
The 40% Rule - jhonovich
http://avc.com/2015/02/the-40-rule/
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toast76
I'd never heard of this rule, so I can't say it was planned but I've just done
the maths on our startup ([http://macropod.com](http://macropod.com)) and
we're exactly on 40%.

I certainly didn't use this equation, but our monthly expenditure is
controlled quite heavily by our growth rate. So maybe there's something in
that....I think I'll go work out whether this hold true for various growth
rates using our method...

FWIW:

\- I have a spreadsheet which maps out our revenue and expenses over the past
2 years.

\- It estimates our future growth

\- It combines that with our bank balance and our expenses to work out an
"optimum burn rate".

\- We use this number as a guide to how much we should be spending.

The "optimum burn rate" is the spend that will see us use as much of our cash
as possible without us dropping below a certain threshold (which at the moment
3x our monthly burn).

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fragsworth
Maybe I'm missing something important, but I don't see any rationale behind
this. What makes 35% or 45% worse than 40%?

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GICodeWarrior
I would guess he is suggesting that less than 40% means you are over-spending
or under-performing and more than 40% means you are under-spending (eg. you
should invest more in growth).

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mc32
The way I read it, it was more like a rough guideline rather than a strict
rule... but when you put something forth as a guideline, it does not sound as
crisp and presentable. I mean, there is no basis put forward, simply said
someone uses that figure when they want to get a rough idea bout a company. I
imagine once something passes that filter, they would do a more thorough
analysis.

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hammock
You could apply the 40% rule to personal finances as well. If your
income/salary is increasing 20% a year, put 20% into savings. If your income
is increasing 5% a year, put 35% into savings.

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brd
I disagree, in personal finances you aren't afforded the same kind of burn
rates because there isn't an investor model for individuals. If my salary has
increased 100% YoY for the last 3 years, I would be in a troubling amount of
debt.

This applies in reverse as well, if you take a salary cut you likely aren't
going to be able to save more money as a result.

For personal finances I think its better to tease out a baseline amount for
expenses and save everything above that, re-calibrating occasionally as
required.

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nostrademons
This is exactly what people do when they go to school: they take on huge
amounts of debt in order to make their income grow by >100% YoY for a few
years.

Very few incoming college students know enough about finance or exactly what
different choices will payout to make smart trade-offs in this area, but this
reasoning is pretty common with MBA and Law School students. Occasionally it
even works; I've known a few young lawyers who ended law school with $200K in
debt, but it was paid off within 4 years and their income was roughly 8x what
it was before law school.

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jsprogrammer
Some go to school to learn.

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Anderkent
You don't need to go to school to learn, so if it's just learning you're
interested in school isn't a very good investment.

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jsprogrammer
Where can one go to learn lab chemistry or biology? High energy particle
physics? The list can go on and on...

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ukigumo
I think this rule is a nice generalization overall but for my money I would
discount natural segment growth from the company's year on year.

So, if the market (ie mobile payments) is growing 50% YoY and the company is
only growing at a rate of 25% that's actually pretty bad.

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pc86
Would you always expect to grow at a rate higher than natural segment growth
for a "good" company?

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ukigumo
That's a though question as there are always exceptions to the rule but
generally I would be cautious in investing (money) in a company that is
growing slower than its sector would allow for. However I would happy to
invest time in such companies, but that's because I'm a consultant :-)

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dazne
This works as a good "rule of thumb".

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cperciva
_Your annual revenue growth rate + your operating margin should equal 40%_

My immediate reaction: So I guess I need to cut Tarsnap's prices and slow its
growth rate?

On further thought, I suspect "should equal" should be "should equal or
exceed".

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applecore
It means Tarsnap isn't spending enough on growth.

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cperciva
The only way Tarsnap could have growth rate + profit margin equal to 40% is if
it was losing money. Given that Tarsnap is bootstrapped, that's not an option
for me.

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graeme
>Given that Tarsnap is bootstrapped, that's not an option for me.

Indeed. I think the advice is for VC funded companies. Whole different
ballgame. In the ideal case, VC funding lets you grow faster and ultimately
make more money. Whereas bootstrapped companies are constrained by the
requirement to make at least some money from the getgo.

On the flipside, this constraint of bootstrapping ensures that we actually do
make money. Whereas in the less than ideal case for VC the outcome is zero for
the founder.

(Bootstrapping can result in zero too, but you usually find this out faster
than in a startup.)

There are tradeoffs to either method. I prefer the bootstrapped way. But you
can apply that rule to a bootstrapped business to some extent: if your budget
allows it, then it can make sense to trim margins if your growth rate is high
and you can increase growth by spending.

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michaelochurch
This literally means that you can lose as much money as you want as long as
you grow at a stupid-fast rate. It doesn't matter what you're building or
whether anyone wants to pay for it, as long as you get what the monkeys call a
"hockey-stick curve".

You're OK even if you literally win at losing. Good to know.

This explains so much.

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mmastrac
It's not user growth -- it is revenue growth.

If you've got a hockey-stick curve for revenue and you're losing money, that's
not necessarily a problem (within reason). At some point you can start
spending less on user acquisition/marketing and you'll go from losing
money/growing fast to profitable/growing slower.

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michaelochurch
This explains even more.

I've noticed that a lot of startups delay making _any_ revenue, and that this
might not be for bad reasons, because plenty of companies start to really
suffer once they start making revenues (but fall short of what they "should"
be seeing and how has they "should" be growing) not because there is anything
wrong with them as businesses, but because their ADD investors lose faith and
interest.

So now it makes sense that companies would delay revenue until they have
enough of a free-tier footprint that they can control revenue growth for a few
years and ensure exponential growth (this may involve intentionally tamping
down early-year revenue in order to have a sharp upward trend).

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ForHackernews
That makes sense. If your company doesn't have revenue, it _could_ be worth
200 billion dollars! Once your company has actual revenue, it's pretty obvious
it's worth whatever it's worth.

It's advantageous to remain in the mystery-land of hype and unrealistic
expectations as long as you can keep drumming up easy investor money.

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chucksmart
When I was in school the professor said something about interest rates and
opportunity costs that was more algebraic than arithmetic; but I guess that is
all academic.

