David Cummings on Startups

Month: September 2014

  • Evaluating an Early Stage Startup to Join

    Recently an entrepreneurial leader told me he was interested in joining a funded early stage startup in a COO or CEO role. After quizzing him for a bit about what he meant as a funded early stage startup (raised a Series A round from institutional investors), I offered up a few thoughts on evaluating a startup to join:

    • Has the startup achieved product-market fit? Just because there’s institutional money it doesn’t mean that the dogs eat the dog food.
    • Has the startup built a repeatable customer acquisition machine? Customers might love the product but if customers can’t be found in a predictability, cost-effective manner, there’s still a serious amount of risk.
    • What’s the board arrangement like? Is it a functional board? Are the entrepreneurs in control? Joining a startup with a dysfunctional board makes for a poor experience.
    • How critical is culture to the entrepreneurs? Culture is important at all stages and sets the tone for how the company operates.
    • How much cash is in the bank? How much runway does the startup have? Just because the startup raised money doesn’t mean it’s in a strong financial position.
    • What’s the current division of roles and responsibilities of the management team? Some people have broad titles like COO but really specialize in one or two functional areas like product management or marketing.
    • What’s the three year plan look like? While things change all the time it’s still important to look out over several years and have a fluid game plan.
    • What are the top three priorities right now? What does the simplified one page strategic plan look like? Aligning everyone in the company is critical.

    So, with a few ideas and words of encouragement, I told him joining an early stage startup would be an awesome experience and that he’d learn a tremendous amount.

    What else? What are some other thoughts on evaluating an early stage startup to join?

  • One SaaS Application of Record Per Job Function

    Software-as-a-Service (SaaS) is entering its third phase of maturity. Phase one focused on enterprise applications that became platform products like Salesforce.com, NetSuite, and others. Phase two was about general point solutions, mostly for the small-to-medium sized business market like Pardot, Mailchimp, and Zendesk. Phase three is new vertical-specific SaaS applications as well as more specialized solutions that represent portions of more complicated products.

    One way to think about it is that there is an application of record for each job function (that is, a product that people in that job function spend a large number of hours per week to perform their job). The application of record often feeds data into a more general platform (like Salesforce.com) such that data is made available to any other product that might need it. Here are a few examples of applications for job functions:

    Disclosure – I’m an investor in SalesLoft and Rivalry.

    Think about all the different job functions in a mid-sized company. Now, think about the SaaS applications currently used. What job functions currently use a generic solution, but would be better served by a more specialized solution? Look for more SaaS solutions to emerge that help run specific job functions.

    What else? What are some more thoughts on one SaaS application of record per job function?

  • Whiplash from Pitching VCs

    In the second half of 2009 we pitched Pardot to 29 different VCs. Over the course of four months we met with a number of VCs in Atlanta and flew to Silicon Valley twice, Boston once, and Washington D.C. once. Pitching VCs is great in that you get a chance to engage with really smart people, share the vision, and hear feedback.

    Only, the feedback is driven by their view of the world and personal experiences. After the 15th conversation whiplash starts to set in from all the different recommended actions — target this market, make this pricing change, think bigger, etc. Ideas get tossed around at a rapid clip, and as an eager entrepreneur seeking capital, the instinct is to look on fondly and nod ‘yes’ to each suggestion.

    When going into conversations with VCs, have a clear opinion and vision (no different than talking with customers and prospects), so that any suggestions can be put against the plan with a clear head. More ideas and recommendations will stress test the vision, which is fine, but try not to get caught up in the whiplash of different recommendations. Make improvements as necessary and carry on.

    What else? What are some other thoughts on the whiplash from pitching VCs?

  • The Difficulties in Getting a SaaS Startup Off the Ground

    Continuing with yesterday’s post on SaaS and Barriers to Entry, if it seems like Software-as-a-Service (SaaS) products are easy to reproduce from a functionality perspective, why are there so few successful ones? Software development and delivery costs have dropped 10x over the past 15 years due to the rise of open source software and cloud computing. Technically, it’s easy to take one product and make a barebones reproduction of the most basic functionality. Only, there’s so much more than that.

    Here are a few reasons why it’s so difficult to get a SaaS startup off the ground:

    • Initial minimum respectable SaaS products still require years of continuous development to reach maturity and broad applicability (while it might cost a few hundred grand to get a decent product to market, it’ll take several million over a few years to get a robust product to market)
    • SaaS products are often billed monthly, with the occasional annual pre-pay, meaning SaaS companies are really in the financing business as it takes years before a customer is profitable (compare this to enterprise software companies that get paid upfront for the license fees and are immediately profitable, but become much more difficult to maintain growth)
    • Most SaaS products have retail prices in the sub $1,000/month price range, requiring thousands of paying customers to build a meaningful business (at $1,000/year per customer, 5,000 customers are required to build a $5 million/year business, which is a huge amount of effort)
    • Repeatable customer acquisition at a reasonable cost is always the limiting factor (best practices are that the cost of customer acquisition should be equal to or less than the first year’s revenue e.g. spend $1,000 or less to acquire a customer that pays $1,000 per year — see Why Lead Velocity Rate is the Most Important Metric in SaaS)

    SaaS companies are extremely difficult to get off the ground. Once up-and-running with some modest scale (>$2 million in revenue) and modest burn rate, they are a thing of beauty and typically grow fast for several years.

    What else? What are some other thoughts on the difficulties of getting a SaaS company off the ground?

  • SaaS and Barriers to Entry

    Earlier today Zaid Farooqui tweeted that some of his hedge fund friends think Software-as-a-Service (SaaS) companies are over-valued due to low barriers to entry:

    While I agree that some SaaS companies are priced to perfection due the expectation of massive growth, I don’t believe low barriers to entry plays much of a role. Here are a few thoughts on SaaS and barriers to entry:

    • Once a software product works well, especially at a reasonable price, people are reluctant to switch (look at how many people are still using antiquated Microsoft software)
    • Set-it-and-forget-it SaaS apps are more commonplace than realized, such that credit cards keep getting billed and no one notices unless something goes wrong
    • App marketplaces, like Salesforce.com’s AppExchange, create a network effect of other products that integrate (products like the Kevy integration platform are working to decrease this network effect)
    • Achieving scale in a market results in significant sales and marketing resources that only grows as the company grows
    • If SaaS was susceptible to low barriers to entry, more upstarts would have to have successful businesses in the same market as category leaders

    The hedge fund partners would do well to talk to their B-school classmates that have started SaaS companies and hear first-hand just how difficult it is to get one off the ground.

    SaaS startups encounter a number of barriers to entry, especially in markets with dominate category leaders.

    What else? What are some other thoughts on SaaS and barriers to entry?

  • Questions to Ask as a Potential Co-Founder

    Many times a solo entrepreneur comes up with an idea and looks to bring on one or two co-founders (I’m a fan of no more than one co-founder). Naturally, the personality fit and complementary skills need to be there. Even then, alignment and understanding should be spelled out in a simple document. As someone interested in becoming a co-founder, here are a few questions to ask:

    • How are we going to divide up roles and responsibilities?
    • What’s on the horizon for the next 30/60/90 days?
    • How are we going to split up the equity?
    • How much cash is in the bank?
    • How much money do we need to raise and for what percentage of equity?
    • What does the business model canvas look like?
    • How has the customer discovery process gone so far?
    • What will the first 10 customers look like?
    • What will the first 10 hires look like?
    • What lifestyle and family commitments do you have?

    Any answers that aren’t immediately available represent good exercises for the potential co-founders to work through and get to know each other’s style. If you’re going to potentially spend thousands of hours with a person, it’s important to spend time up front and make sure it’s a great fit.

    What else? What are some other questions to ask as a potential co-founder?

  • Getting Better at Correcting Bad Decisions

    Andrew Mason, founder of Groupon and a new startup called Detour, sent out a tweet earlier today saying that while he’s gotten slightly better at making good decisions generally, he’s gotten significantly better at correcting bad decisions:

    https://twitter.com/andrewmason/status/507568813773033472?refsrc=email

    Personally, I’ve encountered this same phenomenon. I like to think that I’m continually working hard and improving my craft, yet I still make plenty of mistakes. Only, now I draw more from previous experience, and when I see a decision heading down the wrong path, I’m quicker to pick up on it and fix things.

    Much of this faster course correction comes from pattern recognition. So many issues that come up fit the mold of similar issues that occurred before. Like Jason Lemkin’s most recent post What the Second Time SaaS CEOs are All Doing, this pattern recognition plays a huge role in decision making, and fixing poor decisions. Entrepreneurs should work at getting better at correcting bad decisions.

    What else? What are some more thoughts on getting better at correcting bad decisions?

  • Monthly Strategy Sessions

    One question I get when talking about weekly tactical meetings is how we deal with the fact we don’t discuss items that will take longer than 15 minutes. The weekly tactical is designed to review our weekly KPIs and talk through any items that come from the ad hoc agenda. When a more strategic topic comes up, and requires additional time for discussion, it gets put on the parking lot (a Google Sheet) for the monthly strategy session.

    Monthly strategy sessions can be anywhere from one to four hours. Once Pardot hit super high growth mode, we’d have a nice dinner once a month that was our monthly strategic meeting. Format wise, we’d keep it simple and semi-structured:

    • Exercise for team members to get to know each other better (e.g. where were you born, how many siblings do you have, what’s one memory from your childhood, etc.)
    • For each department, what’s working well and what’s not working well
    • Parking lot items
    • What are the three most important things we need to do as a company in the next 30-90 days

    Monthly strategy sessions are a key part of high growth organizations for aligning the executive team and debating critical topics. Entrepreneurs would do well to incorporate monthly strategy sessions into their rhythm.

    What else? What are some other thoughts on monthly strategy sessions?

  • Entrepreneurs and Cash in the Bank

    Entrepreneurs love to spend money on an opportunity and opportunities abound. Every day I meet entrepreneurs that are putting all their saving into their idea in hopes of making it work. Some use their personal funds and some raise money from investors. The old adage that you have to spend money to make money still rings true.

    Only, there’s a major downside to spending the cash too quickly — not making enough progress to get to breakeven or be able to raise another round. Unfortunately, the cash in the bank will be spent, it’s only a matter of time for a growth-oriented entrepreneur.

    The solution: find the optimal core metrics for the startup and pace yourself until those are met. Once the metrics are in place, ramp things up. One of the most common mistakes is investing heavily before the business is well understood (I’m personally guilty of this).

    Entrepreneurs love having cash in the bank. And, inevitably, it’ll be gone quickly if there isn’t a repeatable business model. Figure out the right rhythm for the startup and invest accordingly. Don’t be afraid to be patient until the right metrics are solid.

    What else? What are some other thoughts on entrepreneurs and cash in the bank?

  • Gross Margin and SaaS

    One important aspect of Software-as-a-Service (SaaS) that isn’t well understood to first-time entrepreneurs is the role gross margin plays into the business. Gross margin is defined as the percent of revenue left over after the cost of servicing that revenue is taken into account (see SaaS cost of goods sold). For example, with a SaaS company, things like application hosting costs, customer on-boarding costs, customer service costs, and any third-party fees like software licenses or data fees that are required to use the product are included in the calculation.

    Gross margin is also a reflection of how valuable a dollar of revenue is to the business. If the company is an ecommerce business with 20% gross margins (commodity products) vs a SaaS business with 80% gross margins, every additional dollar of revenue for the SaaS business is equivalent to four dollars in the ecommerce business (due to the much higher contribution margin). Margin is one of the main reasons a $10 million revenue company can be more valuable than a $100 million revenue company.

    Early on, a startup shouldn’t worry too much about gross margin. It’s most important to find product/market fit and build a repeatable customer acquisition process. Over time, economies of scale will start to kick in and most SaaS companies will be able to achieve gross margins in the 70-80% range, if not higher. Gross margin, subscription revenue, and great growth opportunities all come together to drive high valuations for SaaS companies.

    Pay attention to gross margin in SaaS companies and understand why it is so important.

    What else? What are some more thoughts on gross margin and SaaS?