Why Starting A Software Company is a Terrible Idea Ep 395



In this podcast, Alex Hormozi of acquisition.com debunks the misguided strategy of information marketers and ecourse gurus starting a software company to increase the value of their business. Hormozi argues that software must be exceptional to be sticky and profitable, and that most attempts to create software by non-experts result in subpar products that neither retain customers nor attract lucrative acquisitions. He emphasizes that software development is costly and highly competitive, and that potential acquirers are savvy investors who won’t be fooled by superficial tech enhancements. Instead, Hormozi recommends service-based entrepreneurs focus on making their existing offerings more valuable through customer retention and satisfaction, rather than chasing illusory shortcuts to success.

Summary Notes

Company Valuation

  • Making an existing company more valuable is preferred over attempting to deceive a potential acquirer.
  • Acquirers are knowledgeable and cannot be easily tricked.

"You can just make the company you have more valuable rather than trying to think that you're gonna trick some potential acquirer. Like, they're not dumb."

This quote emphasizes the importance of focusing on genuinely increasing a company's value rather than attempting to outsmart a savvy acquirer.

The Game of Business

  • The podcast discusses strategies for acquiring customers, increasing customer value, and retaining them.
  • It also covers the failures and lessons learned in the process.

"Welcome to the game where we talk about how to get more customers, how to make more per customer, and how to keep them longer, and the many failures and lessons we have learned along the way."

Alex Ramosi introduces the podcast's core focus, which is to share insights on growing a business and maintaining customer relationships, while acknowledging past mistakes as learning experiences.

Starting a Software Company

  • Starting a software company for information marketers or ecourse gurus is discouraged.
  • Alex Ramosi introduces himself and his company's success.

"I'm going to talk to you about why starting a software company as an information and sort service marketer, ecourse guru, et cetera, it's a terrible fucking idea."

The quote serves as a warning against information marketers and ecourse gurus venturing into the software industry without the necessary skills or focus.

Misconceptions About Software Businesses

  • Software itself is not inherently "sticky"; only well-crafted software retains customers.
  • Starting a software business with the hope of achieving a high exit multiple is misguided.
  • Few information gurus have had successful software exits.

"No, software is not sticky. Really good software is sticky. Your software will not be sticky and will just cost you a lot of money."

Alex Ramosi challenges the assumption that any software created will naturally lead to customer retention, explaining that only high-quality software achieves this goal.

The Reality of Software Entrepreneurship

  • Transitioning from an information business to a software company requires a significant shift in focus and expertise.
  • Competitors who specialize solely in software will likely outperform those who split their focus.
  • Marketing a software product requires different skills than marketing a course.

"And so they end up just having a kind of shitty mix in between because there's another person who's trying to solve the exact same problem and doing it better."

The quote highlights the disadvantage of dividing attention between an information business and a software venture, leading to subpar performance in both areas.

Challenges in Software Development

  • Software development is costly and requires a well-thought-out approach.
  • Competing with seasoned software professionals is difficult.
  • The high-risk nature of the software industry is exemplified by venture capital investment strategies.

"Software is one of the hardest businesses to get into for a variety of reasons. Number one, it costs money to develop stuff."

This quote outlines the initial financial hurdle in software development, setting the stage for further discussion on the complexities of entering the software market.

Likelihood of Business Success

  • The chance of success for new ventures is very low, leading to divided focus and potential failure.
  • Sunk cost fallacy can trap individuals into continuing unprofitable endeavors due to past investments.
  • Ego and public commitment can exacerbate the reluctance to abandon a failing project.

"Likelihood that yours succeeds is very, very low. And so what you do is you take your eye off the main game and then play the one in 50 game likelihood of succeeding."

This quote emphasizes the slim chances of success when starting a new venture and the risk of neglecting the core business to chase unlikely opportunities.

"And then what happens is sunk cost fallacy kicks in and you're like, well, I put all this money in. I put all this time in. I said it publicly, my ego is now attached to it, et cetera."

Alex Ramosi is describing how individuals become trapped by their past investments, both financial and emotional, making it difficult to let go of unsuccessful projects.

Valuation and Multiples

  • Company valuation is based on discounted future sales and the market potential.
  • High churn rates in software indicate a service business rather than a scalable product.
  • Only dedicated and knowledgeable software entrepreneurs should consider entering the competitive space.
  • The attractiveness of a business is determined by customer retention, increasing spend, and market expansion potential.

"The future value of a company is based on a discount applied to future sales between now and the day that the company dies."

This quote explains the fundamental principle of company valuation, which is the present value of its expected future earnings.

"If you have less than or above 10% annual churn on your software, you're fucked. You're just a service business, right?"

Alex Ramosi points out that high churn rates in software businesses are detrimental and categorize them as service businesses, which typically have lower valuations.

"If you have a service business that never loses anyone and each client continues to spend more with you over time, you're going to have a very valuable business, period."

This quote highlights the importance of customer retention and growth in creating a valuable business, regardless of the industry.

Misconceptions About Software Businesses

  • There is a misconception that any software can significantly increase a company's valuation.
  • Successful software companies often require initial funding to gain market share before they can scale.
  • The value of a business is not inherent to the industry but is based on the likelihood of future sales and customer behavior.

"People think that they're just going to slap some bullshit software that they paid some dude in Bangladesh 50 grand to put together, and think that they're all of a sudden going to take their 2 million profit business and get a 20 x top line multiple."

Alex Ramosi criticizes the unrealistic expectations of entrepreneurs who believe low-quality software can drastically increase their business valuation.

The Reality of Investor Intelligence

  • Investors with substantial funds are typically highly intelligent and make informed decisions.
  • Entrepreneurs should not underestimate the acumen of potential investors.

"The people who are going to give you the money are smarter than you. They're smarter than me. They're smarter than all of us. And the reason they have $100 million to give you is because they're not fucking dumb."

This quote serves as a reality check for entrepreneurs, reminding them that investors are savvy and have achieved their wealth through smart decision-making.

Personal Request from Alex Ramosi

  • Alex Ramosi does not run ads or sell products and asks for support in spreading the word about his content.

"Real quick guys, you guys already know that I don't run any ads on this and I don't sell anything. And so the only ask that I can ever have of you guys is that you help me spread the word so we can"

This quote is a call to action from Alex Ramosi, soliciting his audience's help in sharing his content since he does not monetize it through traditional means.

Importance of Authenticity in Business

  • Entrepreneurs should focus on creating genuine value in their products and services.
  • Misrepresenting a product or service, particularly in the tech space, can lead to loss of integrity and customer dissatisfaction.
  • Authenticity is crucial for maintaining a positive reputation and customer loyalty.

"And it's because they're actually bullshit software made by people who don't understand software and think that they're going to decrease their turn or somehow make their business more valuable."

This quote highlights the futility and potential harm in creating inauthentic software products that do not meet market needs or customer expectations. It points out that such practices can backfire and damage a business's reputation and value.

Understanding the Software Market

  • The software industry is competitive and requires a deep understanding of technology.
  • Potential acquirers of software businesses are discerning and will evaluate products based on usage metrics and value.
  • Creating subpar software can lead to negative customer feedback and competitive disadvantages.

"They know it's not software that people are using because they're going to look at time on screen, they're going to look at daily users and look at how much each of the elements according to where they want to drive value for whatever they're buying it for."

This quote explains how potential buyers or investors critically assess software products by looking at engagement metrics to determine their value. It implies that superficial or ineffective software will not stand up to such scrutiny.

Strategies for Service Companies

  • Service companies should focus on enhancing their core offerings rather than venturing into unrelated tech products.
  • Improving customer retention and satisfaction is a more effective strategy than mislabeling services as tech-enabled.
  • Expansion through acquisition, partnerships, and marketing can increase a company's total addressable market (TAM) and value.

"If you have a service company, just make your service stickier. Make it more likely that people will stay with you. That will increase the value of your company."

This quote suggests that service companies should concentrate on improving their core services to retain customers and increase the company's value, rather than attempting to diversify into technology without the necessary expertise.

Recognizing the Intelligence of Potential Acquirers

  • Potential acquirers, especially those capable of large investments, are usually highly knowledgeable and strategic.
  • Underestimating the acumen of potential acquirers can lead to misguided efforts to enhance business value.
  • Authenticity and excellence in one's domain are more attractive to acquirers than superficial attempts at being tech-enabled.

"Think about the people that you know who can stroke 100 million dollar, 500 million dollar check. They didn't get there by being morons."

This quote emphasizes that individuals or entities capable of making significant investments are likely to be very intelligent and experienced. It serves as a reminder to entrepreneurs that any attempts to mislead or overstate capabilities will likely be seen through by such seasoned investors.

The Dichotomy of Service Versus Technology Companies

  • Companies should have a clear identity as either a service or a technology company.
  • Attempting to straddle both identities without a true foundation in technology can lead to strategic missteps.
  • A true tech company has a competitive edge and focuses on innovation and technology development.

"You're either service or you're tech, period. And if you are a tech company, then you will know you're a true tech company because you wouldn't be watching this video because you'll be like, oh no, obviously I love competing against these other guys."

The quote asserts that companies should understand and embrace their core identity—service or tech—and that genuine tech companies are deeply involved in technological competition and innovation, to the extent that they would not need advice on pretending to be tech-enabled.

Competitive Advantage in Tech

  • Alex Ramosi emphasizes playing to one's strengths and competitive advantage.
  • He warns against non-tech entrepreneurs trying to create software for high multiples.
  • Most software doesn't sell, and those that do often sell for parts, not high multiples.
  • Success in software is tied to growth, user retention, and word-of-mouth referrals.

"And if you're not a tech guy and that's not your world, then play the game you're best at where you have a competitive advantage, right?"

This quote advises individuals to focus on areas where they have a competitive advantage rather than venturing into unfamiliar territories, such as tech, where they may not have the necessary expertise.

Misconceptions About Software Sales

  • The misconception that all software sells for high multiples is challenged.
  • Alex Ramosi points out that the majority of software fails.
  • The few successful examples achieve high sales due to exceptional growth and product-market fit.

"People hear that you can get ten times top line, 20 times top, 50 times top line, right, for software. But that's not the vast majority of softwares in general that get sold."

Alex Ramosi is debunking the myth that all software companies can achieve high sales multiples, clarifying that this is not the case for the majority of software products.

The True Indicators of Valuable Software

  • Valuable software is identified by the buy-used-tell model: customers buy, use, and tell others about the software.
  • The software must solve a valuable problem, be used regularly, and be recommended by users.
  • If software usage is dependent on another service, it may not be inherently valuable.

"Until those three things occur, the software is not valuable."

The quote outlines the criteria for valuable software: it must be purchased, used independently, and recommended by its users, signifying true product-market fit.

The Pitfalls of Diversification at the Wrong Stage

  • Entrepreneurs often try to diversify into software around the $1-3 million revenue mark.
  • Ramosi warns against this premature diversification, suggesting that it stems from a desire to prove one's intelligence or escape a disliked market.
  • He suggests that a lack of customer retention is often due to the business not fulfilling its promises.

"I'm really trying to get away from all this guru shit, all this servicing these customers who don't understand my value."

This quote reflects the frustration entrepreneurs may feel when trying to escape a market they dislike or feel undervalued in, leading them to make hasty decisions about diversification.

Building a Sustainable and Enjoyable Business

  • True success comes from solving problems and fulfilling promises to customers.
  • A business that solves real problems won't want to sell because of the satisfaction derived from happy customers and a strong reputation.
  • Sustainable businesses have low churn rates and can expect growth without additional effort.
  • Patience is required to build a good business; there are no shortcuts to becoming better.

"And I promise you that when you actually solve the problem, you're not going to want to sell because you're going to love the business."

Alex Ramosi assures entrepreneurs that solving the core problems of their customers leads to a business that is both profitable and enjoyable, negating the desire to sell.

The Importance of Patience and Hard Work

  • Impatience can lead entrepreneurs to seek shortcuts, but there are none.
  • Building a better business requires hard work and time investment.

"You just have to be better. And better takes work. Work takes time."

The quote encapsulates the message that business improvement is a process that requires dedication and time, and there are no quick fixes to achieving lasting success.

What others are sharing

Go To Library

Want to Deciphr in private?
- It's completely free

Deciphr Now
Footer background
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon
Crossed lines icon

© 2024 Deciphr

Terms and ConditionsPrivacy Policy