Startup Funding and Optionality

One of the challenges entrepreneurs face after achieving a repeatable customer acquisition process with great metrics in a big market is just how much money to raise. Initial thinking might be to raise as much as possible at the highest valuation possible. Only, investors have an expectation to make at least three times their money at the later stages and many more times that at the earlier stages. Couple this with the fact that only 2 out of every 100 venture-backed startups ever sell for $100 million or more, and raising substantial amounts of money greatly reduces the potential chance of a “successful” outcome.

Here are a few thoughts on startup funding and optionality:

  • Discuss this topic with potential investors before raising money to understand expectations and see if there is a fit
  • Ensure the founders, management, and board are aligned around desired outcomes
  • Recognize that not all outcomes are to sell the entire business as high growth tech companies are staying private longer and have more access to secondary liquidity
  • Sometimes raising money at a valuation lower than what’s possible makes sense to get the startup to the next milestone and keep more options open

The next time an entrepreneur wants to raise more money at all costs, explain how startup funding affects optionality. Raising too much money has made many acquisition offers not feasible due to the underlying motivations.

What else? What are some more thoughts on startup funding and optionality?

The Startup Stages in 8 Words

Continuing with yesterday’s post The Four Startup Stages, there’s another, much simper, way to describe the startup stages in eight short words:

  • Pilot it
  • Nail it
  • Scale it
  • Milk it

Pretty simple, right? “Pilot it” is the idea stage with a prototype. “Nail it” is the search for product/market fit. “Scale it” is the repeatable customer acquisition process and growth. Finally, “milk it” is maximizing value.

Need to describe the startup stages? Use these eight words.

What else? What are some more ways to describe the startup stages in a simple way?

The Four Startup Stages

Whenever someone tells me that want to join a startup, I always ask about their preferred stage. Typically, they don’t have a context for the stage name jargon so I go through the common ones:

  • Idea Stage – An idea is in place. Maybe there’s a team, maybe it’s just a founder. There isn’t much here yet other than an idea and a dream.
  • Seed Stage – The prototype works. Usually a few customers or beta users that are trying things out. Likely some friends and family funding or lots of sweat equity.
  • Early Stage – Product/market fit is solid and there are paying customers. Revenue is in the mid six-figures to low single digit millions. Customer acquisition is working and repeatability is the focus.
  • Growth Stage – Things are humming along nicely with the overall business cranking. Revenue is at least $5M and often much higher. Scaling is the main focus and there’s a path to the next major milestone.

With each stage comes the typical pros and cons as well as a risk/reward trade off for potential new employees. When seeking a job at a startup, it’s important to understand the standard stages and think through what’s most appropriate.

What else? What are some more thoughts on the four startup stages?

The SaaS Metrics Framework

Updata Partners released their new SaaS Metrics Framework and it’s excellent. SaaS companies have a number of business model elements that are consistent from one company to another such that it’s possible to run them through a process and see how they stack up fairly quickly. Updata’s framework is one such model.

Here are a few notes from the SaaS Metrics Framework:

  • Two SaaS metrics that matter most: Gross Margin Payback Period (GMPP) and Return on Customer Acquisition Cost (rCAC)
  • GMPP is the number of months required to break even on the cost of acquiring a customer
  • rCAC incorporates the element of customer churn/retention into the equation and calculates the multiple of the acquisition cost provided by the lifetime gross profit of a customer
  • Good is GMPP under 18 months and rCAC above 3x
  • Great is GMPP under 12 months and rCAC above 5x
  • Cohort level analysis is necessary and must be run across at least three critical dimensions: Vintage, Product, and Channel
  • Metrics and sequence of analysis
    1. MRR – Monthly Recurring Revenue
    2. tCAC – Total Customer Acquisition Cost
    3. RGP – Recurring Gross Profit
    4. GMPP – Gross Margin Payback Period
    5. eLT – Expected Lifetime
    6. LTF – Lifetime Value
    7. rCAC – Return on Total Customer Acquisition Cost

One big takeaway: SaaS companies need to be thinking about many of the popular metrics like the SaaS Magic Number in the context of gross margin, not revenue. And, thankfully, gross margin should improve with scale. Want to understand SaaS unit economics better? Head over to SaaS Metrics Framework.

What else? What are some more thoughts on Updata’s SaaS Metrics Framework?

The Dilution vs. Growth Rate Trade Off

Once a startup finds product/market fit and a repeatable customer acquisition process, it’s off to the races to build a large, meaningful company (see The Four Stages of a B2B Startup). Only, when it’s really, truly working, there’s virtually no end to the capital available (assuming good unit economics and a fair valuation). More money is readily available, but every additional dollar of equity results in more dilution. Enter the dilution vs. growth rate trade off.

Here are a few questions to consider:

  • What are some low/no dilution options to grow faster? Venture debt? Raise a smaller round to get to the next milestone?
  • What’s the competitive landscape like? How hard are the competitors pushing (this is one of the reasons scaling SaaS is so expensive)?
  • How’s the growth rate now? What’s the estimated growth rate necessary to win the market? What’ll it take to close that gap?
  • How promising are the expansion ideas? Geographic expansion? Industry expansion?
  • Who’s gone through this before that can be a good sounding board?

Once a startup is working, it’s an amazing thing. Only, the dilution vs. growth rate trade off is real and should be constantly evaluated.

What else? What are some more thoughts on the dilution vs. growth rate trade off?

The Importance of Markets and Timing

Earlier today I was talking about markets and timing with an entrepreneur. Some startups with amazing teams fail while other startups with “normal” teams achieve incredible results. What gives? Markets and timing play a critical role.

Here are a few thoughts on the importance of markets and timing:

  • Being too early to a market is a failure (how many times have you heard someone say “I had that same idea 10 years ago…”)
  • Being too late to a market is a failure (“we got crushed by the competition” said no entrepreneur ever, but happens all the time)
  • The best timing is slightly early so that when the market takes off, the startup already has customers, employees, and a foundation to build on
  • Two popular ways to think about markets: resegmenting a large, existing market with something better, faster, and cheaper or going after a small, fast-growing new market with a solution
  • Occasionally the size of a market can be expanded with a new solution (like Uber did for the taxi market) but often the market size is relatively static, so choose well

Timing a market with the right product is difficult, very difficult. Entrepreneurs would do well spending more time thinking about markets and timing as they play an outsized role in success.

What else? What are some more thoughts on the importance of markets and timing?