David Cummings on Startups

Author: David Cummings

  • Do VCs Add Value?

    Charlie O’Donnell from Brooklyn Bridge Ventures has an interesting piece up titled VC Value add: Why it probably doesn’t matter, but I try anyway. Charlie, having been at First Round Capital and Union Square Ventures, which are two of the premiere venture firms, talks about how he believes 99.999% of billion dollar exits are due to the founders, and nothing to do with the investors. That’s an impressive statement from someone who’s been around the best in the business.

    Personally, I haven’t seen a billion dollar exit, so I don’t know what it’s like at that scale. As for going from idea stage to seed to early to growth, I have seen a number of good examples. Here are a few areas where investors should add value:

    • People – Great talent is one of the top challenges for entrepreneurs, and investors should have a strong network of people.
    • Psychologist – Building a great company requires making a number of hard decisions, and sometimes the best help an entrepreneur needs comes from a good listener that asks the right questions.
    • Processes – Growing a business is hard, especially as more employees are brought on. Putting in processes and procedures, like a Simplified One Page Strategic Plan every quarter, is part of every entrepreneur’s maturation process.
    • Fundraising – One round of funding doesn’t guarantee another, and helping portfolio companies raise the next round of funding is an important role.
    • Introductions – Making introductions is the most important value add for investors, especially in regards to helping find customers, partners, and employees.

    I do believe the right investors can add significant value. Can they influence the outcomes on billion dollar exits? I don’t know. Can they be the difference between building a successful business and not building a successful business? Absolutely. Some investors add value and some don’t, and as an entrepreneur, the key is to figure that out in advance of partnering.

    What else? What are some more thoughts on VCs adding value?

  • Accounting Rules Will Drive Companies to Look at Shorter-Term Leases

    If a fast-growing, growth-stage startup, desperate to find great office space, signs a 7-year lease at an average of $1 million per year in rent, nothing changes to the long-term liabilities in their financials. Now, the company is on the hook for a million dollars per year. What if they downsize? What if they need more space? It seems strange that the same company, whether they have seven years left on an office lease or one year left, doesn’t reflect that huge liability somewhere, encouraging companies to sign longer leases since they’ll get lower rates and more tenant improvement allowance at the beginning, and thus making the company look better in the short-term.

    Well, the Financial Standards Accounting Board is five years into a project to change the standards around accounting for leases. While it isn’t finalized yet, the net effect is that companies are going to have to recognize assets and liabilities that come from lease transactions.

    Here are a few ideas on how more transparent recognizing of leases will affect the market:

    • Lease terms will be shorter on average
    • Companies that can commit to longer terms, and the corresponding liability, will be given more concessions by landlords
    • Furnished, short-term office environments, like the Atlanta Tech Village, will see increased demand
    • Subleases will be more aggressively reviewed (and the flip side is that companies will look to get out of their liabilities more aggressively by subleasing space)

    The amount of liabilities out there for companies with long, expensive commercial real estate leases is staggering. While a FASB change won’t cause the market to correct overnight, it will have a fundamental change on commercial real estate leases.

    What else? What are some more thoughts on accounting rule changes that will drive more companies to look at shorter-term leases?

  • The Delta Between a Startup’s General Value and the Value to a Strategic Acquirer

    Last week I was talking to a gentleman that previously ran corporate development for a large tech company. During his tenure, the firm acquired dozens of companies and spent billions of dollars on acquisitions. After talking about a few experiences, he explained one of the things people have the hardest time understanding: why strategic acquirers buy companies for much more than what it seems like a company is worth.

    Actually, the answer is very simple, especially when the company being acquired has a real business with customers and revenues. The delta between a startup’s perceived value and the value to a strategic acquirer comes down to distribution. In a word, sales. Large tech companies have massive sales teams and partner channels whereby they can add new products and significantly grow product revenue.

    Imagine a software or hardware company doing $20 million in revenue with 50 sales reps and 10 channel partners. Depending on the overall economy, size of the market, growth rate, gross margins, etc, the company might be worth 3-10x revenue. Now, an acquirer comes along and sees the startup as strategic. The acquirer has 10,000 sales reps and 10,000 channel partners. Instead of the startup being worth ~$100 million, to the strategic, based on a model that shows the the product doing ~$100 million in sales in 24 months, the startup might be worth $400 million. That’s a big delta between a $100 million valuation in the general market vs $400 million for a strategic acquirer.

    The next time you see a big valuation multiple for an acquisition, ask yourself how much faster revenue will grow under the new owner, and how that changes the value equation.

    What else? What are some more thoughts on the delta between a startup’s general value and the value to a strategic acquirer?

  • YC Asset Stripping Entrepreneurial Talent

    Over the past year at the Atlanta Tech Village, I know of at least three top notch startups that applied to Y Combinator, got interviews, and didn’t get accepted. That’s not to say these startups aren’t going to be successful. Rather, the bar is so high, and there are so many applicants, the chance of any startup getting accepted is incredibly small. But, still, there were 120 amazing startups in the most recent Y Combinator class, and there are two classes per year.

    An entrepreneur-turned-investor described Y Combinator’s ability to attract entrepreneurs from around the world as asset stripping talent from other regions. Here are a few thoughts on YC attracting amazing talent:

    • With a three month program, entrepreneurs from other cities, that might not want to move to California permanently, have a chance to try before they buy, making it much easier to see oneself staying there indefinitely
    • YC’s alumni network, from what I’ve heard from friends that have gone through the program, is powerful and valuable, such that the instant credibility and access to people is a major benefit for an entrepreneur moving to the Bay Area
    • Valuations and the size of seed rounds for YC companies are considerably higher than the market average, making access to the program even more valuable, and more desirable, as a draw for talented entrepreneurs to move from a different region

    The ability to attract incredible talent at scale is one of biggest reasons why Silicon Valley will continue to thrive, and Y Combinator is a serious contributor to that net import of talent.

    What else? What are some more thoughts on YC asset stripping entrepreneurial talent from other regions?

  • Investor IRR on Paper to Raise Another Fund

    Recently I was meeting with a venture investor talking about the market and opportunities at the Atlanta Tech Village. He had just joined a new partnership, so, naturally, I asked what happened at his previous firm. He said the firm had made the targeted number of investments, but didn’t have the required internal rate of return (IRR) to raise another fund, and was desperately trying to make the existing investments more successful.

    Here are a few thoughts on investor IRR on paper to raise another fund:

    • Current boom times, where hot startups raise more money at ever higher valuations, makes the paper returns for the earlier investors excellent, even though some of those startups won’t be able to grow into their valuation
    • Investor returns, outside of exits or selling a piece of the investment, are measured via mark to market, such that the main way to get a new market price is by raising another round of funding, hence the VC desire to raise more money at a higher valuation
    • Some funds, that had poor overall returns, but good returns for a select number of the partners, market their next fund based on the returns on the partners that did well, and not the overall fund numbers
    • Most funds don’t achieve their stated goal of returning three times the money in seven years, which is 17% IRR (see Demystifying Venture Capital Economics), and thus can’t raise another fund

    When talking with investors, it’s important to understand the firm dynamics, especially where they are in their fund lifecycle. Also, note that returns on paper, not necessarily exits, are needed to raise another fund.

    What else? What are some other thoughts on investor IRR on paper to raise another fund?

  • More Vertical, Niche SaaS Startups

    Over the past few months I’ve talked to a number of entrepreneurs with vertical, niche Software-as-a-Service (SaaS) products. As expected, mainstream SaaS platforms are being carved up into small, specialized point solutions, while also providing a better experience to their customers. Most venture investors are looking for large, platform-like SaaS startups, but more entrepreneurs are going to build sustainable SaaS products that aren’t venture backable, yet very successful.

    Here are a few thoughts on more vertical, niche SaaS startups:

    • SaaS, with strong to recurring revenue, predictability, and renewal rates (hopefully!), makes for a sustainable business, even at limited scale
    • Costs to develop and deploy software has continued to drop due to open source and the cloud, making it easier to get products to market and carve out a niche (scaling a business is still capital intensive)
    • Depth of product functionality is going to be stronger the more narrow the market, and thus serve the customers’ needs better
    • Marketing and sales prospecting is more straightforward with a focused market, especially messaging and talking points

    Look for the SaaS cottage industry to continue to grow, especially as more more vertical, niche products reach a sustainable size.

    What else? What are some other reasons there will be more vertical, niche SaaS startups?

  • Sales Resources for Startups

    With so many startups reaching out and asking for help as they implement an inside sales team based on SalesLoft and the Predictable Revenue book, it’s a good time to highlight a few posts and notes for entrepreneurs. Building a successful inside sales team isn’t easy, but there are a number of proven strategies and tactics.

    Here are a few sales resources for startups:

    To start, most entrepreneurs should hire a sales assistant to get going and then expand from there. Sales and sales teams are the lifeblood of many startups, yet take time to understand and scale.

    What else? What are some other sales resources for startups?

  • Notes from the Shopify S-1 IPO Filing

    Earlier today Shopify announced that they had filed for an IPO and released their S-1 document with the SEC. Shopify is the top Software-as-a-Service ecommerce provider powering over 160,000 online stores. Personally, I’ve talked with a number of ecommerce entrepreneurs and Shopify always comes up as one of the best solutions.

    Here are a few notes from the Shopify S-1 IPO filing:

    • 900 apps in the Shopify App Store (pg. 1)
    • Revenues (pg. 2)
      2012 – $23.7 million
      2013 – $50.3 million
      2014 – $105.0 million
      2015 Q1 – $37.3 million
    • Net losses (pg. 2)
      2012 – $1.2 million
      2013 – $4.8 million
      2014 – $22.3 million
      2015 Q1 – $4.5 million
    • 162,261 customers with an annualized revenue of $1,000/year (pg. 3)
    • Company started September 28, 2004 in Ottawa, Canada (pg. 5)
    • 632 employees (pg. 13)
    • Accumulated deficit of $33.6 million (pg. 13)
    • Stripe powers the payments processing (pg. 15)
    • Separate Class A and Class B shares where the Class B shares have 10 votes, meaning the executives control the company (pg. 31)
    • Subscription revenue accounted for 63.5% of revenue (pg. 53)
    • Payment processing fees accounted for 36.5% of revenue (pg. 54)
    • Payment processing solutions are for both online and offline sales (pg. 54)
    • Most revenue collected is in U.S. dollars but most expenses are in Canadian dollars, so exposed to currency fluctuations (pg. 56)
    • U.S. represents 68.7% of revenues (pg. 61)
    • 85.5% gross margins (pg. 63)
    • Shopify started as an online snowboarding store and then became a software company when no ecommerce system could be found to the CEO’s liking (pg. 82)
    • Core values (pg. 97)
      Get shit done
      Build for the long-term
      Focus on simple solutions
      Act like owners
      Thrive on change
    • Founder ownership – 14.6% (pg. 127)
    • Bessemer Venture Partners ownership – 30% (pg. 127)

    To clear a $100 million run-rate while only having an accumulated deficit of $33.6 million is incredible — super capital efficient. Combine the capital efficiency with scale and a growth rate that’s still over 100%, and you have an amazing story that’s going to do well in the public markets. It’ll be interesting to see how public investors discount, or don’t, the payment processing fees as they aren’t as valuable as the subscription fees, but are still valuable nonetheless. Shopify is a major success story.

    What else? What are some more thoughts on the Shopify S-1 IPO filing?

  • Coworking as a Business Opportunity

    As the coworking space continues to gain attention, especially with the growth of the tech industry and reports of WeWork raising $335M at a valuation of almost $5B, more potential investors are drawn to the market. With the Atlanta Tech Village, we’ve had the chance to learn first-hand about coworking and flexible office space for over two years now, and have several thoughts on the market.

    Here are a few pros and cons of coworking as a business opportunity:

    Pros

    • Fulfills a growing desire for freelancers, entrepreneurs, and creative class employees to have a sense of community
    • Capitalizes on millennials entering the workforce and their expectations of a different office environment
    • Allows repurposing of existing office space into a higher value offering
    • Provides greater efficiency for business expenses like internet access, conference rooms, break rooms, etc. (e.g. with a direct lease, many items are dedicated that don’t need to be dedicated)

    Cons

    • No barriers to entry as office/retail space is abundant
    • High customer turnover due to a less stable target audience
    • Expensive renovations required for a high-quality, creative feel
    • Prevalence of hobby and labor-of-love coworking space providers (e.g. many coworking spaces are subsidized and have a social mission)
    • More labor intensive than traditional office space

    As a business opportunity, I don’t think coworking is a good place to make strong returns unless there’s a unique, differentiated brand whereby people are willing to pay significantly above market rates for the space. Most professional investors getting into the coworking market will fail. Coworking, in order to build community, is an amazing opportunity.

    What else? What are some other thoughts on coworking as a business opportunity?

  • When to Pitch at Startup Events

    With a number of startup pitch events scheduled over the next few weeks, it’s a good time to think through when it’s best to go on the pitching tour. Most events have an element of startup theatre, so the first thing to do is to evaluate the opportunity cost of attending another event vs. making more progress on internal goals and priorities. Assuming there’s an overall fit, here are a few items to think through when considering applying to pitch at a startup event:

    • Fundraising – Is there a desire to raise money and the corresponding metrics to warrant investment? Too often, entrepreneurs head to pitch events in an effort to raise money, but don’t have the corresponding business metrics. If the metrics are strong, pitch events are a good way to showcase them and tell a compelling story.
    • Lead Generation – With a broadly applicable product, pitch events can be a great way to generate leads. Similar to the idea of asking VCs for intros to portfolio companies, ask the audience for leads.
    • Recruiting – Finding great talent is always a challenge, especially during high growth stages. Pitch events can be a good way to spread the word and find new candidates.

    If you ask an entrepreneur why they do pitch events, outside of trying to raise money, the most common answer is networking. Entrepreneurs, generally, are pretty social and want to meet other people, especially other people that can help them achieve their dreams. Naturally, there are a number of other networking events beyond pitch competitions.

    For entrepreneurs considering pitch events, evaluate the current business goals, and make sure that the time commitment is worthwhile.

    What else? What are some other thoughts on when to pitch at startup events?