One of the concepts I stress to hope-to-be entrepreneurs is that they’re best off starting something, anything, and learning from there. Today, one of the fastest things to start is an online store on eBay/Amazon/Etsy. Even though it’s turnkey, there are so many things to learn: inventory, shipping, taxes, SEO, advertising, gross margins/cost of goods sold, etc. Doing something is a forced learning experience that will help inform if you enjoy it or not, as well as spark new ideas. The best way to find a great idea is to work on any idea first. 

Personally, I’ve been starting businesses my entire life. Here are a few I did as a kid before I could be a full-time entrepreneur:

• Hamster Breeding
  One day I was talking to the local pet store owner about the dwarf hamster I had and he offered to buy any babies from me for $1. Well, the next thing you know I had dozens of them in my room at home and I was raising hamsters as a little business. Quickly, I realized the limitations and the amount of effort required for little payoff. The business lasted six months.
• Shareware Apps
  After a friend gave me the book “Teach Yourself C in 21 Days” in 8th grade, I was hooked on computer programming. I built a number of shareware apps and sold them on AOL, CompuServe, and Prodigy. This was a great lesson in dreaming up new product ideas and bringing little apps to market. Customers didn’t even know I was in high school! The business lasted three years and I sold hundreds of copies.
• Flea Market Dealer
  Back in the 90s there was a program known as the Columbia House BMG Music Club where you’d get a certain number of music CDs for a penny followed by monthly CDs at normal prices. Well, I signed everyone in my family up for the promo pricing at both the home and office addresses amassing hundreds of CDs. I’d then cancel the accounts and not continue the monthly program. Finally, to sell them, I’d rent dealer tables at the local flea market and sell the CDs for $5 each making hundreds of dollars of profit. This business helped me look for arbitrage opportunities. The business lasted one year and three trips to the flea market. 
• Sports Cards Dealer
  Sports cards were always a personal passion of mine as far back as I can remember. I would obsess over the prices in the Beckett magazine every month and memorize them all, especially the 1989 Upper Deck Ken Griffey, Jr. rookie card. One day, I realized that I could buy cards online for the hottest players in my area (Atlanta Braves stars like Chipper Jones) at half the cost of the local sports card stores using Newsgroups (think Reddit) and eBay. Well, I bought as many cards as I could afford and then became a dealer doing shows in Tallahassee, Pensacola, and Jacksonville. The online to offline arbitrage was a homerun. The business lasted two years.
• Website Development
  My final childhood business was building websites for local companies first in my hometown and then in college. This was the ultimate gateway business as I learned web development which lead to a number of “real” startups. I’d charge $1,000 for a site and marvel that I’d make $50/hour doing something I really enjoyed. The business lasted three years. 

While I’ve always loved entrepreneurship, these small endeavors early on set the foundation for a lifelong pursuit of startups and company building. 

Starting on an idea — especially something simple — is the best entrepreneurial training possible. There’s no perfect idea and too many people use searching for an idea as an excuse. Just like with anything new, the sooner you start doing, the sooner you start learning. Start now. 

Last week I talked to two different entrepreneurs working on side hustles. We talked about the big ideas, progress so far, what’s working, what’s not, etc. Then, I asked the hard question: what will it take to go full-time? Going full-time is a huge milestone, and rarely achieved. I’ve talked to hundreds of entrepreneurs over the years working on side hustles and it’s easily less than 5% conversion from part-time to full-time status. And therein lies the ultimate problem.

Working on a business part-time almost never provides for enough progress due to lack of rapid iteration.

Sure, you can make some progress. There are simple items to complete, basic infrastructure to organize. Things like customer discovery and business model canvas can be started. These are all worthwhile and part of the journey. Ultimately, startups are all about speed. The faster you translate market needs into solutions, the faster you find product/market fit. The faster you iterate on the customer acquisition process, the faster you find a repeatable, scalable business model. The faster you achieve these milestones, the faster you can raise capital (if needed!). Speed, speed, speed.

Startups require a herculean effort. A day job, plus a side hustle, plus a family, plus other obligations is often too much. If the vast majority of full-time entrepreneurs fail, what are the odds of a part-time side hustle? I realize not all entrepreneurs can go full-time and that other facets of life create their own opportunities and challenges.

Startups are hard. Doing it part-time makes it 10x harder. If possible, figure out a path to being full-time as quick as possible and improve the chance of success.

Continuing with the thread that there are a number of anomalies in startup land now, there’s another one worth discussing. While the vast majority of startups have slowing growth rates, many will reaccelerate. Yes, the new growth rates will be slower than during the pandemic, but these are excellent businesses where growth is masked by extenuating circumstances. In addition, reaccelerating growth rates improve a number of aspects of the business from morale to recruiting to valuation. 

First, let’s dive in why reaccelerating is imminent. COVID pulled forward a tremendous amount of demand taking companies from good growth to hyper growth in a span of 6-12 months. Today, a startup that might be at $50M of revenue would likely be at a much lower number if the pandemic didn’t happen — still a great business but a smaller business. In addition to growth being pulled forward, startups often sell to other tech companies as they’re early adopters. Of course, these tech companies had a COVID boost as well so they hired a huge number of new team members, resulting in even more software spend. Now, these tech companies and startups are doing many rounds of layoffs, and reducing their non-employee costs a corresponding amount. Finally, one more added challenge: the cost of capital went through the roof due to significantly higher interest rates and lower valuations. Startups that would have kept their burn rates up in the past cut even deeper to conserve cash, and that resulted in more layoffs. 

Bringing all these factors together results in higher churn rates and reduced consumption revenue that is worse than anticipated. Record high downgrades and cancellations translates into even lower growth rates. Premature increased customer growth plus premature downgrades and cancellations paint an incorrect picture. Startups would do well to take their historical gross and net renewal rates applied to their core business and project out potential scenarios. Core growth plus traditional renewal rates will likely result in reaccelerating growth in the near future.

The good news: once this painful series of adjustments works its way through the system and we’re at the new normal, growth rates will improve. Many startups have strong business models delivering tremendous value to their customers. The lack of growth is masked by remnants of one-time extra growth and one-time extra churn. Higher, renewed growth is on the horizon.

Several weeks ago General Catalyst, a large investment firm, announced a new type of SaaS financing in their post The Unbundling of “Growth” Equity. Now, there have been a number of alternative financing solutions in the SaaS world for many years now and they all center around lending money as a percentage of annual recurring revenue. This offering from General Catalyst is different: it’s lending against sales and marketing spend with a payback based on the value of the customers signed (disclaimer: I haven’t talked to General Catalyst and I’m interpreting their messaging without any feedback). Let’s dig in.

The most common form of alternative SaaS financing, often called revenue-based financing, lends against committed recurring revenue and a few other factors. Before this type of offering, there were generally only three funding options: customer funded (bootstrapping!), equity (usually venture capital), and specialized bank debt (venture debt that’s going to be much harder to get now with the bank failures). Revenue-based financing is usually less restrictive than venture debt and but often has higher fees and effective interest rate.

Let’s look at an example. Imagine a startup has $4M in annual recurring revenue. Revenue-based financing would provide $1M of debt (roughly 20 – 33% of the annual revenue depending on a number of factors like gross margins, renewal rates, and growth rate) in exchange for a percentage of total revenue for the next three years. The revenue-based lender is making a bet about growth to achieve an outsized return. If the startup doesn’t hit the growth targets, the lender won’t make as much money. Here’s a simplified example where the lender gets a flat 10% of revenue for three years:

Year 1

$5M of revenue

Lender receives $500k

Year 2

$6M of revenue

Lender receives $600k

Year 3

$8M of revenue

Lender receives $800k

So, in this example, the lender receives $1.9M in payments for the $1M loan. While it’s an extremely high effective interest rate, it can be “cheaper” than equity in some instances. Also, if the startup doesn’t achieve their revenue goals, the lender would make less money (or potentially lose money if there was a default). For the startup, that $1M debt might turn into $2M of incremental revenue at the end of the third year, potentially creating an extra $10M in enterprise value. Trading $1.9M in payments for $10M in additional value is a worthy trade.

Now, let’s look at the General Catalyst (GC) offering. From their site:

Traditional debt and variations of it such as ARR financing, credit lines, or revenue based financing can be a cheaper source of capital, but are not designed to fund S&M, for the simple reason that debt has to be repaid or refinanced on a fixed schedule. The payback on S&M is variable in nature, but a company’s debt repayment is typically fixed. 

GC argues that with revenue-based financing the business has to pay a percentage of revenue regardless of results. Customer acquisition doesn’t have a linear outcome (e.g. some quarters are better than others for a variety of reasons), so ideally they payback would flex with results and not be fixed.

Continuing from the GC site:

GC pre-funds a company’s S&M budget. In return, GC is entitled only to the customer value created by that spend, and GC’s entitlement is capped at a fixed amount. After GC reaches that fixed amount, the remaining lifetime value of the customers is the company’s to keep forever.

Sales and marketing (S&M) is often 50%, or more, of the annual budget — a huge percentage for most startups. In this passage, GC talks about funding that budget (loaning the money) in exchange for the “customer value created.” That piece isn’t clear. Is that the enterprise value of an incremental $1 of revenue? Something else?

Let’s assume it’s some multiple of new customer revenue, like 4x. If GC funds $10M of customer acquisition costs (S&M spend), and that returns $5M in new customer revenue, then GC would get paid $20M (a 2x return on the loan). Of course, there’s a wrinkle with how to allocate what new revenue came from that new spend vs previous spend as well as second order sales from brand, word of mouth, etc. The easiest answer is the most likely: all new customer revenue gets counted. 

Finally, from the GC site:

GC only gets paid if and when the company gets paid.

This is a nice touch — only pay down the loan when the cash comes in from the new customers. Aligning cash flow with funding is a great feature.

The other question is over what time period and at what rate does that “customer value” loan get paid back. My guess is that it’s over 5-7 years based on a percentage of that new customer revenue (e.g. add $5M in new annual revenue, 50% of that amount paid towards the debt until the customer churns or 2x the original loan is paid).

It’s great to see more innovation in the non-dilutive SaaS financing space. Entrepreneurs would do well to consider all their financing options, and not just venture capital, when looking for ways to grow faster. Hopefully customer value financing catches on and becomes more popular.

Update: A friend reached out and said it doesn’t work the way I thought from GC. He said that GC effectively does a new loan each month of ~80% of spend and it’s paid back with the revenue of the customers signed that month with a target interest rate of 12-14% repaid in 12-18 months.

One of the common mistakes I see entrepreneurs make when pitching investors is regarding the ask. See, the ask is one of the critical components of the meeting, only entrepreneurs take it too far. Too many work on getting to an investment decision in the first or second meeting, “Will you invest in us?”

Instead, entrepreneurs need to sell hard on getting to the next step, not the final sale. 

Investors usually have a process. First meeting, send me more information based on questions and let me do research, meet my partners or someone I respect to hear the pitch, call a few customers for references, meet again, and so on — it takes time, especially these days (life was different 24 months ago!).

The best question to ask: what’s the decision making process?

The next best question: what do we need to do to get to the next step?

While the answer received might not be always be what’s desired, the experience and expectations will be much better. A one call close isn’t possible, so play for the best next action: making it to the next step.

Of course, this is applicable to most things in startupland (and life). Whether it’s selling a piece of software, earning a mentor, or signing that strategic partner, it’s a process, not a single event. Figure out the process, understand what’s needed for the next step, and work towards it.

Entrepreneurs would do well to sell hard on the next step, not the final sale. 

In the world of startups, there’s a category of product that’s unusually challenging: does solve a problem, more important than a nice-to-have but nowhere near a must-have, and only valuable enough to build a small business. I call these types of solutions the green vegetables of startupland. 

Why green vegetables? We all know that we should eat more green vegetables, yet most of us don’t do it — that burger and fries sure tastes good. Green vegetables are clearly one of the healthiest choices, only we go for what has more dramatic flavors (sweet or salty or fried!). The cravings and urges just aren’t there for this type of food. Now, this isn’t commentary on the value of green vegetables, this is focused on human wants and desires. We want something that’s tasty. We want something that satiates our hunger quickly. We want something that triggers the pleasure receptors in our brain.

These green vegetable products are better than nice-to-have solutions. There’s clearly nutritional value and we should consume them. Only, they aren’t the main course. They aren’t what gets people excited when sitting down to dinner. People buy enough of them to build a business, but the share of wallet and willingness to spend isn’t great enough to build a big business.

When a startup with a green vegetable product raises money from institutional investors, another problem occurs. There’s some momentum, otherwise the startup wouldn’t be able to raise money. Only, for whatever reason, it was hard for the investors to see this wasn’t a must-have product in the path of revenue or truly mission critical. Then, as cash is burned in an effort to grow faster, the rapid market adoption just isn’t there. Modest growth is attained, but hypergrowth isn’t achieved. This often results in a zombie startup that’s big enough to survive indefinitely while being too small to raise more money on reasonable terms or have a decent exit.

Green vegetable startup products are more common than you think. Entrepreneurs would do well to stay as close to the customer as possible and focus on products that are mission critical or clearly help make more money. If there’s any doubt on either of those criteria, go back to the drawing board or dive deeper with the customer to figure out what needs to change. Eat your green vegetables and know how to identify them in startupland.

Yesterday I was meeting with a pair of entrepreneurs and the current fundraising/valuation climate came up. These entrepreneurs had been grinding on their startup for many years. Only, it wasn’t the proverbial hockey stick growth with everything up and to the right. It was slow to get going, but thankfully, now things were growing super fast — the hypergrowth badge was unlocked.

We talked about how some of their friends had raised money at crazy valuations — 25x or 35x annual recurring revenue (ARR) — just 24 months ago. Today, we’re a long ways from seeing that again, if ever, with valuations in the 4-8x recurring revenue range. I emphasized that while the valuations might be more rational now, the amount of enterprise value they were creating was still huge. In fact, most of the startup’s value accrues in the later years, assuming growth rates stay high.

Let’s look at an example with $1 of ARR being worth $6 in enterprise value (for simple math):

• Year 4
  • $1M ARR
  • Add $1M of new ARR
  • $2M total ARR
  • $12M valuation (6x ARR multiple)
• Year 5
  • $2M ARR
  • Add $2M ARR
  • $4M total ARR
  • $24M valuation
• Year 6
  • $4M ARR
  • Add $3M ARR
  • $7M total ARR
  • $42M valuation
• Year 7
  • $7M ARR
  • Add $4M ARR
  • $11M total ARR
  • $66M valuation

In this example, there wasn’t much value created in the first four years. Yes, the early years were critical for building out the technology, recruiting a team, signing the early customers, and assembling the pieces for growth. Looking at the next four years, the valuation shot up dramatically as the business scaled, with the majority of the value accruing in the last 24 months.

This phenomenon of when value is created makes startups especially hard. Tremendous amounts of work in the early years, and no knowing if or when things will take off, is a hard risk/reward equation for most people. When it works out, it’s an incredible accomplishment. Entrepreneurs would do well to know that most startup value accrues in the later years.

While current startup difficulties deserve the most attention (broken cap tables, valuations lower than capital raised, slowing growth rates, etc.), venture firms, especially ones that deployed significant amounts of capital in 2020 and 2021, are challenged as well. Writing checks into startups whereby their real valuations are likely 30 – 70% lower, even after a couple years of growing, makes for an exaggerated J curve (rates of return are negative in the first few years due to the drag from management fees). Only, the story is worse, and more complicated.

While venture fund fees are usually 2 and 20, meaning a 2% management fee and 20% of the carry (profits). The 2% management fee is paid on committed capital. With a $500M fund, that’s $10M/year in fees. Most funds are 10 years with two optional one year extensions, so best to think of the management fee side as really 20% of the fund (2% per year for 10 years). Instead of 2 and 20, 20 and 20 is the real way to think of it (20% of the fund as management fees and 20% of the profits as carried interest). Yes, the fees can be substantial, but it’s best to think of venture as get rich slowly, as most don’t beat the S&P benchmark and take 7+ years to see any distributions.

With venture funds, the general partners (GPs) are required to put 1-3% of the capital in themselves. So, if it’s a $500M fund, and the partners collectively are putting in 2%, they’re committing $10M. Many of the younger partners, while they’re making a good salary, often have to borrow money for their portion of the GP commit. Well, that debt they’ve taken on looks even more distressing considering it could be years before their portfolio company valuations are back to the original investment value, let alone at a scale where they’ll make good money on an exit. 

Net net, the chance of this cohort of VCs making substantial profit is low yet personal debt is high. VC is a tough job to get, and right now, quite a few VCs are thinking about their current careers. Vintage 2020 and 2021 venture funds are likely to perform poorly save for the occasional power law winners. Venture is still an important part of our economy that has an outsized impact, and should be supported and encouraged, even if a couple years prove difficult.

One of the topics we’ve discussed several times as of late is the declining renewal rates, and therefore growth rates, in cloud software. While a major driver of reduced renewal rates comes from layoffs, and the corresponding reduction in seats or user licenses due to fewer staff, a second major driver is the budget pressures and heightened expense scrutiny across companies. 

As a software startup, it’s easy to say that a customer let go of 20% of their staff and their corresponding renewal value was roughly 20% lower (not counting escalations or price increases). This becomes more challenging when the renewal doesn’t happen (churn!) or the downgrade is more dramatic than the layoffs. In today’s climate, it likely means that the company chose not to renew because it wasn’t mission critical or the customer switched to a lower cost provider (another renewal blemish).

In software, we like to talk about must-have products vs nice-to-have products. Of course, it’s a continuum and not binary, but the most successful startups are in the must-have category and the vast majority of failed startups are in the nice-to-have category. Only, when times are good, it’s often hard to know just how much a must-have or nice-to-have a product is as budgets are loose and grow-at-all-costs is the mantra. The easy spending can make products look more must-have than they really are. Then, when budgets contract, the truth comes out. 

This is especially challenging as many startups with nice-to-have products raised tremendous amounts of money over the last few years. After their own layoffs and efforts to conserve cash in order to push out raising another round, they’re getting hit even harder with renewal rates being lower than expected. Look for more investor scrutiny in future rounds to tease out what’s really a must-have vs a nice-to-have solution.

Entrepreneurs would do well to continually work towards making their products must-haves and staying as close to the customer as possible. Budget pressures are highlighting the true mission critical software apps, and many startups are finding out where they exist in the eyes of their customers.

Last week I was talking to an entrepreneur that worked out of the Atlanta Tech Village for several years. When his original startup didn’t work out he went and joined a different startup. Now, he’s on his third one. Only, this one is with someone he met at the Tech Village during his first one.

Seeing this “recycling” of entrepreneurs where startups are regularly shut down and new ones formed — often with serial founders and friends from the startup community — was an early dream and vision of the Tech Village. The idea: let’s get hundreds of people under the same roof building the future while surrounding them with everything we can to increase their chance of success. A byproduct would then be recombinations of entrepreneurs — some entrepreneurs move on from their current venture and start new ventures with other entrepreneurs they’ve met along the way. Now, 10 years later, we’ve seen this happen many times.

To promote relationship building we work on ways to engineer serendipity through programs and events as well as shared resources like kitchens and common spaces. In the world of distributed teams and remote work environments, human relationships are more important than ever, and physical spaces, while not used in the same ways as pre-COVID, are still critical for bringing people together.

The more entrepreneurs spend time with other entrepreneurs, the greater the chance they find a match for a future startup. Entrepreneurs combining on new startups is a strong signal this works and an integral part of startup communities.