Here's the biggest offenders I see when talking to founders:
revenue vs GMV
(if you give GMV, give me your cut/margin)
contract vs LOI
burn vs expenses
users vs customers
(customers pay)
signups vs users vs active users
(you should give active with time interval and measurement of active.
eg. logged in last 30 days)
profitable vs cash flow positive
Others people should know:
diff between retention rate vs churn rate
(both should be given with time interval.
eg. 30 day retention rate is...
monthly churn rate is...)
voluntary churn vs involuntary churn
gross vs net
top line vs bottom line
I've probably been guilty of this but I think revenue & GMV can be confusing terms based on how a lot of commerce works via the internet. For reference, our company used to do dropship e-commerce.
Amazon, for example, uses revenue for first party sales and GMV for third party marketplace, Amazon never owns the product in third party marketplace. If you are a dropship retailer though, you have flash ownership because you buy from the dropship wholesaler and then you sell to the customer using a marketplace or website. You could say Amazon is different here because they physically have the products, but with net payment terms up to and past 180 days, it really isn't much different.
Also, if you just consider revenue to be your cut of GMV and you have net payment terms that gives your company high free cash flow, that seems important to distinguish as well.
[Update] The main point of my post is to show how confusing these terms are in one instance, and every business is different so it is really important to clearly define how you use the terms you are using
I am not an accountant - I was looking most of these up so do let me know if I got something wrong and I'll edit as needed. Just trying to compile things in one place.
Gross Merchandise Value is how much money flows through your system while Revenue is how much lands in your bank account. For instance, a payments processor like Stripe might have a GMV of $100 million while their revenue would only be the 3% commission (in this case $3 million).
A contract is a legally binding and enforceable document. A letter of intent is when one party outlines what they are likely or would like to do - with some bits of it being enforceable like non-disclosure agreements. A memorandum of understanding is a letter of intent signed by all parties involved - it is still non-binding. A term sheet from a VC is like an LOI - however, it doesn't actually happen until after due diligence, negotiation, etc and only official when signed.
Burn rate is the delta in your bank account. Expenses is how much money left your bank account and revenue is how much entered. Thus burn rate is expenses - revenue and is -1 * profit.
Users are people on your site. Customers are paying users.
Signups are how many people created an account. Active users are how many people logged in over a certain period of time.
Cash flow positive means you have more in your bank account than you did before. However, a kickstarter which raised 1 million would be cash flow positive but not be profitable as it has many outstanding obligations.
Churn rate is the percentage of your users/customers who left over a certain duration. Retention is 1-churn.
Involuntary churn is when the customer leaves because they go out of business or in the case of dating apps, no longer need your services. Voluntary churn is all other churn.
Gross refers revenue - expenses of the product. Net is revenue - expense of the product - administrative costs - depreciation - payroll taxes etc.
Top line is referring to gross while bottom line refers to net. Top line growth means more revenue and bottom line growth means cost cutting.
This is a nice summary, and mostly correct enough. One part I'd like to correct. Revenue is not characterized by whether or not it hits your bank account. Its amount is about who is the principal in the transaction, and its timing is about when the seller has done the activity to earn the money.
So, let's say I'm a payment processor, and my business model involves me collecting money on behalf of my customers. My customer makes a $100 sale, and it all goes into my bank account. That's still not my revenue, as I received the whole $100 on behalf of my customer. Separately, I charge my customer $2, for the work I did to process the transaction. That part is my revenue.
I think stripe is the perfect example of GMV.
A clear distinction between the transaction volume they handle and the revenue they take from that volume.
There are more confusing examples though.
If Uber accepted cash payments, and the driver post paid just the commission, would the whole trip cost be GMV or just the commission?
eg
Regular Uber:
Ride Cost: $20.00 GMV (goes through ubers payment system)
For a marketplace, GMV is GMV regardless of how the funds flow. eBay and PayPal are separate. eBay still has GMV, and this number is useful to investors.
Interesting...been in finance all my life & dealt with pretty much every industry out there...never heard this one before. Must be some type of startup slang so to speak.
I'm not sure if it is Internet slang, but if it is--I wish people would stop reinventing words/concepts. It's not cute, or interesting anymore. I'm so glad "wired in" didn't catch on.
I picture the writers on that movie thinking, "How can we make typing on a laptop, while listening into whatever on head phones seem cool?" Awe--"Wired in" will get their attention?
Pretty standard usage in online marketplaces that connect buyers and sellers and take a commission/cut on the transaction. The first official use was probably in the ebay IPO prospectus from 17 years ago (they call it gross merchandise sales which is the same concept). So I wouldn't call it startup slang.
It's a term of the trade in the retailing (and by extension e-commerce) industry. It refers to the value of the goods sold. If a retailer sells a widget for $100 at 50% margin, then the GMV is $100 and revenue to the retailer is $50.
GMV is only meaningful for "marketplace" businesses that facilitate sales for third parties. It's essentially the combined revenue for all parties involved in selling through the marketplace. For example, if someone sells something for $100 through eBay and eBay takes a 10% cut, that's $100 GMV for eBay, $90 of revenue for the seller and $10 of revenue for eBay.
eBay and many other marketplaces use it. My guess is that since these marketplace platforms are not actual retailers their GMV is pretty high as compared to revenue. To showcase the dollar value of total sales that happened on the platform they use GMV. But again I am not an expert in this field.
Yeah I googled it too - a while ago - wikipedia isn't exactly a winning moving here.
>eBay and many other marketplaces use it.
That is deeply disingenuous. You originally said its "term of the trade in the retailing". I called bullsht - because I know its not used in retailing. In response you shift your argument (!!!) and reckon its used by ebay (FYI NOT A RETAIL OPERATION) - and copied the ebay stuff straight off wikipedia.
You would be right, if the goods sold were purchased by the retailer and then resold. In that situation, you would have revenue and CoGS. However, often retails do not own the goods they sell. In that situation the price paid for the widget is not the revenue of the retailer. It counts as the GMV, and the revenue is the portion that goes to the retailer.
Wait... I thought COGS referred to the production costs of goods sold. The direct material and labor costs. For example, in a restaurant it would involve food costs and wages for cooks.
GMV sounds like it refers to what in this example would be revenue from the finished food. A burger COGS is meat+bun+cook, a burger GMV is the menu price.
No. Its a bit of a regional difference. UK affiliated people prefer "cost of goods sold" while the rest of the world uses "cost of sales". They're essentially interchangeable with CoGS leaning towards enterprises that produce physical goods.
>GMV sounds like it refers to what in this example would be revenue from the finished food.
GMV was pulled out of thin air & means nothing at all, aside from CoGS/CoS with a lick of startup paint. Anyone that reckons otherwise please step forward with a coherent argument...
If I build a box and sell it to you, the cost of the parts is cogs. If you buy someone else's box through my website that's gmv. Your example is correct too, but probably not what somebody would use because in that example it's also the revenue.
I'm pretty sure if a retailer sells a widget for $100 then the revenue is $100. COGS is $50.
GMV is probably a term more useful in situations where the entity is not a retailer per se, like eBay, who still wants a number to represent the value of the goods they are facilitating transactions upon. They don't own the items on auction so the purchase price is not revenue to them, but the fees are revenue.
I always thought GMV is more like gross revenue. So if you sell 5 of these widget at $100 your GMV is $500.
Which is different from your Net Sales. Because let say if one of these widgets got returned. And one of them was sold at 20% discount. Your GMV will still be $500 but your net sales will be:
What is the value of this number? I can see how some research into operations would identify the cost incurred by holding a certain value of inventory, but decreasing inventory costs by selling at a discount without recognizing that decrease in value really seems like it is using the number for the wrong purpose entirely. Sure, if you're looking into decreasing insurance costs or something, but I how is it defensible when trying to explain your value to investors?
What's voluntary vs involuntary churn? (googling but if anyone wants to save me the time) :)
A: Voluntary churn occurs due to a decision by the customer to switch to another company or service provider, involuntary churn occurs due to circumstances such as a customer's relocation to a long-term care facility, death, or the relocation to a distant location.
involuntary can also occur when you cannot renew for technical reasons, such as credit card rejected. these aren't always fraud related, you can have someone who wants to pay you but cant anymore.
IANAL, and Sam mentioned a felony charge. Are there any legal protections for investors (or.... whoever this is protecting) for e.g. misrepresenting "signups vs users vs active users"? Surely that falls under subjective fraud rather than a straight up objective lie, especially for sites e.g. reddit where the line between "active user" and "lurker" is extremely murky.
Usually and investor makes a Due Diligence in the company. Depending on the stage of the company, investor profile, this due diligence can be a formal one, where you hire external auditors to make the process or in a more early-stage phase you can do VC firm (or angel) makes the due diligence themselves.
Either way, at least in Brazilian Law (I work with VC in Brazil, but I imagine there is something similiar in USA), we have a "Hidden Liabilities" clause in our termsheet. It says that anything prior to the investors investiment is liable to the founders only.
RE: "Subjective fraud". Regardless of whether the fraud is intentional or accidental, misstating something to investors (i.e. "our revenue was $1 million last month" when you're talking about GMV) will still subject you to a lawsuit and/or arrest.
Is there a concept in law as "you should have known"? Like, its one thing to not know that the thing you are saying isn't true (i.e. "my co-founder went to Yale" when he actually believes that he did).
But another to not know the definitions of words you are using when you should know that? Can you say "I have a million dollars in the bank" when you honestly believe "a million" = 1000?
In American law, there are civil offenses (torts) and criminal offenses (crimes). Criminal cases are prosecuted exclusively by the government.
In both categories of law, there is a subset of offenses that fall under "strict liability" — for which you can be punished regardless of your state of mind when committing the offense.
Fraud, like most criminal offenses, requires establishment of mens rea (knowing wrongdoing), so Sam is incorrect in saying that financial misstates are "felonies" on their face. But once you've become an investor you can bring a claim of breach of fiduciary duty (a tort) — rather than establishing that the CEO intentionally misled you, in this case you only need to show that they breached a "duty of care" — essentially, "you should have known".
The concept of mens rea[0] touches on this. One of its applications is that ignorance is not an excuse for being culpable. All of this is not to say that lack of intent makes someone blameless, only that it is not fraud without intent.
Ignorance of the law is no defense to criminal charges. But law might also specifically entail intent. For instance, this is the difference between first and second degree murder.
IANAL and I have no knowledge of the business/financial/contract end of things. I do know I've signed quite a few "due diligence" and "reasonable effort" clauses. I don't know how legally defensible they are in situations like user reporting when it's not specified.
I know nothing about startup investor terms. But I wouldn't be surprised if they often included some clause "accounting shall conform to Generally Accepted Accounting Principles [GAAP]", at which the signing company is responsible for knowing and using the GAAP terminology for various items.
How those responsibilities translate over to criminal / civil law would be a question for a lawyer. I think Sam's use of "felony" might be meant to get people's attention. Even finding yourself in an argument with your investors over civil liabilities probably means you have huge reputational issues that could kill you among the investor community.
I have reason to think oral statements about your financial condition aren't actionable as fraud by your creditors in bankruptcy. I know nothing of liability to investors, securities law, etc.
We have the concepts of negligence and recklessness, which often constitute offences of varying severity. I don't know anything about the specifics of fraud.
Unless you specifically state that you are using the GAAP term "revenue", revenue could mean anything, just like "made" could mean anything, like saying "we made $1M last month".
I highly doubt if you were making a presentation and you said "We had 1M in revenue last month", and it wasn't actually GAAP revenue, I find it hard to believe you would be subject to lawsuit or arrest. In fact, arrest is even more of an over-exaggeration.
Even Groupon had a hard time defining exactly what its "revenues" were pre-IPO, and yet no one got sued or went to jail.
If someone invests in you because of a revenue claim when no one else in the room would agree with your definition of revenue, you might end up getting sued. That's pretty reasonable. If it's in a casual conversation, they should have plenty of time to look over the books later, so it's not a big deal.
That said, why not use appropriate GAAP values? You should already know them, assuming you're keeping proper books, so it should be the easiest value to give.
You could get sued, but in the US you can get sued for anything. But you would win the lawsuit.
"Revenue" can mean anything. Look up the term online, for example http://dictionary.reference.com/browse/revenue, and you'll see 6 different definitions. One of them is: "an amount of money regularly coming in". How is this definition of revenue wrong, or how could it result you getting sued? The answer is you won't.
Sure it could cause misunderstanding, but that happens all the time. As long as you don't misrepresent it as "GAAP revenue", you're perfectly fine using it in any reasonable way. Unlike what Sam Altman says, it's not a felony. My wife is a CPA and she laughed out loud when she read that.
2. What does the service provider think the terms mean.
3. Can the difference between 1 and 2 be construed as a violation of a contract.
4. If 3, is it possible to discern unintentional vs fraud.
I used reddit because it so easily demonstrates the different tiers of the 1% rule[1], except with reddit there are un signed in users, signed in users who don't do anything, only voters, voters and commenters, people who submit, and "power users". I don't know the details now (and reddit has changed a lot), but last I checked they seemed to descend in numbers by about ~10%. This would be a place where you could easily portray a very different ecosystem than reality, intentionally or not, simply by categorizing the users as "active" or not, and how you're characterizing the value you're getting from them.
Part of the problem is that most startups run with zero revenue for the first few months (or longer).
Generally speaking, if you have no revenue then burn == expenses.
So for the period during which most founders are starting to learn about these terms, "burn" and "expenses" are indistinguishable. That tends to cause them to think of them as essentially the same thing for far longer than they should.
Mr. Altman is talking about the basic misunderstanding of these terms and it's surprising to me that he didn't take a bit of time to define the terms himself. Maybe I'm naive and those terms are a lot harder to define than I'm imagining, but even then some references linking to other sites could have been provided.
I really enjoy reading Sam's posts and I'm usually bookmarking and/or forwarding his articles to a ton of friends. This one is a nice amuse-bouche but I guess I'm use to getting a full meal from Sam. Maybe a quick update with some links is all it needs? Good read otherwise.
I agree. I'm a CPA and some of these terms (GMV) I've never heard before (must be because I'm in a different industry - payments, and we use TPV - total payment volume), and others (burn) are ambiguous to my accounting brain.
Is that cash flow used to fund operations? Is that the accrual based operating expenses? Is that the difference in cash between this month and last month?
I think the point is less these particular terms and more the general responsibility to know and use the accounting terminology properly. Sam probably has a dozen examples of financial terminology errors, of varying seriousness and intent, and startup models, by definition, are going to raise still more questions. Sam can't possibly lay out a definitive vocabulary -- the applications of these terms is always dependent on the particular business. He can raise a flag that founders have to take this stuff seriously.
Whether this is exactly the best post for that is maybe another question. It definitely raises the question of how, exactly, founders without any accounting are supposed to navigate this stuff. Accounting is a language of its own, whose conventions make sense once you understand the various problems it must solve, but absent that knowledge it is very easy for people to make innocent but very important mistakes.
I think the more important thing is to make sure that a company clearly defines exactly what it means by certain financial terms. Someone correct me if I'm wrong, but IIRC during the original .com boom Priceline counted the entire sales price of an airline ticket as "revenue", which should clearly be considered GMV. More recently, I've seen terms like "gross revenue" and "net revenue" used by the financial press to describe total booking volume vs the cut a company takes.
Isn't it also surprising that investors aren't taking the time to define and clarify these terms as well? I feel this shouldn't fall entirely on a founder's shoulders unless they're intentionally lying.
This post sounds fishy to me. If the "financial statements" are sufficiently important for the fine details to matter, then they need to be produced by someone who knows exactly what they are doing (a properly qualified accountant). If they aren't important (why are the financial statements for a YC _applicant_ important?? surely they have zero revenue typically and nobody believes their projections), then who cares if the terminology is slightly wrong? Certainly if I were given such a document, I'd ask who prepared it and go from there as regards how accurate I expected it to be.
Also, if your role is an incubator investor, isn't it your job to educate the inexperienced founders about things like this?
fwiw I don't understand how anyone could confuse LOI with executed contract. I mean, really the only way that the concept of a LOI can arise is when you ask "can we get a contract in place?" and the answer is "not at this time" so you counter with "how about an LOI?". Hard to get confused about that..
There are so many startup accelerators that take a team of engineers / product people and do their best to make businesspeople out of them. I'm one of those CEOs, for sure, and learning about the financial world, accounting, and trying to make sure to not mis-speak was quite difficult.
The primary training I received during the accelerator helped a lot, but it was more along the lines of how to more accurately model in excel. It was up to the CEO (?CFO? if you're lucky) to get all this exactly right, and it's not easy.
I think that when an accelerator knows that its teams are not well-versed in the financial part of running a startup, there should be more emphasis on helping them learn. It's daunting to try to do that alone.
What are the reasons startups can't hire good finance people? Or at least contract with an expert?
Is it a difficulty in judging their abilities when it's not your area? Is it something where only at a certain size would it be worth the reduced financial risk to have someone on it? Learning from scratch has to be the slowest, highest risk way of doing it -- which is the exact opposite of what a startup should be optimizing for (reduce risk where possible, move fast)
It seems like helping identify business talent is what an accelerator should be helping with, not becoming a half assed B-school for engineers..
There's some implicit assumption here that learning from scratch is better than hiring talent, and I think that's a mistake.
you're a company. you're built to make something and grow it. outsourcing financials (I don't mean getting help with them, but actually offloading them) is in some ways like outsourcing development.
the "CEO" personally does finances for the same reason the "CTO" personally codes. If either of them can't do something they learn it.
I do want to make a distinction between "offloading" and "outsourcing".
That said, you may very well be correct. My point was simply that, if it's a good idea, it's mostly not for the same reason that has the CEO emptying waste baskets.
They can, and do if they are being sensible. One of your fairly early hires should be a real finance person (not an executive but someone experienced enough to take over the day to day effectively). Not doing this is false economy.
Well before that point, you should have a contract accountant of course.
Why didn't you hire people to empty the trash? Would save your time, and another soul out there who is struggling to find a job get something.
Personally, I love the fella who empties our trash. He's become a close friend of ours, with his heavily accented "Hello friend!" message he greets us all with and everything!
Hiring anyone to do anything carries a (quite significant) cost both financially (not their hourly wages -- all the other fixed costs) and in management time, and in the cost of added risk (perhaps they steal employees' stuff, set the place on fire...). In that case it wasn't worth all those costs vs just emptying the @&^#& trash myself, which took all of 5 minutes at the end of each work day with the added bonus of giving me some brain-idle time to wind down.
The accountant and lawyer examples have the opposite characteristics : lots of risk from not hiring someone competent and experienced.
> What are the reasons startups can't hire good finance people? Or at least contract with an expert?
Its the exact same problem with hiring quality engineers. The good ones have many options. So a startup's offer of $150,000/year plus 5% of a company that might not be around in 3 years just isn't that appealing.
I'm guessing the good ones have job options starting around $400,000/year, whether in Finance or public companies.
If you are a great company though, you'll be able to hire a very capable person...
This isn't really finance though; it's accounting. Accountants don't even cost $150k a year, and a CPA can explain to you the difference between the terms and what is legal / illegal (or at the very least a non-GAAP measure).
If your startup is past the garage stage, you should probably have a corporate accountant on retainer so you have an "expert" with whom to discuss these terms. They're not super-expensive.
I cannot disagree more strongly with this. It is essential for a small business owner and/or startup founder to understand the fundamentals of business finance -- at a minimum the basic accounting equation (A = L + OE). Outsourcing that knowledge to someone in finance is a recipe for the "accountant" to steal all the money in the corporate bank account. Only once they understand how to do it, should they then proceed to outsource the work to someone else to minimize the distraction to the core business.
> What are the reasons startups can't hire good finance people?
Perhaps there is a correlation between being a good finance person and not overlooking the risk associated with working for a startup, such that good finance people -- who command high salaries anywhere -- aren't particularly attracted to work at startups, making it even more expensive for startups to hire them than it would be for others to do so.
What are the reasons startups can't hire good finance people? Or at least contract with an expert?
In the early stage, when your total team is 2-5 people, there's rarely enough work to justify spending a full time, senior salary on a good finance person. You probably have close to zero revenue/billings, so the main jobs are around payroll, taxes, a few accounts payable, and cash-flow projections.
You can (and should) hire an accountant to do the first 2, and work with your accountant to do the second 2, but
1) Pushing all of payable through the accountant is an easy way to lose track of what your outgoings looks like, and end up with dangerously high expenses. At an early stage startup, the founders should be aware of every expense.
2) The founders definitely need to own the projections. Some help from an accountant is going to make a big difference, but they can't do it for you.
But the more important issues are:
- You aren't likely to drag your external accountant into investor presentations. You might (should) get the accountant to review the financials that go into the presentation, but they won't be there to talk about them, so the founders need to know what they mean, and use the right words.
- The average accountant cares about accounts, not investor terms. You cannot really expect your external accountant (who you hired based on their ability to keep the books to an appropriate legal standard) to know whether that piece of paper in your drawer )that they had no part in producing) is a contract or LOI or MOU. Nor would they necessarily know whether certain income streams should be classed as revenue or GMV unless they are quite familiar with your business. They know about income & expenses & liabilities, but those aren't the same thing and part of the problem for founders is that they seem like they should be.
You can hire a part-time accountant. When big enough, you'll hire a full-time CFO, but that person will have an eye on a personal return via merger or IPO. As a small startup, it is absolutely the CEO's job to live and breathe financials, in terms of where money comes in and goes out. Outsourcing that role is a major red flag.
I agree with Sam's message, but I sympathize with founders who make mistakes here.
Founders are told to hustle, to aggressively push themselves and their visions in order to build momentum for their businesses. Founders are encouraged to bend - if not break - the rules in order to get things done.
First-time founders are thrown into the world of finance with a good deal of ignorance about the meanings and conventions of specific financial terms, combined with a culturally ingrained bias towards spinning things as positively as possible. Broadly speaking, this seems like a recipe for disaster.
but they'd know they didn't make 201M - and conceptually that them buying and selling that house doesn't value them like a 201M revenue publicly traded company with billions in market cap. Founders know exactly what they're overselling. They do it for spin.
Using your example for a business more people understand - A real estate agency can honestly say "We sold $20M of real estate last year" and everyone knows they probably took in about $1M in revenue. With new businesses where revenue models are changing it is possible to make honest statements that mislead an investor.
This is yet another way in which Y Combinator can differentiate themselves as a place for startups. A once a week course on this type of material would probably be very useful for most founders, I'm working under the assumption that most Y Combinator founders are first time founders.
As a side note, it feels like this type of communication straddles the boundary between something that could have been a tweet vs a blog post.
Interesting idea: VCs should have in-house finance folks specifically meant to work with portfolio companies who spent a few days a month for year 1 after investment, or until the company gets it own finance team. Most VCs do less than 10-15 deals a year, so this seems tolerable and a relatively low cost way of to really know what's going on with the portfolio. (I know some VCs already kind of do this (Vantage Point). Also, harder for YC, given # of investments, so maybe not as applicable for true seed funds but still might be worth it - I'm sure they could get 5 mid-career CPAs for the price of one partner, and they would love the job! I think)
The fun part is that then the VCs will have a direct line into the company's nitty-gritty operations, which really they are entitled to receive anyhow (though usually they just take the board deck at its word..which is not always good).
This might suck for the company since you have the VC in-the-know on your nitty-gritty (though I'd argue that if you don't want them in-the-know, you should not have taken their $$...though I understand it's more complicated than that haha), BUT that might also serve to incentivize the company to build out the finance team quickly, and also give the management team a taste of what a good finance person can provide (assuming the person the VC provides is good, which they should be if they are to be trusted with multiple portfolio companies).
There are honest and competent people willing to work one day a week as contract CFO. Such a person works as part of the management team and doesn't have divided loyalty (management / investors).
you are right, I've worked with a few. Problem is that it's a cost to the company they often don't want and they don't value the work (I think this is what SA is trying to change). Also, vetting/hiring folks etc. is it's own burden. VC pushing this gets rid of the friction and forces founders to take this seriously.
Agreed they may have divided loyalty, hopefully mitigated by a very temporary relationship and the fact that at early stages, VCs and founders should be super aligned, at least around the ops numbers (sale decisions, etc. are a totally different ballgame for sure).
> Interesting idea: VCs should have in-house finance folks specifically meant to work with portfolio companies who spent a few days a month for year 1 after investment, or until the company gets it own finance team.
Doesn't a16z already do this, not just for finance, but also for PR, hiring, etc.?
We always put a new CFO in the company. But non of them are from the VC firm.
This method you talk about is way more commom on large deal, like Private Equity, LBO, etc. Those companies make 2 to 4 deals a year. 10-15 deals isn't a small number of deals.
I've seen early stage VCs suggest hiring temp CFOs (though it didn't pan out for Virtual - highlighting that the onus is still on the CEO) and late stage VCs saying, "We'll give you $25 million, but we hire the CFO"
As an engineer it's pretty easy to get used to dismissing opinions about technology from people that don't understand it. At times that's reasonable, but it's also easy to take it way too far.
Sam seems to have a healthy respect for his own ignorance, and encourages others do to do the same, particularly in areas where that ignorance can have significant practical consequences. That's not "amusing", it's commendable.
This post leaves a bad taste in my mouth, at least to the degree it's talking about executives of YC companies.
I mean, the whole model of YC is to take kids straight out of college (if not before) and turn them into startup CEOs. If those CEOs come out of that process not understanding the legal obligations of their new position, whose fault is that, exactly? It's not like they're bringing decades of business experience to the gig. The only thing they know about what being a CEO requires is what YC teaches them.
If their only preparation for the post is YC, and they're ending up ignorant of stuff that could get them slapped with a felony charge, I would think that would say more about YC than it does about them.
My impression of YC has never been that it is some hand-holding after school special. This is an investment firm in the world of business and the world of business is very serious. As a startup founder, you are treated as an adult and that includes both the freedoms and responsibilities implied.
That said, you may have a point here. If there is a recurring issue that some founders are too immature for their own good and might be a risk to their own personal safety (e.g., committing felonies out of pure ignorance), YC should probably be intentional about filtering those people out during applications. But this article isn't just about YC candidates and that's not a solution for the whole industry.
It's strange that you think that an investor who owns 7% of a company is "being serious" by declining to do any diligence about illegal behavior undertaken by management.
Isn't the whole article pretty much basis for that ? :(
If sam is saying YC founders are using terms wrong, doesn't that imply that YC was fine with those terms?
So confused.
Anyway, the simple fix would be to just have a 1-3 day finance bootcamp to make sure everyone speaks the same language. Rather than getting everyone to try to being kinda-sorta competent.
It's not YC's job to teach executives anything. Their entire model is self-service: they give founders access to people who know this stuff, but you have to ask for help to receive it. At the same time, a lot of these founders don't know what they don't know, so IMO this blog post is a way of saying to current and prospective founders "Hey, you need to be careful about this because creative accounting is often illegal". The startup mindset is to find creative solutions to problems, but that doesn't work in finance/accounting.
> I mean, the whole model of YC is to take kids straight out of college
Isn't the average age of YC founders closer to 30?
It is interesting how this blog-post directly follows the "The Post-YC Slump" post [0]. One can easily make the mistake of considering time spent on financial statements "fake work", fake work being identified as one of the reasons for the slump.
The fact that there are financial misstatements indicates that there is more need for this type fake work, or perhaps the whole fake work thing isn't so fake after all.
Why not have a bootcamp for a few basic finance rules/jargon? Assuming they see the same sort of issues crop up, surely a 1-3 day bootcamp is a lot less "fake work" than every founder now needing to figure out what they need to know and then know it?
Depends how much these financial misstatements end up costing them. Plenty of successful startups base their business on breaking the law, to a lesser or greater extent.
At what point do people start acting like grown-ups who take the time to learn what responsibilities come with their actions?
I think college graduates certainly qualify. If I'm going to call myself "CEO" then I better damn well figure out what that means, and if I don't know, I should study or seek the advice of someone who does.
You mean maybe the accelerator? It would be awesome if YC/the accelerator had a bootcamp of 1-3 days talking about this stuff. Because, let's face it, this "finance stuff" is complicated and most of us don't have a clue: it's not intuitive or something that can be reasoned from first principles. Anyway, are we supposed to build product or become focused on learning all this new jargon(is this fake work?) ? Seems like a lot to duplicated effort if the latter is the case. So, it should make sense for YC to have a short bootcamp.
So why wont they? Because maybe it will open them up for liability? I hope that's wrong because they obviously see the need for such a thing, but are too risk averse(?) to provide value there.
Anyway, why are most of sam's post about how stuff sucks/his disappointment as opposed to: this sucks, and here's how we want to try fixing it? He's running the accelerator and this lack of ownership is really hurting the brand.
Sigh. I'm going to get shadowbanned again. What am I saying that's so disagreeable?
I think you might be misapprehending Sam's posts. Demo Day just finished and he's advising startups by warning them about pitfalls. YC has a tradition of making these kinds of posts public—pg used to publish his advice to YC startups in the form of essays for anyone. I always thought that was great. (Off topic: I've been inspired by it to (slowly) write some advice for YC startups about what counts as good content for Hacker News, and when it's ready, will make that public too.)
As for what's disagreeable in what you said, let's look at your paragraphs: (1) 100% fine; (2) assumes its conclusion and makes an unfair jab; (3) mischaracterizes Sam's posts on the whole, as well as the recent ones; (4) off-topic posturing about bannage.
Regarding your specific complaints:
(2)Assuming conclusion and using that to open up discussion is a fairly standard rhetorical practice. Are you saying that that paragraph doesn't move the discussion forward? Why is it unfair? It's an assumption/leading for sure, but it's as fair as anything else.
3) Ok. So here's the thing: when you put things out on the internet, other people read it. They especially read it when it's the top link on HN :). And, they read the content not the intent. Mischaracterization isn't something I'm trying to do malignantly: but unless I'm missing something recent posts have been very much in the vein of "here's what I don't like" rather than "here's how we are fixing some thing we don't like". Maybe I'm still being unfair? But when these posts are up for consumption for the world, the cop-out that it was only meant for the YC class seems a bit silly. Is seeing that opinion voiced really worth the effort of silencing it? Are only "positive" (fawning) posts the ones that are allowed?
The average age of founders in YC startups is 29, that's not really straight out of college. I think you might actually have misconceptions of what YC does. It's not a school for sure.
"I’ve seen people use GMV for revenue or refer to an LOI as a contract many times in the past year when talking to investors. This is a felony."
This is only a problem when you're asking investors for more money. That's when you need an accountant to review what you're telling them. You need an accountant and a lawyer at that point anyway, or you're going to get screwed.
It doesn't specifically address the terms in the OP, but it should be the starting point for non-MBAs (like myself) to start understanding basic Finance.
In my experience, if you're a co-founder and you don't understand basic Finance and let your Finance department do whatever it's doing you may be setting yourself up for trouble. The OP described the other case of simply saying non-sense because you don't understand the terms :)
> One particularly bad one is misunderstanding or misusing basic financial terms. I started noticing this in Y Combinator applicants a couple of years ago [...] I’ve seen people use GMV for revenue or refer to an LOI as a contract many times in the past year when talking to investors. This is a felony.
Not sure who the target audience is. If a business person is willfully deceiving people, let's call that out. But if a programmer is using financial jargon they don't understand, then let's educate them.
It's not hard to read this blog post and come away believing that if you use the wrong acronym accidentally the author thinks you're a felon. I'm sure that's an overstatement, but overall this could have been an article that was educational yet had a serious warning. Instead it kind of stirs drama and fear. That's fine but I can't help but compare PG's essays which are a delight to read and get lost in.
This is probably a too-broad-brush use of the word.
Other than that, I like this essay.
People should be taught financial literacy early and accurately. Like learning maths notation: It's useful, compact and efficient. But...it must be precisely grasped/implemented to be of any benefit to speaker or the audience.
I like Sam, and I even agree with him in this post. However, I don't think everything he blogs about needs to shoot straight to the number one spot on HN. I'm not sure if this is the community's voting or the YC algorithm's bias, but it would benefit the community if we could stop the fawning and treat his posts like we would anyone else's.
That's a valid point, but if you think about what it's like to raise money, do you really want to be in the position of establishing --- to a prosecutor's satisfaction, since being dragged into court for this is game-over --- that you were unaware of the materiality of these distinctions when you improperly made them to potential investors?
From model jury instructions, which might be misleading here: the "intent" a prosecutor needs to establish is that you knowingly said something false, in the process of seeking something of value, that the falsehood was material to the decision of whether to give the thing of value to you, and that the other party later gave you that thing.
The bigger issue is it's very very very very very unlikely that a tiny startup is going to be prosecuted for attempting to defraud an accredited investor.
I agree, but there is also the civil aspect, and while its exceedingly unlikely that this would become a criminal matter, the civil liability could be substantial...
I don't think it's even negligence. When you are a startup, you are not required to file official SEC disclosures or anything of the sort. So you can use whatever you want as your terminology. Having said that, it's a really bad idea to use misleading terminology, because any sophisticated investor will know it and will consider you full of shit anyway
while its true that you may not have to file disclosures with the SEC, do not kid yourself, the second you discuss a potential investment in your company with someone you have to conform to both federal (sec) and state securities laws...
well, that's why startups talk to qualified investors who essentially sign something that says they are aware of all the risks of losing money, etc - not to general public. The point isn't the laws, the point is bullshitting sophisticated investors is a losing strategy
That is incorrect and somewhat ironic in a post about using correct terminology
Sure. I'm just saying it doesn't detract from the underlying point. But you're right, it is ironic and slightly amusing... Just goes to show, we're all susceptible to making silly mistakes when we step outside of our primary domain(s).
But you can still get in legal hot water, and getting (mostly) back out involves having to prove that you were ignorant of the rules rather than deliberately trying to deceive. It's still going to be an incredible mess, and it's still going to wreck your reputation.
Agree with you here. Although negligence comes with it's own set of rules which may/may-not apply given what he mentioned in the post. I too found this ironically funny to call it fraud. Further for the sake of argument, not all fraud is criminal, so not all fraud convictions are felonies.
Strictly speaking, negligence has its own 4-part test (duty, breach, causation, damages). Fraud (intentional misrepresentation made to be relied on by another to their detriment) without intent (or reliance) is simply an unactionable misrepresentation.
> This year, the firm expects to clock $10.84 billion in revenue which — calculating the 20 percent commission that it takes — should bring in around $2 billion in revenue for the year.
A voice recognition company was in the process of IPO in the mid 1990s. They had some big purchase orders from institutional customers. The trouble was, those POs had side letters giving the customers the right to return the products for credit if they didn't work correctly.
Not disclosing those side agreements to investors was treated as felony securities fraud. It made the company seem more valuable than it really was.
That's the whole dealio. Don't cook the books. Don't make stuff up. There's enough that can go wrong even if you are transparent with investors about your deals.
Some of the more extreme stuff is the fault of "stretch the truth till it breaks" ideology in business culture. This stuff is dubious in any form IMHO, but when naive first-timers without MBAs pick it up it easily devolves into outright fraud. Someone who knows finance, law, and accounting inside and out knows when and where to stop stretching, but non-experts in these areas do not.
I've heard some jaw-droppers myself in conversations with other founders/entrepreneurs over the years. It's okay to put a positive spin on it, but it's not okay to lie. You can't say you are "cash flow positive" if you are not in any way shape or form collecting actual cash from anyone.
If you don't understand MBA-level accounting and finance, then the safest and most honest thing to do is stick to concrete numbers and things you clearly do understand. Revenue is actual dollars that land in your bank account-- real money that really exists. Profit is revenue minus expense. Customers are actual people or businesses who have given you money for an actual thing. Contracts are actual promises to do so in the future for some length of time. Users are people who are actually handling, running, or consuming your product right now, etc.
It's also perfectly okay to say "I'm not an accountant" in response to questions you don't understand. Your prospective investors are looking for someone to build a product and sell it, and if you can do that then that's your expertise. Accountants and lawyers can be hired on a consulting basis just like any other domain expert. It's okay not to have expertise in all areas as long as your expertise is where it counts and you have traction/results.
Investors will appreciate that too, since anyone operating as a VC or serious angel will see right through any nonsense you spew. It will simply discredit you, and any investor who doesn't have very sensitive radar for blowhards and con men will not be an investor long.
I've seen this is in many businesses. The biggest offense is gross vs net revenue. "Oh, we're an X million revenue firm" is frequently tossed out, when the company only keeps 15% of that to pay the bills. This is especially prevalent in AdTech. I used to think this was lack of financial knowledge on the part of the founders. Lately I've started thinking it's deliberate.
I see Virtual being an example of this too, though not in AdTech.
Some of this does fall on the VCs. It's very important for the VCs to dig into financials before investing, and asking for precise definitions. It also highlights the need for professional financial talent in startups.
After reading this and going through some of the comments, it may be worth while for YC to hold a small online course, or at least make a small business wiki, that discusses these terms and other concepts specifically in the start-up domain. I mean especially if misusing these terms, unintentional or not, can be considered as a felony, then it would really be worth while to at least give them some information to read up. Even though the ideal team of founders is one CompSci and one business, it seems that some of the business gurus posting here have a hard time defining a few of these terms, like GMV. That's just my two cents.
If you're choosing between "should I commit a felony or not" should it matter how often other are charged with it? What happens if law enforcement suddenly becomes more interested?
Have you considered the possibility that founders aren't being charged with felonies left and right because they're not committing felonies left and right?
Note that the freelancer startups do this emphatically...
UpWork
Toptal
Gun.io
all list Revenue as total amount via gigs posted not as total amount actually awarded via finished gigs..ie project revenue on system which means that they are over or understating their actual earhed revenue from project fees
Easy to catch as in accounting terms you would list the full project revenue listed on system times the percent project fees as unearned revenue and the booked earned project fee revenue as earned revenue.
You don't post "projects" on Toptal. Everything we do is time & materials, so the concept of misrepresenting financials based on posted projects simply isn't possible. ARR is calculated by actual sales right now multiplied out for a year of time.
I find most people can't name the summery lines of an income statement (Revenue>COGS>gross profit>sg&A>operating profit> etc.) let alone a balance sheet or cash flow statement. but frankly the one annoys me the most is is the way "cash flow" is misused.
With a good accounting you can check the health of any company with just minute reading of the statements, cash flow, profit/losses, debits for short term, investments, etc.
With accounting you can easily know how your investments are going, when you have many and other people administrating.
You can also use accounting to invest in good companies for long term, and for this, I recommend Peter Lynch books.
It's a learning process. A lot of times the Bay Area (like some other places in the world, for different endeavours) is the first real-life encounter with excellence and some times with geniality. Experiencing failure will make felons better, if they survive rejections, mature and learn from mistakes.
>misunderstanding or misusing basic financial terms
Well if you stick the average finance guy in front of a python JIT compiler anyone looking over his shoulder will conclude he's an idiot. Yet somehow the average IT guy thinks it just takes a bit of terminology to "get" the finance side.
this is where having an MBA (or undergrad business degree) can be helpful. note, i'm not saying you need a business degree to be a founder, just that it can help if you already have it. =)
in business school, you learn that much of finance & accounting is storytelling with numbers, but with the added twist that there are legal consequences for crossing over (and sometimes, just into) the gray area. that's what sam is pointing out, where the gray area ends and the legal consequences start.
as others have pointed out, quantitative finance & accounting classes can be very helpful:
Can someone clarify the difference? Using Uber as an example: their GMV is the sum of all fares, whereas revenue is the 10% they take off that number—is this correct?
Stop what, exactly? A post that makes references to Sam Altman's previous post in the context of his present post has 3 downvotes. It's a legitimate point. You want me to stop making legitimate points? I am under the distinct impression that downvotes are not intended to be used when you simply disagree with someone, yet that's exactly what they are being used here for. Hypocrisy.
You're breaking the HN guidelines by making unsubstantive comments, going on about downvoting, and engaging in a tedious one-sided flamewar. Downvotes and flags are justified.
