Pre-Paid SaaS Contracts are Free Working Capital for Startups

January 30, 2012 4 Comments

Software-as-a-Service (SaaS) as a business model has a number of advantages including alignment of value between customer and vendor, strong cash flows, high gross margins, and great economies of scale. As with any growing startup, one of the most limiting factors is cash — the faster the business grows, the more cash it eats. Another benefit of SaaS that should be mentioned more often is that of pre-paid contracts.

With pre-paid contracts, like Salesforce.com requires, payments are made in advance of service being rendered. These contracts are often pre-paid quarterly or pre-paid annually with a discount (e.g. pay for the full year and get 10% off). For the startup this results in free working capital to grow the business. Yes, there’s an unearned income liability and an obligation to fulfill the service, but with the money in the bank, many startups use it to grow the business even faster than if they didn’t have pre-payments.

There’s another secondary benefit of pre-paid SaaS contracts: potential profits in the bank aren’t taxed until revenue is recognized and profit earned. Say it is December 31st and the startup’s bank account has $100,000 more than it started the year. Normally, if that’s profit it would be taxed around 30% leaving only $70,000 left to invest and grow the business. Well, with accrual accounting and $100,000 of unearned income due to pre-paid contracts, that money isn’t taxed until the revenue is recognized resulting in more capital to grow the business on January 1st.

Pre-paid SaaS contracts provide free working capital for startups and should be considered when thinking through business ideas (e.g. can we get customers to pre-pay us to help fund the business?).

What else? What are your thoughts on pre-paid SaaS contracts as free working capital for startups?

Filed under Entrepreneurship, Operations, SaaS

Professional Services Revenue as it Relates to Software Startups

January 28, 2012 2 Comments

In the software business not all revenues are created equally. Revenue from subscriptions or licenses is significantly more profitable and scalable compared to revenue from professional services. When talking to entrepreneurs I like to get a feel for the mix of revenue from subscription/license vs professional services. One of the simple proxies for this is the number of employees they have in professional services.

Here are some notes on professional services revenue for software startups:

  • Professional services revenue as a percent of total revenue is often super high for early stage startups still looking for product/market fit (e.g. they are doing consulting work to pay the bills)
  • Once a product takes off services revenue is typically a small percentage of overall revenue, especially if channel partners (value added resellers) are used
  • As the core business and market matures, many software companies add more services as a way to grow even though margins decline
  • Some services companies masquerade as software companies when in reality the software is for lead generation for their consulting work or their product requires so much customization it doesn’t get much in the way of economies of scale

When thinking through startup opportunities, and evaluating companies, it’s important to understand how the services component fits in.

What else? What are some other thoughts on professional services revenue as it relates to software startups?

Filed under Entrepreneurship, Operations

SaaS Leaky Bucket Number

January 13, 2012 1 Comment

Software-as-a-Service (SaaS) has a number of important metrics for the business model with one of the most important being customer renewal rates / customer churn. Josh James, the co-founder of Omniture, which was bought by Adobe for $1.8 billion a couple years ago, sent this tweet out last week:

The idea that they’d sign up 1,200 customers per month and have 800 customers leave per month drives home the need to closely watch customer renewals. The ratio of new customers to lost customers is critical and now has a formal name:

Leaky Bucket Number = New Customers Per Month / Customers Lost Per Month

Note that it doesn’t take into account the average revenue per new customer vs the average revenue per customer that leaves as well as customer upgrades or downgrades. Generally, it’s a good metric to monitor because it’s easier for people to understand we signed 29 customers and lost 11 customers because it continues to keep the number of lost customers top-of-mind. And, it’s especially important for this number to be greater than one otherwise the startup is losing more customers than it’s adding.

What else? What do you think of the SaaS leaky bucket number?

Filed under Entrepreneurship, Operations, SaaS

Revenue Growth for Startups isn’t Linear

January 5, 2012 1 Comment

There’s plenty of jargon terminology in startupland, one of which is ‘hockey stick growth.’ The idea is that revenue growth isn’t linear but rather starts out really slow and at some point (hopefully) things really take off.

Imagine the annual revenue numbers as follows:

  • Year 1 – $75,000
  • Year 2 – $150,000
  • Year 3 – $300,000
  • Year 4 – $1,000,000
  • Year 5 – $4,000,000

So, if the company did $4M in Year 5 revenue, and they are on the accelerated growth part of the hockey stick, their growth as a percentage basis is higher than the earlier years and on an absolute basis it’s tremendously higher. The value creation for most successful startups takes place when they hit the accelerated growth portion. From a startup valuation perspective, high growth is significantly more valuable than low growth, everything else being equal. Revenue growth for successful startups is almost never linear.

What else? What are some reasons revenue growth for startups isn’t linear?

Filed under Entrepreneurship, Operations

Financial Controls for Startups

December 28, 2011 1 Comment

As a startup grows, inevitably more processes and procedures get put in place. One area of note that should be done sooner than later is financial controls. Yes, at first it is easy to keep track of everything when there are only five people but that doesn’t scale when there are 50 people.

Here are some simple financial controls for startups:

  • Require two signatures for checks over a certain amount (e.g. $5,000)
  • Put a modest spending limit (e.g. $2,000) on all corporate credit cards except for one that is designated for larger purchases
  • If possible, separate out the accounts receivable function from the person who actually deposits the checks
  • Pay for an annual review of your books by a CPA or get a full audit if required by investors
  • While not financial controls, backup your data using Dropbox and your website using CodeGuard

For banks, it is a best practice that all employees take two weeks of consecutive vacation each year so that potential fraud will surface. That’s obviously for a different industry, but it is interesting to think about nonetheless. Financial controls are important for startups and should be implemented early on.

What else? What are some other financial controls startups should implement?

Filed under Entrepreneurship, Operations

Credit Card Processing for Startups

December 21, 2011 2 Comments

Recently there was a Flashpoint email thread on credit card processing options for web startups. Processing customer payments is both good (get $$$) and bad (payment gateways are usually difficult and frustrating to deal with). At the end of the email thread there was no general consensus but several were offered up that startups in the cohort had used and were happy with.

Here are some credit card processing vendors that were mentioned:

There are also add-on services that interface with the payment gateways to provide more functionality, especially around recurring revenue with Recurly and CheddarGetter being two popular ones.

Payment processing is a part of startups and these vendors provide a good starting point to comparison shop.

What else? What are your thought on credit card processing and vendors for startups?

Filed under Entrepreneurship, Operations

Simplified One Page Strategic Plan from Rockefeller Habits

December 17, 2011 3 Comments

Early last year I mentioned that the Rockefeller Habits One Page Strategic Plan is too complicated, cluttered, and jargon filled. Answering all the questions and providing it in one page form is a great exercise but team members need something that is much more digestible. Well, here’s a simplified one page strategic plan that fits on one page of a Google Doc with margins set at .3 inches and a font size of 10 (Google Doc template):

S.W.O.T. Analysis

  • Strengths – answer on the same line
  • Weaknesses – answer on the same line
  • Opportunities to exceed plan – answer on the same line
  • Threats to making plan – answer on the same line

Core Values

  • General – fit on one line
  • People – fit on one line

Purpose

  • One line purpose

3 Year Targets

  • One line with the year and three goals

Annual Goals

  • Four annual goals in table format with last year’s values of each as a baseline

Quarterly Goals

  • Four quarterly goals in table format with the value of the same quarter last year as a baseline

Quarterly Priority Projects

  • Three priority projects with one bullet point for each

Market

  • One line description of your market

Brand Promise

  • One line brand promise

Elevator Pitch

  • No more than three sentences for the elevator pitch

Now, it’s still a significant amount of information but the jargon has been removed, it flows top to bottom, and it fits on a single side of one sheet of paper. My recommendation is for entrepreneurs to do an updated one page strategic plan on a quarterly basis following the ideas from Mastering the Rockefeller Habits (Google Doc template).

What else? What do you think of this simplified one page strategic plan from Rockefeller Habits?

Filed under Entrepreneurship, Leadership, Operations

Alternative Daily Check-in Format for Startups

December 10, 2011 1 Comment

Previously I’ve talked about how we do bottom-up daily check-ins. That means each morning we get together for a five minute meeting with everyone standing where each person answers the questions what did you do yesterday, what are you going to do today, and do you have any roadblocks. Well, at the Cameron Herold event earlier this week, he introduced a different format for seven minute daily check-ins:

  1. Share good news
  2. Cover numbers by department
  3. What does it all mean to the company goals and revenue?
  4. Missing systems or opportunities for improvement
  5. Sports team cheer with all hands in

There are pros and cons to each type of daily check-in but the general benefits of daily, quick, in-person communication remain true.

What else? What do you think of this alternative daily check-in format for startups?

Filed under Entrepreneurship, Operations

Assessing Customer Renewal Rates and Churn Trends

November 28, 2011 Leave a Comment

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Customer renewals rates are one of the key tenets for Software-as-a-Service (SaaS) startups. It’s important to track relevant details as to why a customer leaves so that these can be analyzed and addressed.

Here are some common categories for SaaS companies to track in order to assess customer churn trends:

  • Budget
  • Product functionality
  • Usefulness
  • Personnel change
  • Project needs

Another general question I like to track is whether or not the item was within our control. The idea is that some things, like budget, are outside our control, but product functionality is within our control. Another area to look at when assessing customer renewal rates is to look at the sales reps that brought in the account to see if certain reps are signing clients that aren’t good fits, and thus have higher churn rates. A third exercise is to do SaaS cohort analysis and look at renewal rates of groups of customers from defined time periods (e.g. how do customers signed in Q1 2011 compare to customers signed in Q4 2010).

What else? What other ways do you assess customer renewal rates and churn trends?

Filed under Entrepreneurship, Operations, SaaS

Google Spreadsheet Marketing Budget Template for Startups

November 25, 2011 4 Comments

Presentation-quality budgets.

As a startup grows and matures so too should the tools and processes used. A simple Google Spreadsheet suffices for company-wide forecasting and budgeting until the business expands to the point that each department needs to do it on a more detailed basis. Here is an example marketing budget Google Spreadsheet template we use that includes the following info:

  • Categories for Staff, Lead Generation, and Communications
  • Monthly, quarterly, and annual totals
  • Budget, actual, difference in dollars, and difference in percentage

This marketing budget Google Spreadsheet template for startups isn’t limited to marketing departments and is readily used for any department. Budgets are an important part of the planning process and collaborative tools like Google Spreadsheets make them easy to develop and use.

Note: To use the spreadsheet for your own purposes, load the View-only version and go to File -> Download as Excel from within the File menu on the page (not in the browser window) and then upload the Excel file into your own new Google Spreadsheet.

What else? What are your thoughts on budgets in startups?

Filed under Entrepreneurship, Operations, Sales and Marketing

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