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Musings On Operating Models

When you're at the low end of the market like we are, there just isn't that much cashflow to do stuff with. That work is done by you (+ team) or doesn't get done. If you're trying to operate them profitably, you're left in a tough situation.

Andrew Pierno

Jun 18, 2021 — 9 min read

We're still in the throughs of figuring out how to operate the 3 companies we bought.

When you're at the low end of the market like we are (for now), there just isn't that much cashflow to do stuff with. Stuff namely being hiring people to do work. That work is done by you (+ team) or doesn't get done. If you're trying to operate them profitably, you're left in a tough situation.

I knew going into this it was going to be 'a lot of work'. I did not anticipate how much. I did not foresee an 11PM Sunday night database migration. I did not foresee rewriting 2/3 products from scratch. Perhaps I should have.

We're still working on a playbook. PE firms have them. They work well for them. We'll have one too. Maybe it's bullshit, I'll let you guys know. I'd say in a few months we'll have a decent engineering playbook. That playbook, if it were a book, would be titled "How To Win Developers For $20/hr and Influence Software Design". In all seriousness though I do think we've done well at finding good, JR talent and focusing on editing code vs writing it all ourselves. Except, of course, for Toybox. You couldn't pay me enough to go through that codebase. Nor apparently could we pay any dev shops either. Unsurprisingly, even outsourced talent has a limit of shit they'll take. I'll save the engineering playbook post for after we successfully relaunch Toybox. All that was to say that we're taking any and all cash sweeps to pay down technical debt for the next 6 months. And by technical debt I mean we're setting the fucking thing on fire and starting from scratch.

With respect to operating the companies, I/we haven't congealed on an operating model yet, but there are two experiments I'd like to run. One of which we're doing by default (running them ourselves). The other will have to wait until we can buy something with enough cashflow to support a skeleton team or grow one of the ones we own up to that point.

Roughly, there are two options after buying a micro-saas. Do nothing or do something. Doing nothing has it's upsides... you don't have to do that much. You can tell your friends that you bought a passive income stream. You'll probably get some good tweets out of it and maybe feel pretty good about things for a few months. But that belies the reality of these things... they can go to zero. Maybe Henry, one of our partners can tell the story of his very first acquisition (a content site) and how it went to zero (like actually zero).

Let's get into some sketches on what I think works for acquiring and, more importantly, running tiny SAAS companies.

Models 1 + 3 are good entry points. You want to move from model 1 / 3 into model 2. Model 2 should start looking and feeling like a regular ass SaaS company. Good.

Model 1 - You bought a job (A.K.A the one (wo)man band)

Congrats, you just bought a job. Being CEO of a micro SAAS might either make your mom proud or sound cool at your first cocktail party in 18 months, but the reality is much more modest. Micro SAAS companies are often labors of love. Founders put their heart and soul into this little project and typically spent an absurd amount of time figuring out product market fit (or some semblance of it, let's call that product market foothold for anything with < 100 customers or $10K MRR). That's great news for you as the buyer, you get to skip that. You probably bought it with some ideas on how you'd grow it, or some kind of angle or unique insight the founders missed.

There is absolutely nothing wrong with buying a job. In fact, I was speaking with Nile from https://www.nocode.tech/ / Concrete Capital. He bought a job, and then turned that into an anchor (See Model 4).

This section is mostly here to tell you that you bought a job, if you're reading this to figure out how to operate a company, god help you.

The process I see for regular micro SaaS companies is something like Build => Grow. If you buy something and don't have to touch the code, that would be the ultimate. I've heard other companies like ours say everything from 'make sure the tech is rock solid or don't buy it' all the way to 'screw the code, you're buying traffic and customers'.

Whether that 'Build' phase is just a check to make sure everything runs like you think it does, I still think it's step one. If you can't trust the product to work when you sleep, how in the world is the thing supposed to make $$ when you sleep! Also nothing ruffles my feathers quite like customer support.

The 'Build' phase to me is complete when you have at least one (ideally two) dependable devs to build incremental features. For tiny companies, they can be contractors but they should know the codebase well.

Once you are comfortable with the tech (or became comfortable because you had to write the damn thing over yourself) that's when you can start the 'Growth' phase. Ideally when you bought it, there was at least one channel that showed promise. If so, step on the gas, see what happens. Test all the usual channels getting enough data to objectively say a channel is revenue positive or revenue negative. The good news is that I believe only one channel needs to work well to get to ~$10k-$20k MRR.

Model 2 - You hire an operator

This is the model I want to dig into a bit as I'm certain it will work, it's just a matter of figuring out a minimum run rate it will work at. I think it's roughly $200k ARR (from a North American perspective). That number might be lower where you are (opportunity?) but we'll circle back to this.

If you naively thought you were buying a passive income stream (slightly guilty on this one) and found out you actually bought a job (guilty again), then this is step two. There's no way for us as a fund to continue not only stacking funds but also stacking companies if our heads are in the weeds operating time. So we can't do it long term, but someone has to.

Here's the rub. Hiring a full time person (even just one) is expensive. If the business only does $5k MRR, that doesn't leave much room for a salary.

PE firms buy companies with people. Those people run the business, or used to before they were bought. The PE playbook varies widely, but let's look at a common one: Fire + Squeeze. Step 1 is fire some business unit(s). I'll run through a somewhat recent example. Mind Body, a fitness company your S.O. has probably booked a yoga class through at least once, went public. That didn't go so well. A PE firm came in and guess what they did? They fired the sales people. The balance sheet looked great without a large cost center like a sales team and they made the math work with a reduced sales force. The squeeze is to get as much cash (or as little churn) as possible. You can't do this with a micro SaaS. There's no head count to cut, and hardly any customers to squeeze.

Another common play is to put the PE firms employee(s) onto the board or into senior leadership. This also generally involves firing people (as is tradition). This also doesn't work with a micro SaaS. There's just you buddy! Though shalt not fire thyself!

At face value the concept of 'We'll take the PE playbook and apply it on a smaller level' is a good idea. It just seems to have a minimum floor value of cashflow to work. And micro SaaS's tend to be under that threshold.

So, we sort of need a different playbook for micro SaaS. Here's the experiment I'm going to run as soon as we either buy something with enough cashflow to do it, or grow something until there's enough cashflow to do it.

Hire a 'JR CEO'. I don't think I "invented" this, but I really love this concept of hiring a JR CEO. Someone who effectively is CEO but reports to you. You can edit instead of write from scratch. Quickly course correcting will be much less time intensive. Also, I believe most decisions are two way doors, you can easily go in, and come back out if you were wrong. Not only would this be a cool opportunity for someone a little earlier in their career, but it would free up the partners time to repeat the model.

I think you need $200k ARR to do this. Here's my math:

1 JR CEO - $50k. Not sure if you could find someone for $50k, but you should be able to be scrappy and make it work. Somewhere between $50k and $75k sounds reasonable.

1 Developer - $50k. I think you could get someone out of a bootcamp or a more senior person in another country. Devs in LA are $10k. Devs in Viet Nam are $3k. Devs in Morocco are $2.5k.

Expenses - $25k. Server costs, support system, other bullshit

Marketing Budget - $25k. This is going to be inefficient spend since you probably don't know what's going to work yet. Maybe your CEO can do this, but it would be. nice to afford an agency or two to speed up experimentation.

Buffer - $50k. Shit happens.

The "Pro Move" would be to buy something and run it yourself first. Then over time, grow it into a real business where you don't have to do all the work. When you go to sell it, you the people, who are now employees of the business (right?!) increase the valuation because now the next buyer doesn't have to go through the bullshit that you did. They have their own playbook to run. They don't call it 'micro' for nothing!

At some point, I'm going to raise a $1M fund, buy one company, and execute on this. I'll let you know how it goes.

Model 3 - You Buy An Anchor For Your Fund

Growth by acquisition is a tried and true strategy. Read some books on it. People have been doing this forever with boring ass businesses like CPA / law firms.

The insight I want to point out here is that if you have an anchor in your portfolio of companies (i.e. a mothership), then it makes the next acquisition that much easier. Everything points to the mothership. The mothership is the main point of monetization. Everything else can just feed it. That frees you up to explore other potentially cheaper acquisitions like a newsletter with a shit ton of people on it making no revenue. You don't care about the revenue in that case because you know that if you point that group of people (in a tasteful way) to the mothership, you can make your money back on the acquisition.

I love this concept. We're not doing it at XO yet, but I'm thinking about this daily.

If you want to pin it to an existing concept, think the traditional PE roll-up strategy. You buy one storage unit site that has a great brand and then you just keep buying storage units. Do you buy thing that are not storage units? No, if it's not a storage unit, you don't buy it. That's an easier pitch to investors too.

It's not sexy but it's worked since people figured out money can make you more money.

Model 4 - Passively watch your investment go to zero while drinking adios motherfuckers in thailand

I put this in here to dispel any ideas of micro acquisitions being a means to passive income streams. I know there are at least 2 people who read this newsletter that have 99% passive businesses. Congratulations (tips hat).

For the rest of us mere mortals, if you don't work on the business, it can and likely will go to zero. Take Toybox for example. That codebase hadn't been touched in a year and a half. Customers were pissed off, churn was high, and my god did those servers crash every 6 hours. That's when suckers like us came in and thought we'd buy it and just put the cashflow in our pockets. We were wrong. This business is going to need a lot of love to turn it around.

ok that's all i've got this week.

A note on no-code:

I've spoken with several people in the past few weeks about no-code and their relationship to micro acquisitions. Here are some findings:

Nocode is a growing space. You're not too late.
Buying a company that was unprofitable with 2/3 engineers, flipping the product to nocode such that it's profitable with one Bubble.io developer is a thing. It's here. This is a really dope idea.
Buying a thing that doesn't have much traction yet, flipping it to no-code and being a fast-follower on a trendy product niche is a thing. It's also here, and also pretty cool.

Fund Updates: