up for the ones you lost. And so the easiest way to do this is have a clear way for cheaper customers to spend more with you. And if you're service, keep doing the thing they need you to do, which part of it is making sure that that person that you sell actually needs it in the first place. And this is why qualifying customers is so important. But for example, if I have a $9-month membership and a $99-month membership, like school, if someone comes in at $9 and then goes up to $99, then I get an 11x in terms of value from that customer. And so even if 20% of customers leave from the $9, if I get even 10% of customers to take an 11x, I have more than 100% revenue retention. And that means that when a customer enters the business, that means that the business will continue to grow, whether we do nothing at all, over time. And that becomes a very valuable company. Now, let me give some interesting data on school that manages hundreds of thousands of memberships that you can use for any recurring business. Number one is that the first amount of churn that's the greatest is month one. So if you ever have to focus first on your first 30 days, across all categories, it was over 20% plus churn in that first month. All right. The next big kind of like drop off point in churn is about 10%. And that happens at about month three. The third and kind of final spot where the big drop in in churn is month six. And so the big takeaway here is do whatever you can to get people to month six. So in your mind, you might be like, how long do I get to keep them forever? It's like you really just got to get people to that six month, which really means make sure the first 30 days are awesome. And then have a clear way to get them past that third month. And then you basically walk your way to month six. And at that point, churn drops to almost 2% a month. And that's across all categories. All right. So this is just structural how people consume and value memberships or recurring subscriptions of any kind. And so please take this as like, this is where I'm going to focus all of my attention to get people that 2% churn, which means we just got to give them to month six. So let me give you examples of businesses that are not sticky. So education on its own is not a sticky thing. That's why you graduate when you go to school. Like you're not going to go retake the same math class over and over again. Roofing, car sales, these are businesses that do not have a lot of stickiness to them. They're one time shots. Right. On the other hand, a good example of sticky businesses is term life insurance. You sign up for life insurance. You pretty much just pay until you die, right? Alarm systems. Like, you don't really think, oh, I'm going to shop my own system. You have it. As long as it works, you're going to go internet, phone providers, banking, and to use that kind of education, a different version of that for like school, for example, is if you have something that's based on community and something that's based on consumables, meaning people consume it month over month over month, then it means that they're going to want to pay month over month over month. And so if I could only have one thing for of these five, it would be this, right? And so think about like this, let's imagine company and company B. So company one sells a hundred customers year one and then loses a hundred customers year one year two, they sell 200 customers because they get better at marketing and sales and then they lose 200 customers. And then year three, they sell 300 new customers and then they lose 300 new customers. All right. Now company B same time period sells a hundred customers and then loses zero. Year two, they sell 100 customers again. They don't scale their sales and marketing at all. But now they have the original hundred. So now they have 200 active customers, which means they actually have the same revenue. Year three, they sell another hundred customers, they still have the first two and they have 300 customers in total, meaning both of these businesses in each of these years is doing the same revenue of these, which would you pick company A or company B, obviously company B. And so I'll give you two reasons. One that's personal and one that's math. On a personal level, the idea that you could just have no new customers at any given point and then every year after that, you still have your 300 customers who pay you over and over and over again. That helps you sleep at night great. Now from a math perspective, getting 300 new customers in a year is very expensive. So look at how many total customers this business that needed to acquire over that period of time. So they do acquire twice as many customers as company B. All that additional cost is taken out of the profit of the business. But on top of that, getting 600 customers versus 300 and especially 301 year versus 100, the cost of getting that additional customer is not going to be just one X more. Oftentimes it's two or three times more. So it's really almost like getting 900 customers from a cost perspective compared to that 300 that you had to get and spread it over three years. The cash flow of the business, the profitability of the business will be significantly higher and as an owner, way more fun to out. And this is just like me talking to my younger self, building a business that does this takes time. But what it unlocks is compounding. And so the reason that you don't usually want to do this B thing is because you're excited to jump from thing to thing because your current thing still feels month to month. Once you see compounding unlock and you see revenue lock in, you really never consider other vehicles because you can literally just excel sheet out your wealth knowing exactly how big you're going to be in the future because you know the customers you have today are going to be there tomorrow. Real quick, I'm going to show you the exact 10-stage roadmap from zero to 100 million plus that less than 1% of companies finish. I've now done multiple times. And so I can say with a lot of confidence that these are the stages as headcount increases that you need to get through. And I broke each of these down by eight different functions of the business. What the constraint feels like? Like what are the symptoms of it when you're going through it? And then what steps we actually took to graduate? And we've done this across software, physical products, service businesses, brick-and-mortar, all of this and it works. And it's my gift to you. It's aptly free. And so the links in the description, but you just go, "acquisition.com/roadmap", just enter info and it'll spit it right back to you, offering. Now the second thing that I see is like a big advantage is expensive. So what does that mean? In a perfect world, you'd want something that costs a penny that you could sell for a buck, right? High-gross margins means that you can pay people better. Your cash-dune version cycle is typically faster. You can reinvest that cash in more growth. And this typically has higher EBITDA margins. So if you have high-gross margins, you'll typically have higher net margins. And so for example, if I had a hundred-million-dollar revenue business with 10% margins versus a 20-million-dollar business with 50% margins, you'd make the same money at the end. Now, you get five times the incremental EBITDA per dollar made. And that's certainly nice. It's less work for more money. Now this was the topic of my money models book that I spent a lot of time on. And the goal was to see how you can combine things to speed up the money cycle and increase gross margins and cash from the business. So let me give you some examples of businesses that have low gross margins. So grocery stores, right? And a touristy gross small gross margins, farming, restaurants. And you'll notice that all of these are kind of grouped around one thing is because food is one of the most elastic products. So take note to that. But fundamentally, it's really like things that are commodities, which is why the first chapter that I have in the offers book is how to decomodify yourself so that you can increase your gross margins. So you can ultimately get the cash you need to grow. Now on the flip side, examples of good businesses that have great gross margins. Media, I mean, think about it. A podcast read that you do when you've got a thousand people listening or a million people listening takes the same effort and all of the extra that you can charge is just profit, right? Information, that's one education itself. Community access, these are things that have high gross margins, data, software, pharmaceuticals, right? They cost them a penny to make a pill and they saw it for a buck. Lociens and potions, it doesn't cost a lot to create, you know, a supplement you can sell for a lot. All of these things are businesses that have high gross margins. Now quick disclaimer, many of you wonder what you should pick or whether you're in the right vote. And as a reminder, this doesn't mean you watch this video and then like jump ship in your business. But you should at least see the levers that you have available to you to improve the value of the business you have right now. And to be clear, all of these are continuums not binaries. It's not, is it stickier? Not stickies. It's how stickies it. It's not like, oh, this has, you know, zero gross margins or 100% gross margins. It's how, how big is the gross margin and all the way down? So that brings me the third one, which is expansion. I want something that is growing, right? That's the, that's the easiest way to grow is to go into something that's already growing. So if you just do a normal amount, you still grow by default. And so I'm thinking about this more as an industry growing rather than the business itself growing. The business growth would ultimately come down to marketing and distribution. And I can do that. So that's not something that I care as much about. This is a skill advantage to us as entrepreneurs picking the right markets because once you know how to generate demand, then you don't need to always have a tailwind behind you. You just need to not be in a headwind, fundamentally, right? Make sure you're just not fighting an uphill battle. I speak about this in the offers book. And the main reason is this, even if you know how to market in sell going into or staying in a space that shrinking isn't uphill battle. And this is why I use the example of newspapers. Most people are like, I don't really read the newspaper it every single year goes down. If you're like, hey, I want to get into formal education, probably not the time to do it because it's going, it's shrinking by 6% a year. Tobacco shrinking, alcohol shrinking, right? Retail like brick and mortar where you're selling stuff, not to see, can't make money in it. It's just harder, right? Administrative roles, clerical data entry. These are things that are that are shrinking because of technology. And this is just normal and how the world works. Now, the flip side is what are examples of industries that are growing? Energy going through the roof, AI through the roof, healthcare through the roof, cyber security through the roof, e-commerce through the roof, alternative education through the roof. And this is what fundamentally the bet that I made on school was about. The cag are so compounding a growth rate for alternative education is over 20% annually, right? People are tired of traditional education. And this is why platforms like YouTube are proliferating like lazy. People want to learn specific niche skills that are useful to them, which brings me to, Dr. Moore, please. Number four big advantage that you want to have. Air, you want something that has operational scale or low operational complexity and low capEx. So let me define each of those. So low operational complexity means the number of variables that you need to actively manage to expand production. So if I make a podcast like I said earlier and then I sell an ad read inside of that podcast, someone gives me money, I read it and then I hit post. That's pretty much it. There's nothing else. And that scales all the way up, right? And so that's low operational complexity. Now, if I manage 100 restaurants of a chain, I have thousands of employees, I have suppliers, I have inventory that goes bad, I have buildouts, I have leases, I have parking, I have permitting. And there are many more pieces that I need to actively manage in order to expand production, even a small incremental unit. The other side is CapEx, which is just a fancy way of saying capital expenditure, meaning how much money you got to spend to get the business to keep growing. Now, there's a little asterisk on this because I'm explaining why it can be a good thing when I bring up my very last point. So wait and pay attention to the end because it's going to be very important for number five. Now, the reason that this is valuable as a founder is you typically when you need less capital, which means you can dilute less for your ownership, for equity, for cash to continue expanding, which means you can expand faster without needing money from the outside. So Warren Buffett talks about this because he wants businesses that generate lots of cash, not ones that generate it, and they'd have to consistently reinvest that cash in order to maintain competitiveness in the business. And so this is the important caveat. If you raise capital grow faster, you could have all the correct economics. You just want to grow faster. That is a strategy. It's an advanced one. But if you're trying to cap her market share and capture market share has actual advantages beyond the economics of scale, like we'll make it up in volume. It's rarely true. But if it actually is true, then there is reason to go get market share actually have some sort of network effect. That makes sense. In my experience, it's very rare, right? School is a great example of actually it doing it right. Additional users to school do not cost very much. But getting everyone on school is worth doing because there are strong network effects. And so it's worth us putting more cash in now rather than taking distributions. Said differently, taking that cash and putting it into the business yields tremendous ROIC, which means return on invested capital. And if you have great ROIC, then you become a magnet for money. So this is just a little pro tip. You should never have any difficulty raising money if you're in a business that's like that. Because if you do, it means that you need to make the deal better. Let's say you have a restaurant chain and you want to grow it. And to be fair, I think it's a very tough thing to do. But if you wanted to grow it and you're like, man, I can't get people to invest in my franchise or one of my franchise locations. Like how do I have a better marketing strategy? For sure, there's things you could do to market and sell better. But if you come to somebody and say, hey, it costs a undergrad to open my thing. You'll take three years in order for you to get your money back. That's kind of like a mediocre-ish offer. If you say it's going to cost 100 grand to do my thing, and then you're going to make $300,000 back on average in the first year, that's going to be a significantly more a-ticing offer. And so for most people who want to use outside capital in order of scale, the reason they can't raise it is not because they don't lack some big skills because the core economics of the thing they're trying to scale just aren't that good. And so the fifth and final is unique. So you want a competitive mode, something that no one else can build. Now, part of what can raise the bar and create a larger mode is the number of people who can afford to enter the market. So if you have a market that is virtually no barriers to entry, you'll have a lot of competition. And this can be a huge driving factor. So for example, social media marketing agencies, the bar is virtually nothing. It can be sticky. It can be high-grossed margin. It is kind of an expanding thing. People always want more customers. It can be air from a capex perspective, but from an operational drag perspective, it's not as good. Now with AI, it can actually become really interesting. But the main issue is so many people can do it. And that's what makes it so competitive. And that's ultimately what drives down. The price is very difficult to differentiate. Now, let me explain what I was saying earlier about capex as a way to have a mode. So if you are competing against every human being who has hands to dig holes, if you buy a shovel, you'll be significantly better than people who don't have a shovel. And that'll cost you a little bit of money. That'll make you more efficient. And so in a way, you can actually use capital that you do to invest upfront into building things that make it less competitive for you and more competitive for other people to try and enter your marketplace. This is why building a power plant is probably very profitable. It also costs a lot of money. And so these are things that you can do to any business. If you find a way you can have return on invested capital for things like technology, for things like equipment, those become modes that make it more difficult for other people to enter, which means that you'll have more pricing power. And so once you start to see some success, I like getting into businesses that cost some capital to expand because it just means that I have fewer people that I have to compete with. Now, after this point, I've only talked about capital as a kind of mode. Now to be clear, it's not indefensible, but it's better than nothing. But the best kind of modes are the things that you know how to do, but no one else can do. So for example, NVIDIA chips. This is something that costs a ton of money and has incredibly specialized skills as a result. They're one of the seven most viable companies in the world, right? Pretty wild. Nuclear energy costs a lot of money and is something that's super proprietary and not a lot of people know how to do. If you didn't have the capital, then it would be recipes, processes, patents. These are trade secrets. You're special sauce. And just as a side note, you're like, what differentiates, you know, like a trade secret from a patent? Well, patent just requires three things. It's got to be new. It's got to be non-obvious and it's got to be useful. Those are from the patent office. I was just thinking about what are the things in my business that are brand new that I only do that are not obvious and that are useful? Those things are patentable, right? Kind of cool. Now you have to defend patents, which is another story, but that's a way of creating a vote. Now, one of my favorite ways of creating a vote is creating a brand. You can make anything that's commodity, unique by adding a brand to it. So, for example, Revlon is kind of like a mass market brand for beauty stuff. You can get it at CVS, whatever. Anyway, I think, oh, that's a, that's a cheap brand. Now, the point though is that even if Revlon is cheap, it's still a little bit more expensive than White Label Generic. So CVS might have some CVS brand makeup, right? Revlon's can be a little bit more expensive than that, but they literally will come off the exact same manufacturing belt and they'll stamp on Revlon and they'll stamp on CVS and they'll ship them there. And that premium converts a higher percentage of people at a higher price and increases the stickiness. And so a brand is one of my favorite ways of taking something that's otherwise a very normal service and making a vote or making something unique about it. So let me give you a different example that that manages some of these, all right? So Coke requires capital to enter new markets, but it gets great returns on capital. So people are happy to provide it or it can provide capital to itself and get returns on its own capital. And it has patterns for the flavor of Coke and the brand itself. And so these are things. And if we're looking at this, right? When people start drinking Coke, they usually keep drinking it for a long time. It costs a few pennies to make a can of Coke in terms of the liquid inside of it, but they can sell for a lot more than that. Now, is it expanding as a marketplace? I think Coke's pretty global. And I guess the only expansion is just more human drinking stuff. So I guess there's probably right now still some expansion that's happening from an operational scale perspective. This is one where it's a little harder. Now, is it easier than scaling and accounting firm globally? Absolutely. Is it harder than scaling software globally? Yes. And so it's kind of like in the middle on this one. And then unique, what it does to create that uniqueness, so shastocola doesn't take over the market, right? Is it has the brand and it has its recipe? And so those are the ways that it creates something that is harder to usurp, which is why Warren Buffett's been a long time investor in the business and it just continues to grow and print money. And so that's what you want. Now, you're not going to have something that has all of these. It's very, very hard to do that. There are trade-offs, but the perfect business would include many or all of these. And if your business includes none, that's okay. Work at retention first and then backfill the rest. But if you're in an industry that has no retention, then switching to one that does, if you're early in your career, may not be the dumbest decision. And so if I were starting it all over again, this is what I would look for in a business that I'd want to start. Ideally, something that people keep buying, something that is expensive relative to what it costs me. It's in a market that's not going down at the very least. There's less operational complexity in order to scale. And it's unique to me or at least I know a way to make it unique to my customer. Real quick, I'm going to show you the exact 10-stage roadmap from zero to a hundred million plus that less than one percent of companies finish I've now done multiple times. And I broke each of these down by each different function of the business. And we've done this across software, physical products, service businesses, brick and mortar, all of this and it works. And it's my gift to you, it's aptly free. And so the links in the description but you just go act as an.com/roadmap, just enter info and it'll spit it right back to you all free. (upbeat music)