Why Most Companies Die After Hitting $1M Revenue | Ep 300 with Yarin Gaon Founder of Fractional Partners

0:04So Yarn, it's great to have you because something I've been wanting to talk through is when companies tend to die. I know and I've seen this before where there's revenue milestones and then immediately after that revenue milestone is a place where many times companies die. And founders don't really know this going into it. I think a lot of people just go into business, but they are not prepared for these things. I know you have said that companies die from indigestion, which I hate indigestion. So why is the journey from 1 million to 10 million what you would call the graveyard for founders? Yeah, so these are just different stages.

0:45So if we take a company's life cycle, you start by hustling, right? The zero to one, zero to two. And it's a stage where you grow by adding more. You add more product, you add more revenue stream, more type of clients, and you try to see what works. But once you hit that milestone, usually, it depends on the company, anywhere between$1 and$2 million, you have some traction, some market fit. But now what happens is a lot of founders try to apply the same logic that they use to grow the hustle mentality, and it doesn't really work. And I'll give you an example. So they try to add more products. They try to add more type of clients.

1:27They try to add more revenue streams. And the challenge is that these are still very small companies. And at that stage, they really enter what we call an adolescent stage. It's almost like a human. Just like a company, there's infancy. That's the zero to one, zero to two. And then there's an adolescent stage where a company decides what it wants to be when it grows up. And a lot of companies or a lot of founders miss that step where they have to decide what are we exactly. So we did a lot of things with multiple different amount of products, multiple different types of segments. But now there's the question of, OK, so what am I scaling?

2:04And a lot of founders never ask that question. So they try to scale everything. If you try to scale everything with a capital constraint, which is meaning that I just don't have enough money to do all of these at the level that I need. That's where they fizzle out, a lot of them. That's where a lot of great companies, if they don't die, then they just they stall. and they waste a lot of energy and money kind of trying to figure things out. Does that make sense? It makes total sense. I think there's a misconception that if a company gets to, let's say, a million dollars, they're going to have so much or$2 million.

2:39The profit margin is going to be so much. I hear this a lot. Like, I want to hit one to two million. I'm going to make all this money. But I don't think they realize that many times they're not still taking home very much money. What are you finding once somebody gets to that one to two million, how much money are they really taking home? And then what has really changed? It's really an interesting question. The answer is at a one to two million dollar business, it's still a lifestyle business. So profit equity doesn't even look at these kinds of businesses. They're way too small because if you actually take the cost to replace the CEO or the founder, a lot of time, either they make very few, very little amount of money or don't make any money at all.

3:20So you said$2 million company. Great. It's 20 % net. That's$400 ,000. Okay. But now if I'm an investor and I need to put someone else in your shoes, it's going to cost me$100 ,000,$150 ,000, $200 ,000 to replace. So now the company is making$200 ,000. Not as attractive. So it's just, it's not the end, right? Zero to two or zero to one is the beginning of something that you've proven that something works you found some success uh it's very hard to exit at that stage at a like a life-changing amount does that make sense yeah so got it okay so i've hit the one to two million mark i've proven the concept i want to scale this thing because i want to exit where do i typically need to be in order to even even have start having a lot of these conversations where I can exit to something that could be very life-changing money?

4:16Interesting conversation. So the short answer is it depends on the industry and it depends on what you do. But let's talk about regular businesses, not highly valued startups. Regular businesses start to become interesting to a sophisticated investor like private equity around$2 million EBITDA. And EBITDA is basically a different name for a net profit if I put back the cost of the owner that I need to replace. So with$2 million profit a year, you start to become interesting enough to sophisticated investors that can pay a significant amount of money. And to get to a$2 million EBITDA, you have to build probably anywhere between$10,$15 to$20 million revenue or sales a year business.

5:01Assuming that most businesses sit between like 20 % profit to 10 % profit depends on the business. That's our goal, right? Like that's the hope. I know you've exited some companies. Was there a few things or something that you learned when you exited maybe the last company or a company before that? Was there something that you learned that you said, you know what, every single founder needs to know this? Yeah. So I learned or I learned a lot of things when I sold my last company. But what I really learned is from working as an entrepreneur in residence at a venture capital firm and mentoring hundreds of founders.

5:36and what I saw all these founders that come at the at that stage that we're talking about like at the two to twenty million dollars so I found some product market fit but I'm still in the adolescent stage I found that all of them really have one major challenge that is preventing them from moving forward and that challenge or that that gap that they're missing is is clarity so I'll explain what I mean by that. Clarity is the ability to really understand your business to the granular level, and then make sure that everybody in the team share the same mindset. So I'll try to explain what I mean by that.

6:17When you approach growing a$5 million company, a$2 million company, a$3 million company, it's not just you anymore, probably. You probably have a core team in place. You are trying to leverage other people's abilities. And what usually happens is that founders and teams feel tactical pain. It looks like our cac has gone up, or our churn has gone up, or our campaigns are not converting anymore, or we have a low conversion. Many, many, many different pain points that are now starting to emerge as you grow. But the challenge is that all of them or nine time out of 10, they're looking for like a tactical answer.

7:02What should I do? And what I found after working with 100 of them is they're asking the wrong question. Usually they're facing this challenge because there's a question that they never asked, they never answered upstream. So it's kind of ambiguous. I'll explain one minute. So for example, if your CAC is going up, yeah, you can try a different campaign, but maybe the problem is you're not clear on what kind of segment you're trying to pursue, or you're trying to pursue too many segments, and it's not really clear what is the value that you're providing to them. So your marketing messages has been diluted a little bit.

7:37So that's the problem. So the idea here is if you fix the upstream, or if you ask a couple of high-level questions and you agree on them as a team, everything else becomes easier as you execute. Does that make sense? A little high level, but it's the key that I found. If you are clear on your finance strategy and operations, mostly on your strategy of accepting what am I building here? What am I building this for? What is my revenue roadmap look like? What do I do better than anybody else? These are just simple, not easy to answer, but simple question that if you answer as a team, you get a mental picture that is shared, these tactical decisions become easy because you know what needs to happen.

8:26Does that make sense? Yeah, I think that one of the biggest challenges is that you have to do so many things because you don't have enough money normally to hire a big staff, to have a big team. Obviously, there's a lot of tools and things nowadays, but you still as a founder have to do. And if you're the only founder, you have to do a lot of things. You have to wear so many hats, which is stretching. And you never really take a chance many times to just stop and plan. Correct. How did you look at this? That's the key, right? The planning piece is the hardest part, but it's the highest leverage one.

9:04It's the most impactful one. and the challenge is, or the way that I like to think about this, if you don't find the time to plan, then you take the little time you do have and the little resource you do have and you just waste them. Because instead of saying, okay, I'm going to focus on X because A, Y, like A, B, C, and this is the reasoning and this is what we decided and I'm going to put all my eggs on this activity or this path and I'm going to commit to this. But because they didn't do that process, not because they can't, but because there's missing knowledge of how to do that practically, they don't do it and they just react.

9:43And the reaction basically takes all of their energy and instead of directing it like a laser to a specific area, it just disseminates and becomes very wide and ineffective across multiple areas. That's the shift of shifting from a hustle mentality into a adolescent mentality. Something worked. now I need to be able to say no we're not doing this and the ability to say no comes from planning if you missed that step it's super hard for you to say I'm not going to pursue this kind of campaign I'm not going to pursue this kind of client we're no we're not developing this product because you skipped it that make sense it makes total sense how did you fit the planning in because I think the other thing is, yeah, we're running like our pants are on fire.

10:33Like things come up, you start to do something and then you get a phone call and then it throws your whole day off and then you get this. It seems like there's always things that are popping up, but you could work really an unlimited amount of hours per day many times in the beginning, right, in the earlier phases or maybe even later on too. There's always something that you could be doing. How did you plan your day? So you start with, so the day is a byproduct of a larger decision. So the question is, how do you actually plan what kind of business you want to build? And the reason is you use a system.

11:09Just like we have EOS, which is an entrepreneurial operating system. EOS is a great system to systemize chaos or to clean chaos, right? To make sure that everybody's going in the same direction. So you use a system and a system has a cadence. So EOS has like the daily cadence, the weekly cadence, the quarterly cadence. You do the same for planning. So what I've built is I basically built a system. It's publicly open, so everybody can use it. It doesn't cost anything. I want to put it in the ecosystem. It's called the Clarity Playbook. And the idea is just like you have a system for execution, which is EOS, you need a system for planning.

11:48and that system for planning comes before the execution and sits on top of it. Meaning that you first start with the planning, you figure out where cash is coming from, what business model you're pursuing, and then what needs to happen. Then you take these insights and you bring those to your entrepreneurial system. What are we doing tomorrow? What are we tracking in the scorecards? What quarterly priorities are we creating? And it's a waterfall effect. You bring a system. You know what, EOS, I know many people that have, when they implemented the system, it completely changed their business. Like pretty much everyone I know that did that, that took the time to implement the system.

12:28The problem was implementing the system, right? But I love that. I love that you have something for free, you know, a great resources that, you know, that people can use. Can you go into more about, you said something early on, like you have revenue streams and then all of a sudden you add more revenue streams. And I don't know if that's a good thing or a bad thing. When did you in business look at diversifying or adding in different revenue streams? Oh, that's a great question. So let me start with like the idea. Profit is an average, right? It's an average of all of your revenue streams. Some revenue streams bring a lot to the end profit.

13:10Some revenue stream might be even costing you some of your profit. So the idea here is first to get clarity on where money flows to the business and where is actually profit coming from. And it's not the same as sales. Sales are very hard to see. I can see that this revenue stream bring more money than the other revenue stream. That's great. But the second stage or the more interesting question is, okay, where is the actual profit coming from? because you might find that a single revenue stream is responsible for a very small amount of sales, but it produces most of the profit from the business.

13:45And I've seen this multiple and multiple times. So first, you have to identify what brings the cash or what really brings the profit more than the cash. Once you have this, then you ask yourself the question, okay, what am I doing today that is not contributing to that revenue stream? So to answer your question, I would even think about adding revenue streams. I would think about eliminating revenue streams and say, okay, I have three revenue streams, four revenue streams, which one of them is actually producing the most profit. So if I focus on that one alone, I'm going to become more profit without needing to develop more revenue streams.

14:24Does that make sense? So the idea here is to growth by subtraction, not by addition until you reach a scale where you can add more product at the $20 million mark,$30 million mark. But a$5 million business is still, at least in the U.S., infancy. It's still at the beginning. You have so much more to explore inside a specific revenue stream than just say, I want to add more. So it's a mindset shift. Does that make sense? Yeah. Some of the best companies I know, they make like one product. Like they, they just, they're like the, the world leader of one product, like water or like toilet tissue, like something they become like the best, the, the industry leader in that one product.

15:10And then where I know other people that are, are barely industry leaders in anything. And then they add a bunch of stuff and it just becomes very complex and complicated and they might not survive. But I, I really like where you're going with that. I want to go back in time for you, though. When you were 14 years old, you started your first business. When you looked at when you were younger, before you, let's say, exited one or two companies, what did success look like for you? What did you tell yourself, when I do this, I'm successful, compared to now, when you say, okay, when I do this, or this milestone, now I'm successful?

15:45Oh, wow. That's a really interesting question. When I was 14, the measure of success was to be able to afford a car, right? That was my measure for success. I think that's a really interesting question about success. It's success metrics. So I want to touch on this from a different, I learned the value of success metrics. So let me just expand on this for a moment. So I learned the value of setting a right success metric. So a lot of companies measure their success with revenue. I want to be a$10 million company. I want to be a$29 million company. But that doesn't really add a lot of value when you need to make decisions because there are multiple paths to get to an end result.

16:30the more interesting thing and what I preach and I it's part of my playbook and I push it that you want to create a success metric that is a little bit more interesting and connected to your problem solution thesis and I explain what I mean by that basically why are you why did you start this business what are you really trying to achieve and finding success metric that is not just revenue that tells you if you made it or not. Because once you have that, when you come to a decision, you can apply a filter. Does this is going to, is this decision going to help me get the success metric? But if the success metric is just a number or more just a revenue number, it doesn't really tell me anything about what path I should take.

17:17The power of a really sharp success metric is much more powerful than any just like revenue goal. Why do you want to be 20 million? Sounds like a nice number. Versus I want to impact 10 ,000 people with my solutions because XYZ, much more interesting success metric. I want to have this framework in the hands of 100 ,000 founders. So just like EOS is in hundreds of thousands of businesses, and it's a great system, and I use it in all my portfolio companies, I want to take this system, this planning system that I developed and bring it and have it actually be used by individual to help them make smarter decisions.

18:01Because I believe if you have strong team and you just are able to help them make slightly smarter decisions along the way or more logical decisions, they rock. And that's where I draw my pleasure, right? Smart people plus direction equals enjoyment for me. I don't know how else to say it. Yes. I like that. We had Gino Wickman on before, but many years ago, right when he had exited EOS. So that was an interesting conversation. I was listening to the NetJets founder. I think he's like a billionaire founder. And he said a comment. I thought it was interesting. And I wanted to hear if you've had the same thing.

18:45they were asking him about his watch collection and he said watches have no meaning to him like he doesn't really care about watches when he exited his first company he bought a watch and he made that his success metric in the sense of like every time he has a milestone he buys a watch and his watch reminds him of that success do you have anything in your life where you're like okay every time i do i hit a milestone or a success every time i attach it to something else The short answer is no, I don't. I don't attach it to something else. In my world, success is almost like micro successes along the way.

19:25Because what I'm really building here is like this different category that doesn't really exist. It's really hard. It's really, really hard. So my successes are micro successes. So when people deploy that playbook on their own company and get an aha moment, that's a success. When people start saying no to stuff, that's a success. When people come back to me and they have like, oh my God, I understand now, or I know the path. This like moment of pre-confusion, post-confusion, that's what I celebrate. That's what keeps me in the game. That's what I celebrate. I don't buy a watch, but it makes me feel really nice.

20:06We had another guest on who talked about passion without profit. And he was talking about longevity. He's a doctor. He said, everybody needs passion without profit. And that's what they're finding is something that keeps people living longer. So that's what it sounds like for you. It's this free resource is bringing a lot of passion without profit as a focus for you, which is amazing. If you reach a level of success and you do certain things and you have the ability you might as well do something to give back. And you're making a big difference for people all around the world. I hope. So this is like, I want to be completely transparent.

20:45It's not a not-for-profit, right? Because I give away the playbook because I believe the knowledge should be free and there isn't a secret to scale. There's no secrets. It's just better planning plus good execution. And the planning part is what I'm trying to solve. My monetization or how I get paid is when companies want to do it with me. So when I take that playbook and I deploy it on them, and I act not just as their implementer, but as their thought partner, answering these questions as we propose them, right? So when we talk about, okay, so what is your strategic advantage, instead of just facilitating, I act as a seasoned investor coming in as I was your co-founder, how would I answer that question if I was in your shoes?

21:24So it's not fully not for profit, but I wanted to mix the two between what I love doing and what I'm good at and what I want to do for my life, like do grow into. So in 10 years from now, if I have a success, that would be me working with 10 to 15 founders in my portfolio deeply, because that's why I like to get my hands dirty and just like be a part of a lot of smart businesses. I just need someone to help them kind of zoom out every once in a while. So Yaren, and I appreciate you sharing those things. what is the system? Can you talk about what is the system? Is there two or three things that people can listen to this right now and that they could take away from this?

22:20Because I'm sure they're going to need the whole system. And I imagine it's a long-term thing, but can you dive more into it? Yeah. So the system or what we call the clarity playbook is basically the same private equity playbook that I would have deployed if I bought your company, but I'm giving it away without buying your company. So basically, this is what a private equity firm would do to your business if they bought you tomorrow. But instead of selling, you can just take it and do it yourself for your own business. And the idea here is really just to create three sources of truth of one pagers, financial one pager, strategic one pager, and an operational one pager.

23:04And I believe that if you have that, we call it those clarity canvases. If you have those, everything becomes easier. So the system is basically just a series of workshops and modules. It's in Notion. You can do it yourself. You can do it with your team. Where it just, it walks you through how to answer each question. Question like, who's my perfect customer? Or what are they truly buying from me? Or what is our ultimate goal? Or what is our revenue roadmap? And if you have answers to these questions, everything becomes easier. And that's the missing piece that I found in these other lessons companies was they just become explicit and they align with their team.

23:44Everything becomes it. It just flows down. I would think, too, now you could plug this into AI and you could maybe work with AI to helping you along the way. But you don't have to go it alone because maybe they don't have a big team or maybe I know people that don't have any team at all. Maybe they have a few outsourced employees or virtual employees. Do you think you can leverage? Obviously, it's in Notion, but can you leverage technology alongside the system if it really understands your business? Absolutely. It's just this system really is just a bunch of questions that you ask. Financial questions, strategic questions, and operational questions.

24:24So you take that question and you ask Chachapiti or you ask your employees or you just have a discussion. It can be with AI. It can be with your team. It can be with your spouse around, okay, what do we actually do better than anybody else? For example, it's one of the questions. Ask. I use it with Chachapiti all the time to answer and reflect on questions because even if you answer it, stuff changes, you learn more, business evolves. So it's almost like you're taking a snapshot of what you believe to be true today. Then you take it and you refresh it. So the strategic clarity canvas is like once a year.

25:01And operationally, you can refresh it once a quarter. Just different questions at different times. If you answer, you get clarity. If you get clarity, you do less. And you become more impactful with what you actually do. You focus on the stuff that actually moves the needle. That's my core belief. I like this clarity. I feel like we always want to say we're hustling, but in reality, nobody really wants to hustle. Nobody wants to really do that, but we feel like we have to say we're doing that. So I like the clarity and starting early, implementing things, like you said, before you're getting to the phase of private equity.

25:37Why would you not start at day one? Maybe you had$200 ,000 a year,$500 ,000 a year,$300 ,000, start it now, build up. I don't know if a lot of people really understand those. So if you're in business and you're getting to these milestones and you're starting to get approached by VCs and you're starting to get approached by private equity, I don't know if I even understand what is the difference. Yeah. So let me explain. So I came from VC. I used to be an entrepreneur in residence, which is basically a fancy name to say I was the entrepreneur that the fund sends to their portfolio company, the companies that they invested in, to help them grow.

26:12And specifically what it is, is I fixed them, fixed the broken ones. But let's talk about VCPE. The major difference in VCPE, there are a couple of differences. One is stage. So VCs can invest in different stages. Most of them invest a little earlier, a little bit more risky. Usually PE comes when a company is a little bit more mature. So that's why we said$2 million EBITDA. When they have some predictable revenue, stable team, the mature companies tend to go to PE and the slightly more risky one, disruptive one goes to VC. So as a founder, the first question is like, what kind of company are you trying to build?

26:56And what kind of growth are you looking for? Are you looking to double the business year after year? And it's almost like playing a binary game. either you make$100 million or you fade. That's like a more VC type of investment, right? It's a little bit more riskier. They play a portfolio game, meaning that they invest in 20 companies knowing that 16 are going to fail and that's okay because it's baked in because the other four, really one or two out of the four is really going to make up for all their rest. Versus PEs that are a little bit more hands-on, depends on the PE, working with mature businesses, value profit over growth, So their success metric is EBITDA, which is net profit, versus VC might value just number of users or year by year growth.