Over the last couple years a business concept has dramatically increased in popularity: the North Star Metric. As expected, the North Star Metric represents the most important indicator of the health of the business. Put another way, if you were to only track one single metric for the entire company, this would be it. And in the spirit of the Simple Strategic Plan, the North Star Metric brings clarity to an area that’s often over complicated: measuring what matters.
At a board meeting last week we were talking about startup products that were working well in different portfolio companies and I was reminded of our early fundraising efforts at Pardot. Three years into Pardot we decided to raise money in an effort to accelerate growth. Personally, I started asking people in my network for intros to VCs and we were connected to one in Boston. I jumped on a call with this particular VC and he said something that has always stuck with me, “I just saw Pardot metrics in one of our most recent board decks. When I saw the intro request, I immediately accepted.” Hmm, I thought, instantly knowing what Pardot customer was also a portfolio company of this particular investor.
As expected, there’s tremendous value in having a customer that’s a portfolio company of a potential investor. Potential investors want to talk to unbiased customers. Potential investors want to understand the good and bad about a startup. What better source than an existing portfolio company where there’s a strong relationship and economic interest?
In this example, Pardot was even more compelling to the VC because it was the source of truth for marketing. By incorporating Pardot’s metrics in the board deck, it was telling this potential investor that it was a mission critical product with strategic value to the business.
Ultimately, after meeting 29 VCs, we decided not to raise money due to soft valuations (this was during the Great Recession) and our continued growth without capital. Today, the calculation is completely different. Capital and valuations are much more entrepreneur friendly.
When raising money, entrepreneurs would do well to find potential investors that already work with one or more of their customers. With this comes instant credibility and interest that’s invaluable when trying to find the right financial partner.
Learning where great startup ideas come from is a passion area of mine. Naturally, ideation and “light bulb” moments aren’t actually glamorous, but the ability to profoundly change the lives of so many people creates a sense of awe.
Last week I was reminded of this when hearing an entrepreneur pitch her business over Zoom. Her idea instantly met a number of key characteristics:
Obvious idea that needs to exist in the world
Clear offline analogy that hadn’t been brought online yet
Limited competition currently (some competition is ideal)
Small, high growth market with potential to be massive
Genuine authentic demand whereby people clamor for a solution
Key innovation available due to an advancement in technology
Most ideas don’t emerge fully formed. In fact, the best ideas often come from first exploring a related idea and stumbling upon a better idea. Putting together a simple list of characteristics provides a heuristic to evaluate against. Entrepreneurs would do well to put more time upfront in the selection of their idea, knowing it takes 10+ years to build a meaningful business.
When evaluating business ideas, start with these characteristics and adapt them to your own preferences.
Last week I talked to two different SaaS entrepreneurs that were considering acquisition offers from private equity firms to buy their startups. Historically, it was more desirable to be acquired by a “strategic” (a company that would pay a big premium because the startup fit in so well with their current business) and less so to be acquired by a private equity firm because they were often a “financial” buyer that didn’t pay a premium. Now, there’s often no difference as private equity firms are paying “strategic” valuations for SaaS companies.
Almost a year ago, I highlighted that 2021 will be a banner year for private equity SaaS acquisitions and the prediction proved correct. While I was right, my assessment wasn’t nearly the whole picture. In 2020, many SaaS companies cut staff and burn in response to the pandemic lockdown thereby making them more desirable to private equity firms (cutting costs made many of these SaaS startups profitable, a common requirement). What I didn’t expect was the pandemic to accelerate digital transformation and growth for many SaaS startups, making them more valuable (growth is one of the biggest drivers of valuation multiples). In addition, interest rates dropped dramatically making the value of a future dollar of cashflow more valuable. Finally, for these reasons and others, publicly traded SaaS company valuations skyrocketed (see the BVP Cloud Index).
Before, these SaaS exits to private equity firms were often small to medium-sized (tens of millions to hundreds of millions of enterprise value), but now with the private equity firms getting larger, they are regularly buying unicorns as well (see Pipedrive and Gainsight Exiting to Private Equity). Now, look for private equity firms to do more large and mega deals, along with the typical deals because there’s so much money on the sidelines that has to be put to work.
Finally, this all plays well into the startup community as it solves a long-standing issue of liquidity for entrepreneurs and investors. No longer is the there the concern that it’ll take 10+ years to make money off a quality seed investment. Previously, the it took both building a successful business and finding a great exit via going public, strategic acquisition, or dividends — a tall order. Now, it’s still incredibly hard to build a successful business, but the options for liquidity have grown dramatically, and private equity plus later stage investors are the main reason.
Private equity’s importance is growing dramatically in the startup community, and it bodes well for increased investment in innovation.
Last week I was talking to an entrepreneur that had just received his first real offer to sell the business to a potential acquirer. As an entrepreneur, it’s easy to think selling a startup to a strategic is a fairly routine and common part of the venture world. Only, after being in the game for 20+ years now, I know just how rare it is. In fact, for a “hot” startup in the growth stage ($5M+ run rate) and beyond, a real acquisition opportunity comes around every 3-4 years. And, that’s only after getting to scale with everything else in the business doing well (renewal rates, growth rates, size of addressable market, etc.).
When the first real offer from a potential acquirer comes in, it’s often an emotional experience. Here are a few thoughts:
Don’t Start Spending the Money It’s easy to get dollar signs on the brain and think of all the ways the money can be spent. Stop right there. Fight the urge to think about how the money will change your life as most acquisition offers don’t turn into exits.
Stay the Course Getting a quality acquisition offer is incredibly distracting. Should we sell? Should we say no? How will my life change? What will our employees think? Is it really going to happen? The questions and thoughts are endless. The best thing to do is stay the course and actively isolate the noise.
Find Alternative Options With so much money out there chasing startups, work to create an auction process with multiple parties. Reach out to the private equity firms that have been courting you and see what they’re offering. Secondary stock sales are common now, so there might be an opportunity to sell a smaller piece for financial security and not have a full exit.
Ask For Help Seek out advice and counsel. Find a mentor or advisor that’s been through this experience and lean on them to talk through the barrage of questions. Selling your startup is much more difficult emotionally than it seems.
Receiving a real acquisition offer is a major milestone for many entrepreneurs. But, at the same time, it’s also incredibly distracting. Get help, don’t start mentally spending the money, stay focused on the business, and find alternative options.
Last week I had the opportunity to join a group of Endeavor Atlanta entrepreneurs for an outdoor dinner. As part of the gathering, we shared startup origination stories, current opportunities and challenges, as well as general areas for feedback or help. Without fail, every startup origination story centered around a personal experience where the proverbial light bulb went off and it was clear there was a problem to be solved.
As expected, the most obvious startup ideas are right in front of you.
What isn’t considered enough is the intentionality of life choices with an eye towards finding great startup ideas.
Last month I was talking to a potential entrepreneur. He repeatedly expressed that he wanted to be an entrepreneur later in life. Now, he wanted to learn and better himself. What should he do? What type of job should he take?
Instead of talking in generalities, I tried to get him thinking about trends and growth industries. Where are the best opportunities going to be in the next 10 years? How can you get in those markets now for exposure and experience?
By far, the most successful entrepreneurs I know picked great markets and found amazing ideas within those markets. Was it the entrepreneur that willed the business to such incredible success or was the market more important? Clearly, it’s a combination of both but I believe the market is a bigger driver of the scale of success.
The next time someone says they want to be an entrepreneur, encourage them to think about the life choices that will help them find great ideas in the best markets.
Over the years I’ve been asked no less than 100 times about startup capital in our region. Up until two years ago, the answer was generally that you had to go outside the region for seed, early, and growth stage capital. There were a few pockets here and there locally for seed and early stage but it wasn’t robust and competitive. Now, Atlanta’s startup community is brimming with seed and early stage capital.
Loosely defined, seed stage capital is for startups that are just getting started up to $500,000 in recurring revenue. Early stage capital is for startups that have product/market fit and the basis of a repeatable customer acquisition process with $500,000 to $5M in recurring revenue. Finally, growth stage capital is broadly for startups with $5M or more in recurring revenue.
If seed and early stage capital is now plentiful, what will it take for growth stage capital to be plentiful as well?
Time. And success.
With 15+ local funds doing seed and early stage, the foundation is in place to eventually have thriving capital providers at all stages. New firms coming into the market and providing growth stage capital ($10M+ rounds) from their initial fund is unlikely. What is likely is a small portion of the local funds doing well and raising larger funds. As almost all the current funds are under $100M, and most are under $40M, it’s going to take at least two 3-5 year investing cycles for the funds to achieve a scale of $250M or more to supply growth rounds. And that’s only if that have a high level of success (return 2x capital after fees, at least).
So, the pieces are in place but it’s going to take upwards of 10 more years for the growth stage segment of the capital stack to be available locally in our region.
The good news is that there’s an oversupply of growth stage capital outside of our region, and local startups are raising more capital than ever.
Our startup community is humming along nicely and we’ll eventually have growth stage capital locally.
Bedrock Capital’s founders have an excellent post up titled In Search of Narrative Violations where the authors argue that some of the best opportunities exist in areas that go against the grain of the currently accepted beliefs. Citing examples at specific points in time like cleantech as a failure but Tesla was a winner and cryptocurrency as a failure but Bitcoin as a winner, people are quick to band together and say some trend or industry focus was overhyped and not successful.
Taking the cleantech idea as an example, if you read the article Why the Clean Tech Boom Went Bust from Wired in 2012, it’s clear many entrepreneurs failed and investors lost money. Fast forward to today, one major success from that early 2000s era — Tesla — has achieved a scale, both commercially and financially ($700B market cap!), that it more than makes up for all the losses. Sometimes the power laws are so dramatic that one win makes up for tens of thousands of losses.
Similar to points in time on the Gartner Hype Cycle, opportunities emerge even after the peak of inflated expectations and the trough of disillusionment starts to set in. Prognosticators have moved on to the next shiny trend yet opportunities still exist. If you were to follow the “experts”, you’d believe all the innovation was done. Only, it takes a number of years to really understand how a new technology or industry plays out.
Finally, this is similar to Be Non-Consensus Right. If everyone is betting on the same thing, it’s noisy and more difficult to build a great business. Opportunities exist in the consensus realm, but the challenges and challengers are stronger. Find the non-consensus startup ideas.
Pardot, in hindsight, was a non-consensus idea. Investors told us marketing technology was a bad idea because no large martech company had every been built. Fact. Marketing departments don’t have technology budgets, they have advertising budgets. Fact. The consensus was that martech isn’t a good area. If we listened to the “experts”, we should have shut the startup down and moved up. Only, we were non-consensus right and martech has now created $100B+ of value as a category.
Look for startup ideas in narrative violations and non-consensus right areas.
Be (very) aggressive in pre-empting good tech businesses
Move (very) quickly through diligence & term sheet issuance
Pay (very) high prices relative to historical norms and/or competitors
Take a (very) lightweight approach to company involvement post-investment
Above all, deploy capital, deploy capital, deploycapital
Historically, the VC business is opposite of the startup business. VCs are small, boutique partnerships that don’t scale. Serving on boards, and doing it well, takes time and energy, often limiting VCs to no more than 8-10 engagements. VCs typically have little skin in the game, only providing a tiny percentage of the fund’s capital. In addition, venture firms take many years, if not a full decade, to know how they did for a particular fund.
Knowing that this is the norm, Tiger Global designed their approach to smartly take advantage of the traditional model, summarized as the opposite of the points above:
Wait for tech businesses to raise money and hope they get networked to you or you met them prior to the round
Require traditional due diligence and term sheet issuance standards so that investment errors and write-offs are minimized
Think about historical valuations and pay “fair” prices for startups
Get involved post investment via a board seat, regular entrepreneur calls, and continued value-add
Deploy capital on a schedule and hope that there are enough quality deals during that timeframe to do well
Here’s the conundrum: entrepreneurs still need everything in the historical venture playbook. Building a large business is hard and time consuming. Due diligence is important. Board work is important. Prudently deploying capital is important.
Knowing that the yeoman’s work is being done by the seed, Series A, and/or Series B investor to help the entrepreneur build a great business, why not stand on their shoulders and bypass the traditional model? Lighter touch, higher valuations, and faster speed results in a more scalable, higher velocity business.