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Founder's Story
Why Most Companies Die After Hitting $1M Revenue | Ep 300 with Yarin Gaon Founder of Fractional Partners
00:32:49
In this episode of Founder’s Story, Daniel sits down with Yarin Gaon to break down the most dangerous phase in a company’s life: the jump from $1M to $10M. Yarin explains why founders don’t fail from lack of effort, but from “indigestion,” trying to scale everything at once without clarity, profit focus, or a plan. He shares how private equity thinks, why $1–2M is still a lifestyle business, and the simple planning system he built to help founders grow by subtraction before they grow by addition.
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- [00:02]
A
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- [00:35]
B
So, 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, you know, 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?
- [01:13]
C
Yeah, so these are just different stages. So if we take a company's life cycle, you start by hustling, right? The 0 to 1, 0 to 2. 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 product 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 product, they try to add more type of clients, they 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 adolescence stage. It's almost like a human, just like a company. There's infancy, that's the 0 to 1, 0 to 2. And then there's an adolescent stage where a company decide 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 line of products, maybe multiple different types of segments. But now there's the question of, okay, so what am I scaling? And a lot of founders never ask that question. So they try to scale everything. They, if you take, 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 like 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?
- [02:59]
B
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, the profit margin is going to be so much. I hear this a lot, like I want to hit 1 to 2 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 1 to 2 million? What, what has, how much money are they really taking home? And then what has really changed?
- [03:30]
C
It's really an interesting question. The answer is at a 1 to $2 million business, it's still a lifestyle business. So profit equity doesn't even look at these kind 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. So you said two million dollar company. Great. At 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, 150, $200,000 to replace. So now the company is making $200,000, not as attractive. So, so it's just, it's not the end. Right? 0 to 2 or 0 to 1 is the beginning of something that you've proven that something works, you found some success. It's very hard to exit at that stage at a, like a life changing amount. Does that make sense?
- [04:27]
B
Yeah. So got it. Okay, so I, I've hit the 1 to 2 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 start having a lot of these conversations where I can exit to something that could be very life changing? Money.
- [04:47]
C
Interesting 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 EBIT 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 investor that can pay 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. Assuming that most business are sit between like 20% profit to 10% profit. Depends on the business.
- [05:38]
B
That's our goal. Right, like that. 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?
- [05:54]
C
Yeah, so I learned. Well, 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. And what I saw all these founders that come at the, at that stage that we're talking about, like at the 2 to 20 million dollars. So I found some product market fit, but I'm still in 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 gap that they're missing 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. When you approach growing a $5 million company to million company, a three million dollar 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 times out of 10, they're looking for like a tactical answer, what should I do? And what I found after working 100 of them is they're asking the wrong question. Usually they're facing this challenge because there is a question that they never asked, they never answered upstream. So it's kind of ambiguous. I'll explain what I mean. So for example, if your CAC is going up, yeah, you can try 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. So that's the problem. So the idea here is if, 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, it's the key that I found. If you're clear on your finance strategy and operations, mostly on your strategy of exactly what am I building here? Who 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. Does that make sense?
- [08:58]
B
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, but you still as a founder have to do. And if you're, you know, 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.
- [09:27]
C
Correct.
- [09:27]
B
How did you look at this?
- [09:29]
C
It's, that's the key, right? The planning piece is the hardest part, but it's the highest leverage one, meaning it'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 your deleted 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 abc 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 of they can't, but because there's missing knowledge of how to do that practically. They don't do it, and they just react. And the reaction basically takes all of their energy. And instead of directing it like a laser to a specific, like area, it just disseminate and becomes very, very wide and ineffective across multiple areas. That's the shift of shifting from a hustle mentality into adolescent mentality. So 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 miss 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.
- [10:49]
B
We're.
- [10:49]
C
No, we're not developing this product because you skipped it. That makes sense.
- [10:55]
B
It makes total sense. How did you fit the planning in? Because I think the other thing is, yeah, we're running like. Like our pants are on fire. Like, 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, right in the beginning, right in the. 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?
- [11:25]
C
So you start with. So the day is a byproduct of a larger decision. So the question is, how do you. So how do you actually plan of what kind of business you want to build? And the reason is you use a system just like we have eos, which is an entrepreneurial operating system. EOS is a great system to systemize chaos or to clean chaos. Right. Make sure that everybody's roaring 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. Doesn't cost anything. I want to, like, put it. 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. And 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, right? What are we doing tomorrow? What are we tracking in the scorecard? What quarterly priorities are we creating? And it's a waterfall effect. You bring a system.
- [12:48]
B
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. The problem was the implementing the system, right? But 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, uh, 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?
- [13:25]
C
Oh, that's a great question. So let me start with like the, the, the, 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. Some 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 signal revenue stream is responsible for a very small amount of sales, but it produces most of the profit from the business. And 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.
- [14:52]
D
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- [15:21]
C
Without needing to develop more revenue streams. Does that make sense? So the idea here is to growth by subtraction, not by addition until you reached a scale where you could add more product at the $20 million mark, 30 million dollar mark. But a $5 million business is still in, at least in the US 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?
- [15:52]
B
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 industry leader in that one product. And 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 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.
- [16:46]
C
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, that's, 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, right? I want to be a 10 million dollar company, want to be a $29 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. The 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, and connected to your problem solution thesis and explain what I mean by that. Basically why are you, why did you start this business. What are you really trying to achieve in 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 to the success metric? But if the success metric is just a number or more in just a revenue number, it doesn't really tell me anything about what path I should take. The power of a really sharp success metric is much more powerful than any just like revenue goal. Why do you want to be a 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. Because I believe if you have strong, strong team and you just have, you are able to help them make slightly smarter decisions along the way or more logical decisions. They rock. And that's, 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.
- [19:23]
B
Yes, I like that we had Gino Wickman on before but many years ago, right when he had exited eos. So that, that was a interesting conversation. I was listening to the NetJets founder. I think he's like a billion billionaire founder. And he said a comment. I thought it was interesting and I wanted to hear if you've had the same thing. They 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 like, okay, every time I do, I hit a milestone or a success. Every time I attach it to something else.
- [20:14]
C
The short answer is no, I don't, I don't. I don't attach it to something else. I don't really success because in my world success almost like micro successes along the way because it's 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 aha moment, that's a success. When people start saying no to stuff, that's a success. When people come back to me and, 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 sell. That's what keeps me in the game. That, that's what I celebrate. I don't buy a watch, but it makes me feel really nice.
- [21:06]
B
You know, I. We 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, you know, for you, it's this free resource is bringing a lot of passion without profit as a focus for you, which is amazing. You know, like 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, you're making a big difference for people all around the world.
- [21:42]
C
I hope so. This is like, I want to be completely transparent. It'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. If I was your co founder, how would I answer that question if I was in your shoes? So I. It's not a 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, 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. They just need someone to help them kind of zoom out every once in a while.
- [23:05]
B
So Yarin and I, 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? Because I'm sure they're going to need the whole system. And I imagine, you know, it's, it's a long term thing, but can you dive more into it?
- [23:27]
C
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. And 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 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 adolescence companies was they just become explicit and they align with their team. Everything becomes it, it just flows down.
- [24:47]
B
I would think too now you could plug this into AI and you could maybe work with AI to helping you along the way. Like you don't have to go it alone because, you know, maybe they don't have a big team or you know, maybe I know people that don't have any team at all or maybe they have a few like outsourced employees or virtual. Virtual employees. Do you think you can, you can leverage. Obviously it's in notion, but can you leverage technology alongside the system if it really understands your business?
- [25:16]
C
Absolutely. It's just this system really is just a bunch of questions that you ask. Financial questions, strategic questions and operational questions. So you take that question and you ask, or you ask your employees, or you ask. We just have a discussion. It can be with AI, can be with your team, it can be with your spouse around. Okay, what do we actually do better than anybody else? For example, to one of the questions ask. I use it with ChatGPT all the time to answer and reflect on questions. Because even if you answer it, stuff change, you learn more, business evolve. So it's just, 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. And operationally you can refresh it once a quarter. So 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.
- [26:17]
B
I like this clarity. You know, I feel like we, we always want to say we're hustling, but in reality nobody really wants to hustle. Like, like nobody wants to really do that, but we feel like we have to say we're doing that. So I like, I like the clarity. And starting early, implementing things. Like you said before, you're getting to the phase of private equity. Why? Why would you not start at day one? Or maybe you're at 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 a. 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.
- [27:01]
C
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. And specifically what it is, is I fix them, fix the broken ones. But let's talk about vcp. The major difference in vcp, 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 slightly more risky, one disruptive one goes to vc. So as a founder, the first question is, what kind of company are you trying to build and what kind of growth are you looking for? Are you looking for 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 big team because the other four really one or two out of the four, zero really going to make up for all day 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 Ebida which is net profit versus VC might value just number of users or year by year growth. So they're looking at different things and it's really important if you are a founder to know who you're getting, you're getting to bed with and to choose what kind of partner do you want to have. Because a VC partner and a PE partner are going to have very different expectations on how you should react to different events and how quickly you should grow and how risk you should take. Just different ways to invest with different, sometimes different kind of assets in a.
- [29:16]
B
Different stage because you were. And by the way, I never knew what entrepreneur residence really meant. I see it but I've always wanted to know what does that even mean? So thank you for, for clarifying that. When you looked at being from the founder side, the exit side to then PE side and looking at the investment side where what do you think is broken in in the private equity world that you're like you know what, we need to fix this. Coming from the perspective of the founder.
- [29:47]
C
There is ton of businesses in adolescent stage two to 20, they're too small for private equity to touch, it's too risky for them. But on the other hand from a founder perspective, there's so much value. There are businesses, they have product that people love, they have customers, they have revenue streams that produce cash flow. The challenge is that they're just adolescent stage so they're not readying for sophisticated investors to come invest in them. So either they're able to either grow or figure this out or they phase and or they sell to other small players at small multiples. They never enjoy that PE multiple. And that's what I'm trying to change. I say okay, there is a breed of businesses that are the 2 to 20, found some success, are not yet stable, too risky for regulating, they need more hand holding, they need more support than a regular investor would like to give them. But there's A ton of value and there's a ton of opportunity. If you are able to help them, they will grow. And what I found is the missing piece is the planning piece. They know how to build, they know how to execute, they know how to sell. What you need to do is just help them to focus on who is the better customer, who is the better revenue stream, what's the better business model. Once they have it, they will grow organically. You don't, they don't need me for the growth. Does that make sense? It's my thesis about private equity and they're just missing it. It's this too. They they it because they're not built to work. So hands on with these businesses and they're just too risky. But if you can help these business become a little bit less whiskey, that would more mature, a little bit more predictable, a little bit more proactive. So much opportunity.
- [31:39]
B
It just reminds me there's a lot of opportunities in business as a whole. Whether you are in business to sell a service or product, if you're in business to invest, if you're in business to help people grow, if you're in business to create a system. It just reminds me that there's a lot of opportunity as well as there's so much opportunity. I imagine from the investment side to the PE side. Like there's a lot of things. But the issue always is that I think when you create a business you basically know nothing about nothing and you do it because you found a problem to solve and then the journey gets, then you're down the wild path of this journey. But, but the more knowledge I think you have up front, I think you then can plan out for these things, which is what I'm hearing. You can create the clarity, you can do the plan, you can do these things upfront and not wait. And then you create a better business, you have a better time with your family, your friends. It doesn't destroy your personal life, which we've had many founders have told us, you know, it's basically led to the destruction of everything in their personal life because they had to sacrifice. But yarn, this has been amazing. If people want to get in touch with you, they want to find out more about, they want to get this notion because I want to get this notion. So how can I do that?
- [32:58]
C
It's at playbook that fractional partners and maybe we'll put a link in the, in the bio. It's publicly open. It's a notion. Use it, use it like the idea here. Why, why would you scale without first taking a quick pause and decide what is actually worth scaling out of everything you've built. Do this and everything will become better. It's my true belief. Your family life become better. I don't promise you you're going to work less, but you're definitely going to be more effective and more. Usually it's, it's more energizing. It's nicer to work with a company that knows what they're building. It's just that that's my whole belief.
- [33:40]
B
Well, I love it. Yarn thank you so much for joining us on Founder Story.
- [33:43]
C
Thank you, Daniel. Thank you for having me.
- [33:51]
B
If you like the show, please take a moment to rate, review and subscribe. It really does help the show to grow. Thank you for listening.