David Cummings on Startups

Author: David Cummings

  • 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?

  • The Sales-Oriented and Technically Proficient CEO

    When I think of the most successful startup CEOs I know, they all have a common thread: they are sales-oriented with a strong technical understanding of how things work. By sales-oriented, I mean that they enjoy and value the sales process. While some are more salesy than others, they all would do well in a standalone sales role.

    The other, almost as important piece, is that they are technically proficient. Some have written code and some haven’t, but every one of them loves technology and can tell you exactly how their product works. I call this being technically proficient. Think of it as having the technical understanding necessary to be a sales engineer, but not a full software engineer.

    So, for aspiring entrepreneurs that haven’t done sales, figure out how to get some sales experience, even if it’s as simple as having a hobby business on the side where you have to repeatedly sell something. For aspiring entrepreneurs that aren’t technically proficient, sign up for Codecademy and build and run a simple Rails app on Heroku.

    Think of the most successful tech CEOs you’ve worked with. Do they fit this bill? I bet they do.

    What else? What are some other thoughts on the sales-oriented and technically proficient CEO?

  • Not all Tech Startups Have High Growth Potential

    Many tech entrepreneurs, no matter how hard they try, won’t be able to make their current idea a high growth business. And, while sometimes it’s due to the entrepreneur, often it’s because of the idea. Not all tech startup ideas are bound for high growth — let’s look at a few reasons why:

    • Timing – Ideas that are good, but too early, are still a failure. The importance of timing should not be underrated.
    • Market – Some markets are small, very small. A successful business is not the same as a high growth business and often companies can be the former without the later.
    • Customer Value – Many businesses suffer from the cost of customer acquisition being prohibitively high relative to the amount of money the customer is willing to pay for the product or service. These businesses can be successful but often aren’t high growth (many small consulting firms suffer from this).
    • Capitalization – In limited circumstances the amount of capital required for success exceeds the entrepreneur’s ability to secure funds.

    Notice that it isn’t due to luck, innovation, or the competition. Unfortunately, not all tech startups have high growth potential. It’s up the entrepreneur to decide if high growth is important to them and to make the appropriate call if the business idea needs to be changed.

    What else? What are some reasons not all tech startup ideas are bound for high growth?

  • 10 Years and 10 Lessons Learned

    After yesterday’s post on the Top 3 Mistakes as a First-Year VC, it got me thinking of a similar topic across a longer period of time: 10 years and the top lesson learned each year. Every year brings new opportunities, and new challenges, with a number of lessons learned throughout.

    Here’s a lesson learned from each year, with a bit of context thrown in:

    • 2002 – Signed deal to license SuperUpdate to GlobalSCAPE after serendipitous meeting at the December 2001 Internet World tradeshow. Lesson learned: luck plays an important role in success.
    • 2003 – Launched ContentXML (now called Cascade Server) at the San Jose Internet World tradeshow and won the Best of Show award for the Design category. Lesson learned: winning an award at a tradeshow doesn’t result in sales.
    • 2004 – Signed five customers and two were in higher education, so decided to focus on higher education. Lesson learned: figure out how to narrow things down to a defined market that’s big enough to build a business, but small enough for focus.
    • 2005 – Started to transition personal efforts from engineering and product management to sales and marketing, with a heavy emphasis on talking to the customer. Lesson learned: building a repeatable customer acquisition machine is hard, but possible.
    • 2006 – Entered high growth mode and hired a number of people that didn’t have a cohesive culture. Lesson learned: don’t sacrifice culture and core values to get people in the door.
    • 2007 – Started full-time on Pardot after identifying digital marketing as deficient for B2B marketers. Lesson learned: new opportunities emerge and sometimes it requires a tough decision to leave something else that’s going well.
    • 2008 – Heard feedback from customers that Pardot was so important that they didn’t know how they did their job before it. Lesson learned: sell pain-killers and not vitamins whenever possible.
    • 2009 – Hired a number of excellent people and established a foundation for future growth. Lesson learned: recessions are a great time to hire awesome people that were otherwise displaced.
    • 2010 – Market adoption really picked up and it was clear that marketing automation was going to be a big market. Lesson learned: timing a market is incredibly difficult, and one of the most important things.
    • 2011 – On a marketing budget of $1 million for the year, we spent $500,000 just on Salesforce.com’s four day Dreamforce conference, and it was a big success. Lesson learned: sometimes you have to get outside your comfort zone and invest to make your presence known.
    • 2012 – ExactTarget approached Pardot about a partnership and bought the company four months later. Lesson learned: build a company to last, and if an amazing offer comes along, take it.

    Those are 10 major lessons learned from the first 10 years of my career. I’m looking forward to learning many more lessons and continuing the journey.

    What else? What are some of your lessons learned in the last 10 years?