Rich, but Not Silicon Valley Rich for Founders of Box
J Thoendell stashed this in Tech
Aaron Levie and Dylan Smith are worth more than $100 million combined after turning the cloud software firm they started in a Berkeley, Calif., garage into Box Inc., with 1,200 employees and expected revenue of $285 million this year.
They rang the New York Stock Exchange’s opening bell in January to mark Box’s debut as a public company, a rite of success that few Silicon Valley startups live long enough to see.
But getting there took 10 years. Stress made the 30-year-old Mr. Levie’s wild hair gray at the temples, while cash infusions from outsiders drastically shrank each man’s stake in Box and ignited strife about when to go public so early investors could cash out.
In an example of the hard compromises, Mr. Levie went looking for $150 million last summer while Box was still a private company. Plans for the IPO were frozen because of turmoil in the market.
Hedge fund Coatue Management LLC and private-equity firm TPG Capital played hardball. They demanded a 10% discount on the purchase price of Box shares to lock in a profit if the company went public within a year.
The young CEO pulled curls of his hair with both hands and went for a walk with Mr. Smith, Box’s finance chief, who said the proposed terms were “tough” but racing into an IPO was “risky,” the two men recall. Mr. Levie replied with two four-letter expletives but agreed to take the deal.
Messrs. Levie and Smith were among the first entrepreneurs to target the cloud-based storage business. Mr. Levie got the idea after his 11 previous website ideas went nowhere. In 2005, the two men took Mr. Smith’s online poker winnings of $20,000 and got to work in the garage of a house owned by Mr. Levie’s uncle.
“Back then, investors had a hard time investing in a company where the founders acted 40, were 19 and looked 12,” Mr. Levie recalls. “They thought we’d run off to Disneyland with the funding money.”
The board, packed with representatives of early Box investors, decided to go along with Messrs. Levie and Smith but urged the CEO to watch his spending and hire “dozens fewer” salespeople.
Mr. Levie shot back: “We will save our way into the land of irrelevance.”
“I was worth $100 million for a second,” Mr. Levie says. “I did the math.” Messrs. Levie and Smith flew back to California and played beer pong at Box’s headquarters with other employees deep into the night.
Tthere is a fundamental lack of understanding about the subscription business model, aka the “Subscription Economy.”
In order to understand the true genius of Box, let’s look at the four big differences between the subscription model and a traditional software business.
1. Subscription businesses care about a different revenue metric: ARR
The first thing to know is that for a subscription business, revenue is not revenue. It’s the difference between a one-time payment and recurring payments.
Just think about it — let’s say you have two friends: Jack says he’ll give you $10 just this once, and Jill says she’ll give you $5 a year for each of the next 10 years. There is a big difference between the two — you know that Jill’s deal is a better deal.
That’s why smart subscription businesses look at something called ARR, which stands for Annual Recurring Revenue, and consists of only the subscription revenue from customers for an ongoing service. To get at ARR, subscription businesses take the value of their subscription contracts, normalize it to an annual amount, and add it all up. For a subscription business, more so than cash or revenue, ARR is the true indicator of your company’s health.
But here’s the thing: accounting rules today don’t recognize ARR.
In fact, accounting systems do not differentiate between a dollar that recurs and a dollar that does not. Accounting systems today are built on the double entry standard created 500 years ago by Luca Pacioli to help Venetian merchants track the sale of spices. And in that system, a dollar is a dollar is a dollar.
Fortunately, there’s a simple way to approximate ARR from a standard income statement — just take the quarterly revenue, strip out non-recurring revenue such as setup fees or consulting fees, and multiply it by four.
That will give you a close estimate as to what the ARR was as the start of that quarter. (The sophisticated reader here will note that this doesn’t tell you what ARR is at the end of the quarter, and it doesn’t include revenue contributed from in-quarter bookings … but we’ll leave that for another time).
In Workday’s most recent filings, for example, the company reported $141 million in quarterly revenue, of which $110.7 million was subscription revenue. By taking the subscription revenue and multiplying it by four, you can see that Workday likely started out that quarter with about $443 million in ARR.
Has Levie built a house of cards, one that requires more and more money to fuel, but that ultimately will fall apart when the music stops?
I don’t think so. I see a person who, by the age of 28, has convinced some pretty big names in the investment community to give him over $400 million dollars to go after a once-in-a-lifetime opportunity.
That’s pretty amazing in and of itself. But that’s not all. Levie then built a business with strong fundamentals that is intrinsically profitable, if looked at in the right way.
Finally, by recognizing that he’s in a land grab in a fast growing market with multiple players, Levie is showing he has the courage to bet big and spend big to acquire as many customers as he can.
What if one day Levie decides that he’s won, that he sees the market for cloud collaboration slowing, and he’s the clear market share leader? At that point, if he cuts R&D back down to 15%, and sales and marketing down to 15%, he’ll have a 25% margin business. If he’s a $1 billion company at that point, that means he can throw off $250 million in cash.
If he can grow that into a $10 billion company, he’s throwing off $2.5 billion in cash. That’s a great business. And that’s the genius of Aaron Levie.