ExactTarget in the 8x Revenue Club

ExactTarget had a very successful IPO last week pricing above it’s expected range and then promptly gaining 32% in value the first day. ExactTarget is one of the most impressive SaaS companies due to their strong corporate culture (Orange Culture), growth rate north of 40% at scale, and headquarters in Indianapolis (outside the Silicon Valley echo chamber). It’s a small group of Software-as-a-Service companies that have had successful IPOs and the market has rewarded them handsomely in terms of valuations (SaaS IPOs are sexy article).

Based on today’s stock price of $26.32 for ET, the company is valued at $1.7 billion. At a little more than $200 million in recurring revenue that puts them in the 8x revenue club (the company is valued at more than eight times their revenue, which is extremely high). Bill Gurley, a famous venture capitalist and long time blogger, has a great post All Revenue is Not Created Equal: The Keys to the 10x Revenue Club where he talks about factors that contribute to extremely high multiples of revenue (think LinkedIn, OpenTable, etc).

Here are the factors Bill Gurley lists:

1. Sustainable Competitive Advantage (Warren Buffet’s Moat)
2. The Presence of Network Effects
3. Visibility/Predictability are Highly Valued
4. Customer Lock-In/High Switching Costs
5. Gross Margin Levels
6. Marginal Profitability Calculation
7. Customer Concentration
8. Major Partner Dependencies
9. Organic Demand vs. Heavy Marketing Spend
10. Growth

ExactTarget has most the factors including #2 (The Presence of Network Effects), #3 (Visibility/Predictability are Highly Valued), #4 (Customer Lock-In/High Switching Costs), #5 (Gross Margin Levels), #6 (Marginal Profitability Calculation), #7 (Customer Concentration), #8 (Major Partner Dependencies), and #10 (Growth). A sustainable competitive advantage is there but not as obvious as lower cost providers continue to proliferate. In addition, there isn’t organic demand but rather very heavy marketing spend ($30 million in losses last year due to sales and marketing). With eight of the 10 factors readily identifiable, and the stock trading at 8x revenue, it’s squarely in the 8x revenue club.

What else? What are your thoughts on ExactTarget in the 8x revenue club?

APIs Provide Unbelievable Power

Application Programming Interface (API) is the term to describe a way for computers to talk to other computers in an automated fashion. Imagine your accounting software talking to your payroll software to cut checks, pay taxes, and facilitate 401k matching — that would be done via an API. APIs open up a world of unbelievable power due to the ability to control other systems as well as consume data, and vice versa.

The famous Paul Graham of Y Combinator sent a tweet recently saying an API is self-serve business development:

API = self-serve biz dev.—
Paul Graham (@paulg) February 21, 2012

Business development is traditionally slow, labor intensive, and often ineffective. With APIs acting as self-serve business development, companies can start integrating services or data from other providers and mashing it up with their own functionality. This way, they can build real enterprise value and let the market decide faster than humans trying to work out deals with other humans. APIs provide unbelievable power.

The next time someone talks about building a new feature or developing their own data source, do some Google searching and see if an API is already out there — you might be surprised.

What else? What are your thoughts on APIs?

Thinking, Fast and Slow for Startups

Recently I started reading the book Thinking, Fast and Slow by Daniel Kahneman after an entrepreneur recommended it to me. Now the book is a tome packed with anecdotes and research by the author who won the Nobel Price in Economics. The idea is that the mind has two core systems as follows:

• System 1 – the instinctive response that you immediately know (e.g. 2 + 2)
• System 2 – the thinking that goes into a more detailed thought that takes time to answer (e.g. 17 x 12)

Even though Kahneman won the Nobel Price in Economics there’s a significant amount of psychological and human elements that are fascinating with a number of behavioral economics items thrown in as well. As an example, if a person gets the option to flip a coin and can win $13 if they guess right and lose $10 if they guess wrong, they are less likely to take the bet at all due to loss aversion even though the weighted average is clearly in their favor. This applies to the corporate world where people don’t take risks for fear of failure. As for startups, those are the people that like the bet.

If you enjoy psychology and economics I’d recommend the book.

What else? What were your thoughts on the book?

Why Big Companies Buy Small Startups

Last month LinkedIn ($9.3 billion market cap) bought Rapportive for $15 million, which according to LinkedIn (naturally), has less than five people (LinkedIn Rapportive search). Rapportive, which is a great product that I use daily, is a dedicated Gmail plugin that takes the email address of the To: or From: address and shows social information like profile photo, recent tweets, links to Twitter/LinkedIn/Facebook profile, and more. It’s an awesome tool.

Now, why would LinkedIn pay $15 million cash for a Gmail plugin that on the surface looks like the LinkedIn piece could be written in one week by a talented developer?

Here are some reasons why big companies on occasion pay good money for small startups:

• Time to market – Rapportive already has a raving fan base that loves the solid product
• Talent acquisition – The Rapportive co-founders have built a killer product and likely have ideas for many more ways to make the product better with additional resources supplied by LinkedIn (or LinkedIn wants the talent to spearhead the development of a new product)
• Competitive preemptive move – If LinkedIn didn’t acquire them someone else that’s trying to be more social (Google?) might pick them up
• Cost of capital – If LinkedIn is sitting on a ton of cash or has a low cost of capital, which it does due to the large market cap and lack of leverage, putting the money to use immediately, even at premium, helps the company grow faster and create more enterprise value

With engineering resources scarce, and new product development tough (I’ve seen it fail twice inside a small company), big companies buy small startups to get a proven commodity that is already successful.

What else? What are some other reasons why big companies buy small startups?

The Incubator Approach and Startups

Earlier today I had the opportunity to meet with another entrepreneur in town that I hadn’t met before. We got to talking about what his ideal role would be once he made his FU money and he said it was to build a startup incubator or lab that created a number of companies where he helped get them off the ground but someone else would run them.

Interestingly, a story came out today where Kevin Rose, founder of Digg, took the acqui-hire route and sold his incubator to Google after their first product wasn’t successful. Rose is a guy who made his FU money, started a product incubator, and has now moved on to a giant company.

Here are some pros and cons with the incubator approach to startups:

• Idea to product won’t take much time at all since there aren’t any legacy customers to slow things down
• Hockey stick-like revenue growth often occurs several years in, assuming things are successful, so if you start five or 10 companies simultaneously, you still have a long time to see good cash flow even after killing the ideas that aren’t working
• Some startups are successful because they hang around a market long enough to find the pot of gold but with an incubator the staying power is less likely
• Timing a market is one of the most difficult things to do, so building multiple startups at the same time increases the chance that the timing for one of the markets is right

Idealab (great video) is one of the most successful incubators ever and should be closely studied by anyone thinking about doing their own startup lab. Building a successful incubator is hard, and I believe it’s even harder than building a successful startup (successful startup defined).

What else? What are your thoughts on the incubator approach and startups?

Warren Buffet’s 10 Rules from Jimmy John’s

A few nights ago I was out with the kids and we headed over to Jimmy John’s near Terminus. As we were waiting for our sandwiches to be made I noticed a sign on the wall: Warren Buffet’s 10 Rules. Much like the Jimmy John’s sign How Much is Enough, this one is packed with wisdom.

Here are Warren Buffet’s 10 Rules:

1. Reinvest your profits
2. Be willing to be different
3. Never suck your thumb
4. Spell out the deal before you start
5. Watch small expenses
6. Limit what you borrow
7. Be persistent
8. Know when to quit
9. Assess the risks
10. Know what success really means

The next time you’re at a Jimmy John’s read the signs on the wall — they’re worthwhile.

What else? What do you think of Warren Buffet’s 10 Rules?

Startups Should Say No to 99% of Partnership Opportunities

At yesterday’s Startup Riot I enjoyed talking with a number of entrepreneurs. One item that kept coming up was partnership opportunities that entrepreneurs were excited about. Here are some example partnership opportunities:

• Invite to be on someone else’s app store-like marketplace
• Desire to white label or OEM the product by a bigger company
• Exclusive reseller for a certain vertical or geography

Startups should say no to 99% of partnership opportunities. Most partnerships never go anywhere and don’t make sense for the startup to invest significant effort into the relationship due to being time and money constrained. Partnership opportunities do make sense when there is significant skin in the game on behalf of the partner (e.g. large up-front fees) or a super minimal way to work together (e.g. less than 20 hours of work to get something out the door that is useful).

Now, it isn’t that bigger companies are trying to take advantage of startups. Rather, bigger companies have more resources and less focus whereas startups are often looking for product/market fit and need to stay focused on work that’s applicable to 80% of their desired customers. The next time someone approaches you with a partnership idea, ask yourself the hard questions and assess the downside as well as the upside.

What else? What are other reasons startups should say no to 99% of partnership opportunities?

Startup Investment for Short-Term ROI or Long-Term Enterprise Value

As a startup there are a number of different ways to invest precious capital. Some investments, like building a minimum viable product, are obvious whereas others like buying ads on Google vs LinkedIn aren’t obvious until some modest amount of money is spent. Well, there’s another area that needs more thought from entrepreneurs: investments that don’t have a short-term return but do create significant long-term enterprise value.

Let’s look at an example to see long-term enterprise value in action:

• On average it costs $500 to generate a new customer that pays $1,000 per year
• Revenue is recurring and has 70% gross margins, so $500 in customer acquisition gets $700 of gross margin in year one
• Customers stay for an average of four years ($4,000 in revenue at 70% gross margin results in $2,800)
• Enterprise valuation for the company is three times the annual gross margin
• An opportunity arises to acquire more customers at $1,500/each which results in a year one loss ($1,500 > $700 gross margin) but is profitable over the average lifetime of the customer ($2,800 lifetime gross margin) and increases the value of the business $2,100 (3 x the $700 gross margin)

In this example, assuming no cost of capital and no discount for future cash flow, spending $1,500 to acquire a customer that pays $1,000 per year, easily pays for itself when looking at the lifetime value of the gross margin of the customer and the long-term enterprise value of the business. It’s important to get a complete picture of the value of a customer when determining the amount to spend that still generates a positive return on investment.

What else? What are your thoughts on startup investments for short-term ROI or long-term enterprise value?

Transitioning from Profit-Oriented to Growth-Oriented

Earlier this month I had lunch with an entrepreneur that described a situation I don’t hear about too often: after several very profitable years they wanted to transition from being profit-oriented to growth-oriented. The business was doing well and the market was continuing to mature around them creating a desire to gain more market share at the expense of near-term profitability. It seems pretty simple, right? Wrong.

Here are a few reasons why transitioning from profit-oriented to growth-oriented was more difficult than expected:

• Angel investors in the company had grown used to the nice dividends each year and didn’t want them to stop
• Internal team members were the operationally-focused type and not growth-focused (good people but not necessarily right for the change)
• Certain managers that excelled at their current size were viewed as not yet having the skills to take it to the next level, and would have to seriously improve or move on from the business

It was interesting to hear about these experiences first-hand as well as the challenges that come from making a dramatic strategic change.

What else? What are some other challenges with transitioning from profit-oriented to growth-oriented for a startup?