An Exit Value Premium With VC Investors

There’s a refrain I’ve heard several times from venture-backed entrepreneurs: successful startups will command an even greater premium at time of sale if the company is venture-backed, everything else being equal. Some might argue that it’s self-serving for the venture community to promulgate the idea but it makes sense considering an entrepreneur might do one or two transactions in their lifetime whereas a successful VC will be a part of dozens of exits in their career.

Here are a few exit value premium examples:

  • A VC has a relationship with a strategic acquirer whereby the VC is able to build a case for a larger valuation than otherwise expected
  • The startup closed a round with a VC, a strategic acquirer comes along shortly thereafter, finds out where the VC is in their fund lifecycle, and offers a valuation that meets the VC’s desired returns, while being significantly higher than what other acquirers would pay
  • Raising money from a high profile, top tier VC increases the startup’s awareness with corporate development teams at potential acquirers, helping their exit valuation

Venture capitalists work hard to add value to their investments and one of the direct benefits is an exit premium.

What else? Do you think venture-backed startups get an exit value premium?

Physical Atlanta Startup Village Idea

Atlanta has an amazing resource in Tech Square, on the outer edge of Georgia Tech’s campus in Midtown. Tech Square has all the amenities wanted in a startup hub: highly ranked engineering school, great walkability for serendipitous interactions, easy proximity to public transportation including a subway station, many restaurants, tons of creative-class jobs, Starbucks, Barnes and Noble, the ATDC incubator, and the co-working space Hypepotamus (more Midtown benefits from @rkischuk).

ATDC, the Advanced Technology Development Center (not the Atlanta Technology Development Center as many people think), has great office space that’s subsidized by the university and month-to-month leases — perfect for startups. In addition, the Tech Square area is an empowerment zone meaning it qualifies for a $2,500 tax credit for each new employee hired with a salary ~30% higher than the county average (a salary of approximately $65,000 or higher qualifies). With all this said, there’s a high quality problem in that there’s no office space left, a waiting list for future space, and you can’t get on the waiting list unless you’re an ATDC Select company (based on company progress and likelihood of building a sustainable business). Also, the space isn’t designed for startups that have broken through and are starting to scale (e.g. once you hit reached a certain employee size or have been there three years, whichever comes first, you usually have to leave).

The solution is to buy the large, empty lot next to the parking deck that serves Tech Square and turn it into a physical Atlanta Startup Village. Much like an Olympic Village, this would be custom designed to help foster the goal of building a larger, more vibrant startup community.

Here are some ideas for the physical Atlanta Startup Village:

  • Large multi-story complex like the American Tobacco Campus in Durham, NC
  • Loft-style space with tall ceilings and exposed bricks and beams
  • Communal outdoor space with a park-like setting
  • Several multi-purpose event facilities
  • Roof top balcony for tenants and events
  • Octane coffee shop
  • Mellow Mushroom restaurant
  • General Assembly-like education and co-working space
  • A mix of seed stage, early stage, and growth stage companies
  • Affordable gigabit fiber internet access and WiFi

The physical Atlanta Startup Village is a complement to Tech Square and sets the stage for an even stronger and more vibrant tech startup community.

What else? What would you add or change about the physical Atlanta Startup Village idea?

Entrepreneurs That Ride Major Trends

Recently I was talking with a successful serial entrepreneur and he commented that he looks for major trends when deciding on his next business. He described it as finding a big sand box that he likes and digging around in it until he finds a great opportunity — I agree completely. I like to think about it as focusing on a small, fast-growing market doing a zig zag until you find the best wave to ride.

Here are some big trends right now:

  • Cloud computing
  • Crowdsourcing
  • Social media
  • Mobile
  • Location-based services

Those are some very generic trends. The idea is to find an angle or leading edge component within a trends and get ahead of the market. As for timing, 2-4 years early is often optimal.

What else? What are your thoughts on entrepreneurs that look to ride major trends?

Employee Loyalty is a Strong Non-Valley Benefit

Recently I’ve heard increased talk from entrepreneurs and venture capitalists that employee loyalty and retention is an even more serious issue in the Valley that isn’t as top-of-mind for entrepreneurs considering where to locate their startup. The idea is that in the Valley there’s a culture of people moving jobs every year to try and get in early at the next pre-IPO startup, and, of course, most startups don’t make it, so people keep changing jobs quickly.

For us, we have over 100 employees, have been in business five-and-a-half years, and have only had five people voluntarily leave us (along with ~10 that have involuntarily left). Building a strong corporate culture and great place to work is an incredible competitive advantage anywhere, but especially powerful is markets outside the Valley that have greater employee loyalty and less turnover.

The next time you think through pros and cons of your startup’s city, add employee loyalty as an important factor.

What else? What are some other thoughts on employee loyalty as a strong non-Valley benefit?

Growth Stage VC with 3-5x Money in 3-5 Years

Venture capital, in its standard form, is pretty well known. The story is as follows: invest in 10 startups, the majority go bust, two or three make a good return, and one is a huge success returning the fund and them some. Only, over the past decade, most venture funds haven’t made any money at all so there’s more emphasis on startups with traction and other measures that show risk has been removed from the equation.

There’s another segment of venture capital that isn’t talked about as much due to the few number of startups that reach the targeted size: growth stage capital. Growth stage is typically companies with at least $5 million – $10 million in revenues growing north of 30% per year. Once a technology company fits this category, growth stage venture capitalists will pay a nice premium, making a bet that the business will be able to grow substantially more and that worst case scenario they can get their money back (based on a 1x non-participating preferred preference with their stock).

The common refrain when asked for investment return expectations isn’t the 8-10x that early stage VCs talk about, rather the goal is to return 3-5x the money invested in 3-5 years. 3-5 years isn’t the 7-10 year horizon early stage VCs look at, but it’s still plenty of time to generate significant value above and beyond what’s already been created.

The next time you’re talking to a venture capitalist, ask about their expectations and desired return on investment.

What else? What are your thoughts on growth stage VCs looking to making 3-5x their money in 3-5 years?

SaaS Cost of Goods Sold for Startups

Cost of goods sold for Software-as-a-Service (SaaS) startups seems like it should be a straightforward topic but there are a number of different conflicting reports online. According to Wikipedia, cost of goods sold “refers to the inventory costs of the goods a business has sold during a particular period.” Of course, due to the nature of software, there is no inventory but there are costs to deliver the application.

Here’s what we include in our cost of goods sold calculation:

  • Hosting fees (our highest expense after salaries and benefits)
  • Third-party web fees like content delivery networks, embedded software, etc
  • Support personnel costs
  • Customer on-boarding costs (e.g. client implementation personnel costs)
  • Note: Credit card fees and other billing fees often are not cost of goods sold for SaaS companies and are instead general and administrative fees

Notice things like software development costs, customer acquisition costs, and more aren’t included since they are not required once the customer has already been signed. SaaS cost of goods sold is an important metric so that gross margin can then be calculated.

What else? What are some other items that should be considered as part of cost of goods sold for SaaS companies?

SaaS Customer Acquisition Costs Relative to Customer Revenue

One of the core tenants of Software-as-a-Service (SaaS) economics is that the cost of customer acquisition needs to be commensurate with the revenue provided by the customer. As an example, if it costs $50,000 to acquire a customer and the customer only pays $1,000 per month, it’s likely that the business, in it’s current form, won’t work (save for an unusual up-sell situation). When looking at SaaS metrics, the ratio of customer acquisition costs to annual recurring revenue is one of the most important.

Here are a few thoughts on SaaS customer acquisition costs relative to customer revenue:

  • A general rule of thumb is that the cost to acquire a customer should be less than the annual recurring revenue from the customer (e.g. if it costs $1,000 to acquire a customer, the customer should pay at least $1,000 per year in recurring revenue)
  • Length of contract and average lifetime of a customer are also important considerations, especially with products that have high switching costs (e.g. a content management system has much higher switching costs than an email marketing system)
  • Gross margin is another critical piece of the puzzle as SaaS companies with higher gross margins can afford to spend more to acquire a customer, everything else being equal
  • Cost of capital is another consideration when looking at customers that are expensive to acquire but will likely stay for many years

As a SaaS entrepreneur, SaaS customer acquisition costs relative to customer revenue is one of the most crucial metrics for building a viable, high growth business. Many venture-backed companies burn significant amounts of cash to reach profitability, and many of the most successful ones don’t reach profitability until well after they’ve gone public. Regardless, the economics of customer acquisition need to make sense.

What else? What are some other thoughts on SaaS customer acquisition costs relative to customer revenue?