I like their checklist of items they're looking for in a web app. It seems like a good list for anyone developing a product. This item stood out to me as insightful:
"If you’re selling your product then it must have at least a 10% conversion rate. In other words, if ten people download it, or trial it, then, on average, one person should buy it. For us, this is a sign that you’ve got a product that works. We don’t care how many customers you’ve got - the fewer the better, in fact. It’s the ratio of trials to purchases that counts. If your not charging for it then we’ll look for a sign that a significant proportion of your users are actually using it regularly."
I haven't seen so much emphasis put on conversion rate before. Since they have a lot of experience with this sort of thing I think that means it is a better indicator of success than I've previously thought. From reading articles online, I had thought of conversion rate as more related to shiny buttons and A/B tests. That stuff matters, but it really does come down to how good the product is.
In what world does a product that generates $10k/mo have a lifetime value of $400k? I'd think if a business was attractive enough to be purchased they would expect more than a 40 month lifespan.
Depends on the discount rate you apply. If I was producing a SQLServer backup product, I would apply a very high discount rate to projected cash flows because Microsoft might add a button and unknowingly halve my revenue. Or, some open source project might provide sufficient value for some would-be customers. It's like this to some degree for just about any product, software or not.
Also, I read "lifetime value" to mean NPV of revenue, not positive cash flows.
Perpetual revenue is never worth as much as one thinks.
First, even if your product generates $10,000/mo forever, it clearly doesn't generate infinite profits. In fact, money that comes 5 years from now is worth less than money today. Why is that? As a simple example, let's say you have the option between $380,000 today and $10,000 per month for 40 months. Which is worth more? The $380,000 is worth more because if you put it in a CD for that time period, it would become more than $400,000 by the end of that term. So, money in the future isn't worth its full value.
Second, there is risk in a product that generates monthly revenue. A competitor could come by and undercut you and you have to reduce your pricing (and therefore profits). Heck, things could get so bad that your product becomes worthless. A cash buyout doesn't carry that risk.
Third, there is money that you have to put into a product over time. So, you might have something generating $10,000 worth of revenue each month, but you have to work full-time maintaining it and improving it. As such, you are forgoing other ways of earning money. Let's say that other way would get you $4,000 per month (low for a computer programmer with such skill - remember, that $10,000 is pretax as well). So, would you rather $4,000 per month plus $400,000 or $10,000 per month? At 10% interest (the rate of growth of the S&P 500, you'd have an additional $3,333 from the interest off that $400k bringing you to $7,333). So, it might not be as much, but you still don't have the risk of your business being undercut, made obsolete, etc. And if you're earning $80,000 per year (a reasonable salary for a programmer making such valuable programs), you'd be getting $6,666+$3,333 = $10,000 in a much more stable way where you don't have to worry about where the market might go. Plus, those types of jobs usually come with at least $10,000 in benefits (health care being a big part of that). And you have no expenses since your employer is paying for the servers and such.
So, it's not such a terrible price. There's a lot of risk they're taking as the buyer and they're taking over all of the maintenance. Maybe you believe in your product more or maybe you enjoy working on it which gives other value to the project for you. But it isn't that it will only last 40 months.
Again, this might be different if this is a project that requires a few hours a month of work in which case it doesn't change your potential for other salary. It might be different if you see a great way to expand the project to get more revenue. It might be different if there are competitors nipping at your heels. Maybe I'm too risk-averse, but it's important to see how it all fits together - from the present value of future money to the risk of competition and obsolescence to the amount of time you need to put into the project and how you could alternatively earn money with that time.
"If you’re selling your product then it must have at least a 10% conversion rate. In other words, if ten people download it, or trial it, then, on average, one person should buy it. For us, this is a sign that you’ve got a product that works. We don’t care how many customers you’ve got - the fewer the better, in fact. It’s the ratio of trials to purchases that counts. If your not charging for it then we’ll look for a sign that a significant proportion of your users are actually using it regularly."
I haven't seen so much emphasis put on conversion rate before. Since they have a lot of experience with this sort of thing I think that means it is a better indicator of success than I've previously thought. From reading articles online, I had thought of conversion rate as more related to shiny buttons and A/B tests. That stuff matters, but it really does come down to how good the product is.