David Cummings on Startups

Author: David Cummings

  • When a Product Works but a Business Doesn’t

    An entrepreneur emailed me recently asking for advice about his Software-as-a-Service (SaaS) business. After several years of working on it, and signing up hundreds of customers paying a small amount of money, it became clear that it wasn’t a viable business. That is, by all accounts, product-market fit was reached but no matter how hard he tried, there wasn’t a repeatable customer acquisition process that could scale it to a multi-million dollar revenue business and make it worthwhile. This is one of the most challenging cases: years have been invested, customers clearly want it, and there’s no sustainable business in its current form.

    Here are a few questions to ask when a product works but a business doesn’t:

    • Are there any adjacent markets or opportunities that can use the expertise developed with the first product?
    • How excited is the team about the opportunity? Has any fatigue set in from the current product?
    • Is the product a must-have or a nice-to-have? What would it take to make it a must-have?
    • Can you sunset the product or wind it down such that customers have time to switch to a different product?
    • How much effort does it require to keep it running while moving to a different product? Can focus truly be put on something else without worrying about the first product?

    Products that work with business models that don’t actually happen more often than expected. Inevitably, some ideas aren’t economically viable even though they look great from the outside looking in. Even though it’s hard, sometimes the best approach is to stop throwing good money after bad and pivot or iterate into a better opportunity.

    What else? What are some other questions to ask when a product works but a business doesn’t?

  • More Venture Capital vs More Local Venture Capital

    One of the commonly repeated phrases by city leaders is that we need more venture capital in the region. Partly, the statement is conflating the desire for more money to come to the region (presumably from the limited partners in the fund that invests) with the desire for more of the financing in successful local startups to be local money (e.g. local VCs are more likely to have local limited partners). So, a) we want more successful startups, b) we want more venture capital, and c) we want the venture capital to be local, if possible, so that more of the proceeds from the winners stay local.

    Here are a few thoughts on more venture capital vs more local venture capital:

    • More venture capital, in general, will come with more successful startups (entrepreneurs need to come before the money comes)
    • Venture capitalists can be shown good startups in a region, but they’re only going to invest if they believe that a startup is going to deliver the best return compared to all other startups evaluated (e.g. if a VC from California invests in a startup in Atlanta, it’s because the Atlanta startup is going to make them more money than the startups they looked at in California)
    • Local venture capital is going to be smaller dollar amounts as firms build up their track records, and only after many years (decades?) of success, will local firms be able to raise and invest the much larger sums we’re seeing growth and late stage startups raise

    Wanting more venture capital invested in a region is different from wanting more local venture capitalists. Regardless, both will happen with more successful startups and outsized returns from investments in those startups. More venture capital starts with more success stories.

    What else? What are some more thoughts on more venture capital vs more local venture capital?

  • Evaluating if a Startup Idea is Good

    If someone asks if their startup idea is good, and it’s not a good idea to tell them one way or another, what to do? Easy, help them by asking key questions for them to consider, so that they can make the assessment on their own, based on feedback from people in the market. Here are a few potential questions to ask:

    • How many potential customers have you talked to about the idea?
    • How much did the potential customers say they’d pay for the solution?
    • How many potential customers are out there?
    • How expensive will it be to acquire customers?
    • How will potential customers justify the ROI for the solution?
    • Is the solution a must-have or a nice-to-have?

    Clearly, it requires time and a number of conversations to evaluate if a startup idea is good. The best place to start: potential customers.

    What else? What are some other questions to ask to help an entrepreneur evaluate if a startup idea is good?

  • Asking if a Startup Idea is Good

    Recently an entrepreneur was walking by in the hall and asked if I’d listen to the latest idea he was working on. Sure, I said, and we talked for a few minutes. Upon asking me if I liked the idea, I immediately thought on Fred Wilson’s tweetstorm and said that it doesn’t matter if I think it’s a good idea because they’re investing their time in it and I’m not. Finding out what the market and potential customers think is much better than what some entrepreneur thinks.

    Here’s the end of the tweetstorm:

    The next time an entrepreneur asks if their idea is good, tell them what matters is that they think it’s good as they’ll be spending time on it. Entrepreneurship starts with believing in oneself as a prerequisite to getting others to believe.

    What else? What are some other thoughts on asking if a startup idea is good?

  • What if the Atlanta Tech Village were Free?

    In an effort to make the Atlanta Tech Village the best place for entrepreneurs to go to increase their chance of success, we’re always brainstorming ideas to make it better. One idea was “what if the Atlanta Tech Village were completely free?” Of course, it costs a million dollars a year just for things like property taxes, utilities, security, maintenance contracts, and more, not including staff salaries, to keep the building open. Absent the financial questions, here are a few things that might change:

    • Stricter Entrance Criteria – The Village requires that startups have proprietary technology and meet our core values (be nice, dream big, pay it forward, and work hard/play hard). With more demand, entrance requirements could include having a working product, paying customers, or other milestones.
    • Stricter Exit Criteria – Right now, there’s no timeframe on being in the Village and startups graduate out once they have a few dozen employees. The greatest need for office space is in the 2-8 person range, so startups would graduate sooner to ensure room for the smaller firms.
    • Ongoing Metrics Tracking –  Individual startup progress isn’t measured, so there would need to be more focus on metrics and results to ensure that startups not meeting expectations are moved out to make room for new startups to come in.
    • Longer Waiting List – With no cost, demand would grow and a longer list of startups would want to be in the community.

    If the Village were free, it would fundamentally change the dynamics and require more focus on results. While the Village isn’t free, we’re continuing to work hard to make it the best place for entrepreneurs to succeed.

    What else? What are some other changes that would happen if the Atlanta Tech Village was free for startups?

  • B2B Tech Incubator Entrance Requirements

    Over the past couple years I’ve had the chance to talk with several entrepreneurs that are interested in setting up a tech incubator. At the Atlanta Tech Village, we don’t call it an incubator because there’s no equity component. One of the tech incubator discussion topics was around entrance requirements, especially in a B2B context, with a goal of more transparency for applicants.

    Here are a few ideas around entrance requirements for a seed-stage B2B tech incubator:

    • Aligned Core Values – Entrepreneurs, employees, investors, and everyone else that’s deeply involved need to have aligned core values.
    • 10 Paying Customers – Nothing happens until something is sold, and signing up paying customers, even if the revenue is small, is incredibly valuable.
    • 3 Reference Customers – Customers that are raving fans, and happy to act as a reference, are critically important.
    • Pain-Killer (not vitamin) – While this can be subjective early on, once customers are using the product, it becomes clear if it’s a must-have vs a nice-to-have.
    • Clear Path to Scale – Every startup starts small, but the goal is for it to get large, very large, which necessitates a huge addressable market,

    Similar to investor requirements, a seed-stage B2B tech incubator would have its own requirements. Regardless, an incubator would do well to publish what it looks for in resident startups and establish guidelines.

    What else? What are some other possible entrance requirements for a seed-stage B2B tech incubator?

  • VC Managing Partner Economics – Round 2

    After yesterday’s post on Venture Firm Managing Partner Economics, I received a number of good comments and thoughts. Parker Conrad, founder/CEO of Zenefits, offered up that the economics for a VC change dramatically when managing multiple funds simultaneously. So true.

    Here’s how the economics might look with multiple funds under management:

    • Fund 1, with $100 million of capital, performs well (3x cash on cash), and Managing Partners make an average $2 million per year over seven years (most is back-loaded)
    • Fund 2, with $150 million of capital, closes four years into Fund 1 (able to raise it quickly because of progress to date), performs well, and Managing Partners make roughly $3 million per year over seven years, but the first three years overlap with Fund 1, so during those years, the Managing Partners make $5 million per year
    • Fund 3, with $200 million of capital, closes four years into Fund 2 (able to raise it quickly because of progress to date), performs well, and Managing Partners make roughly $4 million per year over seven years, but the first three years overlap with Fund 2, so during those years the Managing Partners make $7 million per year

    Of course, this is all theoretical and is presented in a manner that makes the venture model look smooth and consistent (it isn’t). More complexities to the model include the fact that most venture firms don’t do well (see the Kaufman Report’s PDF – h/t @jalex2003), some have a hurdle rate before the VCs earn a piece of the profits (e.g. a hurdle rate of 8% requires the investors to get that return first – h/t @stephenfleming), and VCs have to invest their own money into the fund (e.g. invest 1-2% of the fund’s capital such that it takes several years of management fees just to get back to breakeven – h/t @lance). The venture business, and corresponding economics, are more complicated than expected.

    What else? What are some more thoughts on the economics of the venture business?

  • Venture Firm Managing Partner Economics

    Recently I was talking with an entrepreneur about his goals and aspirations. He offered up something I don’t hear too often: once he sells his company he wants to become a venture capitalist. We dug into it more, especially the economics, and analyzed how it might work out.

    Here’s an example scenario of a venture firm with a $100 million fund and three managing partners:

    • 2% management fee and 20% carry (profits) such that the firm has $2 million/year to operate for the first 5-7 years and then a much smaller amount after that
    • $400,000/year salary for each partner and another $800,000/year for associates, office space, legal, accounting, etc.
    • Fund goal to produce 3x cash on cash in seven years, so invest $100 million and generate $300 million from those investments net of management fees (say $10 million)
    • Each partner gets 6% carry with the remaining 2% going to associates, venture partners, advisors, etc.
    • With $300 million from exits, less the initial capital invested ($100 million), the firm gets 20% of the remaining $200 million, which is $40 million. The partners would then each earn $12 million (6% out of the 20%).

    So, assuming the fund does well and everyone is happy, the VC earns $12 million over seven years plus a couple million more in salary. The money starts to get much larger when the VCs raise subsequent funds that are larger in size and/or land a once-in-a-generation investment like Google or Facebook.

    The economics of a managing partner at a venture firm are straightforward, if not well understood by people outside the industry. As for the entrepreneur in the conversation, he’d make for a great VC.

    What else? What are some other thoughts on the economics of a partner at a venture firm?

  • 50 $5k Bets or 5 $50k Bets

    Recently I was talking to a successful entrepreneur that wants to start doing some angel investing. As part of this initiative, he wanted to initially invest roughly $125,000 per year for two years ($250k total). He said he was looking at a variety of strategies and debating between two approaches:

    • 50 $5k Bets – Invest $5,000 in 25 startups per year with the idea that it’s incredibly hard to pick the winners, so having a diversified portfolio increases the chances of finding a couple that do well, and then doubling down on the winners. With so many investments, at such a modest amount, there wouldn’t be much time to give individual attention, but in a short amount of time it’d be clear which ones are doing well, and which ones aren’t.
    • 5 $50k Bets – Invest $50,000 in 2-3 startups per year with the idea that he’d pick ones where he can add value based on the industry, domain expertise, and/or connections. The portfolio wouldn’t be diverse, but he’d have a larger stake in a few select companies and hopefully add value beyond just the money.

    After hearing these two strategies, I asked him how much he was reserving for follow-on rounds to participate pro-rata (if any) and his general follow-on strategy. His response was that he’s planning on the same $125,000 per year for follow-on rounds, so likely 1-2x the initial investments, depending on how many make it and actually raise more money. Now, this differs from one recommendation I’ve heard to save 3x the initial angel investment for follow-on rounds but it’s still in the ballpark, especially if he’s not very selective.

    Regardless of what he chooses to do, what’s important is that he’s working on a strategy and getting into the arena.

    What else? What are your thoughts on the two strategies and which one do you like better?

  • Technical Review in a Company Acquisition

    As part of the Pardot acquisition a few years ago, there was an extensive technical review during the due diligence. As you would expect, the idea was to evaluate the technical underpinnings of the product and to try and assess if it was well made and will continue to perform as the company grows. Only, a technical review by a third-party is incredibly difficult as languages, frameworks, deployment strategies, etc. are all different and nuanced.

    Here are a few areas of technical review in a company acquisition:

    • Code Walkthrough – Much time was spent walking two senior engineering managers through how the code was organized and styled. Here, the goal wasn’t to evaluate every line of code, but rather to see that it was maintainable and that we were thoughtful in our approach.
    • Architecture – After the code walkthrough, the next step was to draw out the architecture of the product and explain how all the modules interfaced with each other. With a standard Model-View-Controller approach, the basics are usually straightforward.
    • Data Storage – With so much information being stored across so many different customers, data storage and retrieval was a big deal. Of particular note were the areas where data was growing the fastest as well as our strategy for keeping up with the growth.
    • Deployment – When a software engineer makes a change, what happens before customers get to see or use that change. How much human intervention is required? Is it automated? What tests have to pass? Where does the code go?
    • Hosting – With a complicated web-based application, the number of servers and services can be quite large. An acquirer wants to understand how manageable the hosting configuration is and how hosting costs grow as the customer base grows (hopefully there are some economies of scale in the hosting costs as revenue grows).

    Note that nowhere during the process was there a consideration for how well our product could integrate with their product or if our product was written in the same language and/or style as their product. For acquisitions whereby the product is going to continue on as a standalone application, the goal is make sure that it’s well made and will continue to perform as the business grows. Technical reviews, in my limited experience, are much easier than expected.

    What else? What are some other thoughts on technical reviews in a company acquisition?