David Cummings on Startups

Author: David Cummings

  • Valuations through the 4 Stages of a B2B Startup

    Valuations are more art than entrepreneurs are led to believe. Often, the most common refrain is that business valuations are a multiple of EBITDA (a.k.a. profits with some stuff added back). In reality, the stage of the business, along with other measures like revenue, profitability, growth rate, and more help drive valuation. Like anything rare, a business is only worth what someone else will pay for it.

    Here are a few thoughts on valuations through the four stages of a B2B startup:

    • Stage 1: Search for Product / Market Fit – Valuation is largely driven by the region of the country, background of the entrepreneur, and investor belief in the opportunity (e.g. in the Southeast valuation might be in $1mm – $1.5mm range while in Silicon Valley it could be $3mm – $4mm for the same thing)
    • Stage 2: Build a Repeatable Customer Acquisition Process – Valuation is largely driven by the size of round and desired ownership stake of the venture capitalist (e.g. based on the size of the VC fund, and the number of investments a VC makes of the life of the fund, it’s simple math to figure out the necessary size of each investment, which when combined with a 20 – 30% ownership stake, results in the valuation of the company)
    • Stage 3: Maximize Growth – Valuation is driven by factors like recurring revenue, growth rate, gross margin, market size, etc and is often negotiated as a multiple of revenue (e.g. 3 times forward-looking twelve months revenue)
    • Stage 4: Maximize Profitability – Valuation is driven by earnings before interest, taxes, depreciation, and amortization (EBITDA) where it’s often a multiple of that (e.g. 4 – 6x EBITDA for a small business and 7 – 10x EBITDA for a larger business)

    In the first few years valuation is driven by what investors are willing to value the idea and business, followed by valuation driven by top line revenue and growth, and concluded by profitability.

    What else? What are some other thoughts on valuation through the four stages of a B2B startup?

  • Learning from Past Employees

    While it’s always tough to see employees move on to another company, it’s a standard part of business and being an entrepreneur. One of the things I enjoy doing is catching up with the person after they’ve left and had time to settle in to find out how things are going. I especially like learning about what they like, and don’t like, about the new company. Now, this isn’t meant to be a feel good session that the new company can’t possibly be as good as the one they left, rather I want to learn as much as I can about how others do things.

    Here are a few areas of interest:

    • What’s the corporate culture like?
    • How do they do meetings and internal communication?
    • What’s the goal setting and accountability process like?
    • What do you like overall?
    • What don’t you like overall?
    • What have you learned that didn’t expect when you took the job?
    • What are your thoughts about the market, product, competition, etc?

    These same questions can be used during an interview process as well as to learn from past employees. In addition to doing a standard exit interview, it’s also a good practice to reach out and learn from past employees after they’ve been at their new job for some time.

    What else? What are some other questions you like to ask past employees?

  • The Four Stages of a B2B Startup

    In thinking through the two most recent posts on 5 Ways to Identify Product/Market Fit and 5 Quick Steps to Go From Product/Market Fit Focused to Customer Acquisition Focused, it became clear to me that there’s value in organizing the startup lifecycle into generic stages. With simple stages, it’s easier to communicate and focus in on what’s important when talking with entrepreneurs (e.g. how often have you heard entrepreneurs worrying about scaling their product when they don’t have customers yet).

    Here are the four stages of a B2B startup:

    • Stage 1 – Search for Product/Market Fit (1 – 2 years)
      This involves putting the core team together, building a simple version of the product, signing the first 20+ customers, and honing in on the needs of the market. Most startups fail in this stage.
    • Stage 2 – Build a Repeatable Customer Acquisition Process (1 – 2 years)
      This involves experimenting with a number of different sales and marketing tactics to find as many channels as possible that work in a scalable, predictable fashion (e.g. if you can do something repeatedly but only sign one customer a month, it doesn’t count because it doesn’t have scalability). If the market timing is right, product / market fit is in place, and the team executes, the necessary inputs to achieve the desired outputs become clear and it’s time to step on the gas.
    • Stage 3 – Maximize Growth (indefinite)
      Once it’s clear there’s a repeatable customer acquisition process with scale, it’s time to focus on growing the business as fast as possible. This involves ramping up sales, marketing, engineering, services, support, operations, etc, implementing more processes and procedures, and scaling the corporate culture. As long as the business is growing north of 20% per year, it’s full on maximize growth mode.
    • Stage 4 – Maximize Profitability (no longer a startup)
      After the core growth engine of the business slows down it’s time to transition to maximizing profitability. Most businesses in this mode give some attention to growth and most attention to profitability (and profitable growth, where possible). When attention to profitability is valued over growth, and change has slowed down, it’s no longer a startup.

    These are the four stages of a B2B startup. Between each stage there’s no clear line of demarcation, but it helps to know where the startup stands so as to focus on the most pressing issues. Each stage has it’s own nuances and entrepreneurs that have built a successful business can appreciate the differences.

    What else? What are your thoughts on these four stages of a B2B startup?

    Bonus: Read about the 4 Stages in 8 Words.

  • 5 Ways to Identify Product / Market Fit

    Achieving product / market fit is one of the most difficult things to do as an entrepreneur and the ultimate goal of phase one of the startup process. Most of this first phase of the process is spent building a minimum respectable product and doing whatever it takes to get the product into the hands of users — users provide the required oxygen for the product to improve. While most startups never make it past this phase due to funding, timing, lack of viable market, poor execution, etc., many do complete phase one and enter phase two where they have to build an efficient customer acquisition machine.

    Here are five ways to identify that product / market fit has been achieved:

    1. 10+ customers have signed on in a modest period of time (e.g. 3 – 9 months) and they haven’t been friendlies (people you already knew, favors you called in, etc.)
    2. At least five customers actively using the product with little / no product customization (e.g. the product is valuable and mature enough that heavy development work isn’t required for each new customer)
    3. At least five customers have actively used the product for over a month without finding a bug (no matter how great the product is people always find issues with it, which is natural for this beginning stage)
    4. At least five customers use the product in a similar way and achieve similar results (early on you find that customers use the product in ways you didn’t imagine, which is great, but the goal is to find consistent, repeatable patterns)
    5. At least five customers exhibited a similar customer acquisition and onboarding process whereby they bought and went live with the product in a timeframe that was consistent with each other (e.g. had a two month sales cycle and took a week to get the product running)

    Here, the theme is consistency and a small amount of repeatability. There’s an on going maturation process that takes time, even with extended resources. As a founder deep within the process of developing product / market fit, it’s useful to refer back to these five ways to assess progress.

    What else? What are your thoughts on these five ways to identify fit and what other ones would you add?

  • 5 Quick Steps to Go from Product / Market Fit Focused to Customer Acquisition Focused

    In a simplistic form, I view the first one to two years of a startup as building a fairly basic product and constantly refining it until it uniquely meets the needs of a target group of customers. Once it’s providing real value to 10+ paying customers, then it’s time for phase two: building a customer acquisition machine. It’s hard enough making it from phase one to phase two that many entrepreneurs don’t even realize they need to shift their focus once they’ve found product/market fit to building a repeatable customer acquisition process. Working on the product, talking to existing customers, and refining what’s in place comes much more naturally to most entrepreneurs compared to obsessing over how to acquire substantially more customers every quarter.

    Here are five quick steps to go from product / market fit focused to customer acquisition focused:

    1. Decide that at least 10+ paying customers represent a good cross section of the desired target market and that the product is providing real sustainable value (e.g. you’re ready to transition from phase one to phase two)
    2. Plan to go from spending 80% of your time and focus on the product to 80% of your time and focus on learning sales and marketing to build a customer acquisition machine
    3. Read 10 blog posts per day on sales and marketing and try out at least one new sales and marketing experiment each week
    4. Interview five entrepreneurs that have made the jump from phase one to phase two and have built both a great product and a great repeatable sales process
    5. Talk to the 10+ representative customers and find out what websites they visit, what trade shows they attend, and any other ideas on how to find similar people and organizations

    Overall, the biggest takeaway is that there has to be a serious shift on the entrepreneur’s part going from product / market fit focused to customer acquisition focused. Lack of customers, and the resulting revenue, is the number one reason startups fail (no revenue = no business). Assuming there’s a good market out there, building a customer acquisition machine after finding product / market fit is the difference between success and failure.

    What else? What are your thoughts on these five steps to go from focusing on product / market fit to focusing on building a customer acquisition machine?

  • Doers and Ideators as Entrepreneur Archetypes

    Earlier today I was talking to a successful entrepreneur and we got into detail about our backgrounds. At one point he offered up that he was a doer entrepreneur and not an ideator entrepreneur. When presented with a challenge or opportunity he plows right through it, but coming up with new products or business ideas isn’t his thing. He values the ideas founder while realizing he’s better off playing to his strength as a doer.

    Now, entrepreneurs in general are doers and love to get stuff done. Some ideator entrepreneurs are more head-in-the-clouds type people that are always dreaming up the next scheme, and for them they either need to turn on the doer switch or partner up with someone else that’s got more doer and less ideator in them. Either way, the world needs all types.

    For those interested in entrepreneur interviews, Michael Tavani has a great series of videos online called On Doers at ondoers.com. Tavani clearly understands the doer nature of founders and is great at asking sharp questions.

    The next time you talk to an entrepreneur, dig in and find out their archetype — are they more doer or ideator.

    What else? What are your thoughts on differentiating entrepreneurs as doers and ideators?

  • 1,500 Blog Posts

    Yesterday was a big milestone for this blog: post number 1,500. It’s crazy to think that a few short years ago I hit publish on the first post and slowly started documenting my thoughts on entrepreneurship and startups. Now, on a daily basis, over 10,000 people get the content. For the first couple years, most of the writing consisted of little “how to” guides and tactical information. Lately, the topics have been more big picture items, more philosophical in nature, and more community oriented.

    One of the best parts about writing a blog is feedback and comments from readers. Readers provide great insight, ask hard questions, and help me better understand topics. So, to the readers out there, and the startup community at large, thank you.

    What else? What are some ways you get value from this blog and what topics would you like covered?

  • Buy Equity in Your Startup or Loan it Money?

    Most information on bootstrapping and self-funding a startup revolves around capitalizing the business by buying equity (e.g. you and a cofounder each put in $5,000 to start it). I know one entrepreneur that insists on loaning his business money instead of buying equity in it (after an initial nominal amount).

    Here are some ideas on loaning your startup money instead of buying equity:

    • Money loaned is easier to be reimbursed, assuming the business does well, compared to the effort of having the business buy back equity (e.g. it’s easier to get your money back)
    • If other shareholders are involved, it’s easier to decide on a loan interest rate rather than an equity valuation
    • If other shareholders are involved, and a loan is in place, interest on the loan takes precedence over dividends, thereby providing an income stream to the shareholder that loaned the money, in addition to being a more capital efficient option (equity is always considered more expensive than a loan when it comes to what shareholders have to give up)

    Loaning money in lieu of buying more equity only makes sense if you’re comfortable with the ownership position (e.g. you own a good percentage of the equity or you don’t want to reduce the incentives of the other shareholders by diluting them too far) and are willing to take on more risk without a requisite increase in possible return.

    What else? What are your thoughts on buying equity in your own startup vs loaning it money?

  • Entrepreneurs Giving Back to Help Other Entrepreneurs

    Entrepreneurs have always had a history of giving back to society and other entrepreneurs. Step into any public library in America and there’s a good chance it was initiated by the entrepreneur Andrew Carnegie (2,509 libraries). Step into the Georgia Aquarium, the largest in the world, and know that it came from a $250 million donation via Bernie Marcus, the cofounder of Home Depot. Step into an entrepreneurship program and there’s a good chance it is from or influenced by the Kauffman Foundation, a multi-billion dollar foundation dedicated to fostering entrepreneurship.

    With more societal focus on social entrepreneurship, initiatives like the Giving Pledge where billionaires give away at least half their fortune, and more focus on small businesses as the net new job creators in the country, we’re going to see even more entrepreneurs giving back to help others, especially other entrepreneurs.

    Here are some examples I’ve seen of entrepreneurs giving back to help other entrepreneurs:

    • At the ATDC and Flashpoint, there are always a number of volunteer entrepreneur mentors available
    • The Nashville Entrepreneur Center is getting ready to open after raising $5 million from public and private groups, including many entrepreneurs
    • The Greenville Next Innovation Center came about from a small group of entrepreneurs that wanted a facility to be around each other and to help future entrepreneurs
    • Members of EO Accelerator are mentored by EO members and consistently say that’s one of the best parts of the program

    I expect entrepreneurs giving back to help other entrepreneurs grow to increase and become more commonplace.

    What else? What are some other examples of entrepreneurs giving back to help other entrepreneurs?

  • Pardot Valuation Milestones and Compounding Growth

    One of the biggest fallacies about last night’s post on Compounding Growth vs Investing Residual is that equity value doesn’t increase at a constant rate over five years. In reality, the valuation of a startup fluctuates dramatically based on internal and external factors, with two of the most common drivers being growth rate and scale for a Software-as-a-Service (SaaS) company (EBITDA is more important for most businesses).

    Let’s take Pardot as an example startup, that while not normal, does demonstrate that growth in company value is not constant and compounding growth is amazing:

    • March 2007 – Personally invest money at a $1.2 million pre-money valuation with only a business idea and a great cofounder (at this point, with a new business, the valuation is often more than it’s worth once it starts generating early revenue since there’s still a gap between reality and the dream of what could be)
    • December 2007 – With a few paying customers and minimal revenue, the value was likely barely more than what it was at founding earlier in the year
    • December 2008 – With about $400,000 in trailing twelve months (TTM) revenue, good progress was being made, but there weren’t any signs of breakthrough success. I’d peg the valuation at $2 – $2.5 million.
    • December 2009 – With about $1.2 million in TTM revenue, great growth rate, and passing the magical seven figures of recurring revenue milestone, the valuation really jumped to somewhere in the $6 – $8 million range.
    • December 2010 – With about $3.2 million in TTM revenue and all the desired metrics of a great SaaS business around gross margins, renewal rate, growth rate, lifetime value of the customer, etc, the valuation continued grow fast to somewhere in the $15 – $18 million range.
    • December 2011 – With about $7.4 million in TTM revenue, growth on a relative basis had slowed but on an absolute basis had still grown, and the business was now past the next magical milestone of $5 million in revenue, and the valuation was likely in the $35 – $45 million range.
    • October 2012 – With about $10 million in TTM revenue, clear separation of the market leaders from the rest of the pack, and absolute and relative growth rates increasing due to significant investment in sales and marketing at the beginning of the year, Pardot was acquired for almost $100 million by ExactTarget.

    In this example, which is purely educated guessing using SaaS revenue as a basis, you can see the valuation not grow much in the first two years, then triple for a couple years in a row, then double yearly until the exit. Here, the amazing power of compounding growth is really at work.

    What else? What are your thoughts on these Pardot valuation milestones and compounding growth?