Six Software Products in One Year

Things change dramatically once you retire. First, your net worth on a salary:

Then, when you own a royalty-generating business:

In reality the scale is everything, but the point remains. With the business, you keep earning money even in retirement. On the salary, you’ve just jumped out of the plane - you need to have enough cash to support yourself until you die.

If you’re thinking about this, I strongly recommend making a spreadsheet so that you can stick in your own figures (expected investment return, salary growth, retirement year, etc) and see just how your financial situation will look in various points of your life. You’ll make horrible assumptions, but you’ll learn a lot.

Click here to download the spreadsheet I used. It’s set up to make the graphs look pretty rather than realistic, but the basic idea is sound. Put your own numbers in and see what happens.

In deciding whether to concentrate on full-time work or business-building, I think a lot about the different characteristics of the income received.

Full-time work is typically a constant $N/year. You (hopefully) receive a payrise each year. I’m going to assume 5%/year is a sustainable increase over the course of a lifetime. You put the difference between your income and expenses into investments (equity), which I’m going to assume earn 7%/year. Your net worth over time will look something like this:

Business-building - specifically, software, music, writing or other royalty-based media production - has different characteristics. In year 1, you are going to have fairly low income. You’ll do some piece of work and it will earn income on its own. This is passive income at this point - you don’t need to do any additional work to maintain that income. Then, in year 2, you’re free to do another piece of work - adding to your passive income. Lather, rinse, repeat. Your net worth will look more like this:

The question for any rational person is over the course of my lifetime, which is going to give me a higher net worth? And that’s a difficult question to answer early on. You’ve got steady but rapid growth versus exponential growth - but that growth factor is unpredictable.

This is the sort of bank balance that a startup company might see as well. There are two critical measures to take off this graph: how far into the red does the company go, and is that growth rate sufficient to make it a worthwhile investment? Many startups never even hit positive growth and will just run out of cash. Someone said that starting a startup was like jumping out of a plane; the ground seems like a long way off, but you’re falling very fast as well, and the question is whether or not you can pull out of the fall in time.

In the same way, my savings are my investment. If I run out of cash, I have to stop. I need to build income before I run out of savings. I don’t particularly want to risk all of my savings on this one venture, which is why I’ve set a one year time limit. If I’m still plummetting towards bankruptcy at the end of the year, I need to reconsider what I’m doing and if it’ll be effective. (Realistically, I’ll be watching this all of the time. One year is the big yay-or-nay decision, though).

If you need to borrow to get capital investment, this is going to make your profitability a whole lot tougher. You need to match your loan rate just to break even, as I found while playing with the spreadsheet model I used for the above graphs. Just as compounding looks like a lovely exponential growth curve, it can drag you into a horrible pit of debt very quickly.

Individual preferences are obviously going to play a big part in this decision as well. If you like to live close to your means and enjoy your money, you’re going to want the ongoing income. If you have dependents or medical bills, you need the constant income. I’m have no dependents and am happy to live a fairly lean existence, so I can choose to take this risk.

An interesting point that I read about today was that most micro-ISVs can’t keep building income forever. The income is not truly passive. Support is a big time sink, and the amount of support increases with the number of users. If you’re earning enough you can hire more people to take over this load - but this is the sort of problem that I’d like to have. If I get there, I won’t be complaining.

Playing with the spreadsheet model is highly educational: using the assumption that salary grows at 5% means that your income under a business also has to grow at at least 5% for it to be worthwhile. If you’re increasing your income by a constant amount each year, this is going to be easy to beat in the beginning and rapidly become impossible.

But, wait - there’s more! Part Two will discuss the two strategies once you retire.

In the short term, paid work is vastly more profitable. Even though I work as a contractor, not a salaried employee, paid work is far more predictable, reliable and profitable in the short term.

This raises the question: if my goal is to earn passive income, I have two major options. I could work and earn $N/year plus 0.07 x $N/year in passive income after that (ignoring compounding and expenses). Or I could build this business and start from zero income and slowly build it up - but it’s all ‘passive’ income.

There are almost no sources of income that are truly passive. Even leaving cash in a bank account requires some paperwork and monitoring. It’s a very small amount of work, but it is finite. Another way to look at this might be to compare hourly rates. Increasing the hourly rate is obviously good - you earn more money for the same work, or earn the same money for less work. So ‘passive income’ streams are essentially trying to build income streams that require very little work for a large income - they have a very good $/hour rate. A ten-year property or index fund investment might be worth tens of thousands of dollars per hour. This ignores the fact that you’re very limited in the number of hours that you can do, but it doesn’t matter so much - even if the number of hours is limited, it’s still worthwhile to take them and spend the rest of your time on the most profitable work available.

So by starting this company, I’m acknowledging that my initial per-hour rate is going to be terrible. I’ll be losing small amounts of cash in the beginning, in fact - as cheap as it is to start a software company right now, I’ve spent about USD$20 on this domain name and that puts me into the red. The idea is that over a longer time period I won’t have to put in so much effort to maintain the same income level, and so my effective per-hour rate will rise above that which I could get by working a standard job.

I can imagine a few different outcomes at the end of the year.

• I build some products, but they don’t get any interest or traffic. I’ll have to get a job and will be out a year’s earnings plus the money I spend along the way. This is the worst-case scenario, but I don’t think it’s terribly likely.
• I build some products and they get a little interest, but not enough to build up enough income to live off. This is OK with me, oddly enough. Any income is a sign that I’m doing something right. I’d still have to get a job, but I will have learnt a lot and have some passive income going. So this isn’t a bad outcome.
• I build some products and I earn enough to sustain myself. This is fine. It’s not spectacular. A few years from now, I’d like to be earning a whole lot more than I am now - but I don’t have huge expectations in that respect. More important is that I can choose where and when and how I work, even if it means I don’t earn so much. If I do need extra income, I can always get a job.
• One or more of my products is a massive hit and I become rich. Woohoo! Not terribly likely, but I’m not going to complain.
• I have poor results after the first few months, get discouraged and quit. Since the alternative is that I get a job, I don’t consider that too likely. But it is possible. Maybe a job will seem appealing after that long without income or human contact.

So I guess, the worst thing that can happen is that I lose some cash and have to get a job. I don’t particularly like jobs, but it’s not the end of the world.

Chances are, I’ll still have some part-time work while I’m building these products anyway. Even right now - before I officially start - I’m dividing my time between a (nominally) full-time job and some product development. At the moment it’s about four days/week on the ‘day job’ and one or two days on product development. And that’s OK. I see regular progress, and that’s encouraging. I’d like to be making faster progress, but anything is OK.

Yup. Aggressive schedule. More importantly, I won’t be taking on huge projects and then finding that there’s no demand. What I want to build is strongly influenced by what I will use and what I like, and there’s not always going to be a correlation between that and what other people will use and pay for. The idea is to build some things and find out what other people like, then concentrate my efforts on the most popular (and subsequently profitable) projects.

I use the word ‘product’ to mean more than just a piece of software. It’s the software and the documentation and the FAQs and the marketing collateral and the monetization. Which, when you think about it, doesn’t leave a lot of time to write software. Y Combinator gets three months, there are four of them, and they’re sprinting. I’m one man with two months and I don’t know much about marketing.

Nevertheless, I remain confident that this is a sustainable schedule - at least for the first few products. If one of my early products becomes popular, it’ll probably delay the later ones. Which isn’t a bad thing - one of my products will be popular!

The idea is that when something is popular, I spend more time on it. Popularity is easy to translate to money - pay-per-click advertising is the most obvious way. There’s also paid services, consulting, customization, support, feature development and good old-fashioned networking. Getting attention is the trick. There are billions of other web pages out there, and I need to attract attention to mine. I’ll be thinking about marketing a great deal.

There’s also a discrepancy between working time and wall-clock time. While I really, really want that ‘one year’ to be real (wall-clock) time - it’s not going to work out that way. I’m full-time employed right now and don’t know when I’ll be leaving that. I’ve got two holidays and an interstate move planned. The year will have some major disruptions to it. I also plan to keep working for other people a little during the year.

Still, I think one year real time is the best way to measure this, if only because it’ll cut down on me slacking off because “that day I spent watching TV, it didn’t count anyway”. The days all count. Some of them are going to be disrupted.

When ‘the year’ begins is still uncertain. Most likely it’ll be when I reduce my work commitments to two days/week or less. This still leaves me a pretty reasonable yearly income and is comfortably above my expenses.

A major long-term goal that I want to attack with this company is that of being financially independent. I mean in the sense that I have enough money to live comfortably without needing to work, not in the sense that I’m debt free (but still have to work).

Most of us have to take the slow and steady approach: make investments, live below our means, scrimp and sacrifice to build a retirement fund. I live in Australia, and most of us have to pay 9% of our earnings into a superannuation fund. The problem there is that you can’t get that money out until you’re retired, and I sure as hell don’t want to be 55 years old and crippled before I can enjoy my savings. I view the 9% superannuation contribution as another tax, on top of the 30% (typical) income tax, on top of the 10% GST on expenditure. 49%-ish tax, and that’s before you even start moving into a decent income tax bracket. Nuts to that, I say.

Passive income is the way to go, not just for tax reasons. If you earn enough to support yourself without working, then you have great options. You can travel for a year and come back richer than when you started. You can be more aggressive with salary negotiations. You can choose to work somewhere fulfilling but unprofitable. You can quit your job anytime. You can repeat whatever you did to build up $N/year passive income and make it $2N/year.

There are a few ways to earn this passive income. The scrimp-and-save-and-invest method is the most common, and you’re looking at earning about 7% of your investment size each year that way. The obvious problem is that to make that 7% into a livable income, you need a huge investment. Which means you need to spend a lot of time earning money in the first place. Which means you need to get a job. And I don’t like jobs.

Don’t get me wrong. I’ve found paid work rewarding in many ways, including financially. I’ve worked hard since I left uni and responses from every employer I’ve had have ranged from ‘pleased’ to ‘ecstatic’. If you, future employer, were to choose me, I believe it would be a good choice.

Of course.

But I don’t want another job. If all goes well, I have taken my last job for the rest of my life. This is a big claim, which is why I prefix it with ‘if all goes well’. I’m taking on risk.

But back to passive income. While I am earning some passive income, it’s not enough to live off or pay for anything of significance. It’s not growing fast enough to capture my interest. Consumerism is not particularly interesting to me. And paid work is not fulfilling or profitable enough.

I’m interested in not working, and I’m willing to work damn hard to get there before retirement age.