Author: David Cummings

Last week I was talking to a prominent investor and I asked about the current state of the investment climate. He said that startups a year ago raising money at 30-50x revenue were off limits to his firm and today they’re commonplace. Hearing this, it made me think of Fabrice Grinda’s excellent Welcome to the Everything Bubble.

Ten years ago, a hot, fast growing SaaS company would get a 6-8x run-rate valuation (see ExactTarget at IPO in 2012). Then, in the last 4-6 years, hot, fast growing SaaS companies moved to a 10-12x run-rate valuation (see Zoom raising $100M at a $1B valuation in 2017). Now, there are dozens of public SaaS companies trading north of 20x run-rate and plenty trading north of 30x run-rate (see BVP Cloud Index). What gives?

The main factors:

• Market Size – The total addressable market for SaaS is much larger now, providing more confidence that startups can grow to a scale even bigger than previously anticipated.
• Digital Transformation – COVID has accelerated the adoption of many SaaS products as companies have been forced to work in a distributed fashion, driving up growth rates.
• Interest Rates – With the Fed interest rate effectively at 0%, the bar for a quality rate of return has been dramatically lowered, making investors willing to pay a higher price to achieve the same outcome.
• Money Supply – With so many stimulus dollars flooding the system, and not a corresponding drop in overall incomes, the money has to go somewhere, and many people have put it in the stock market, thereby driving up valuations.

Ultimately, I think about it as a function of startup growth rate and how many years of future growth an investor is willing to pay for now. Let’s say long term, in a normal financial environment, SaaS companies are worth 4-8x revenue because of great gross margins, ability to have high free cash flow margins, predictability of business, growth expectations, etc. If a SaaS company is expected to grow 100% top-line in the next 12 months, and grow 80% in the following 12 months (growth rates typically decline such that growth is 80-85% of the previous year’s growth, depending on a myriad of factors), there’s some basic modeling to look at potential valuations:

• Year 1
  • $10M ARR
  • 100% expected growth rate
• Year 2
  • $20M ARR
  • 80% expected growth rate
• Year 3
  • $36M ARR
  • 60% expected growth rate
• Year 4
  • $58M ARR

Assume at the end of 36 months, the $10M ARR SaaS startup will be at $58M ARR with a trailing twelve months growth rate of 60%. Assume, for simple math, it has a constant future valuation of 8x run-rate (growth rate will slow but economies of scale will expand). At the end of 36 months, it’ll be valued at $464M ($58M x 8).

Now, take different hypothetical valuation climates:

• Ultra Hot – 30x run-rate representing a $300M valuation
• Hot – 20x run-rate representation a $200M valuation
• Great – 12x run-rate representing a $120M valuation
• Good – 8x run-rate representing an $80M valuation

If you could predict the future, and know with certainty the outcome, whether investing at 8x run-rate or 30x run-rate, all scenarios generate quality returns. Reality is much more complicated, but as interest rates go down and availability of money goes up, there are still worthwhile returns even paying what appears to be exceptional valuations.

SaaS valuations are part art and part science. In the age of the Everything Bubble, as long as there are good returns to be made paying ultra hot valuations, looking for high multiples to persist.

Last week I listened to Matt Mullenweg of Automattic/WordPress on The Past, Present, and Future of the Internet. In the interview he talks about how early in his career he felt like he missed the wave of the Internet revolution. Hearing his story brought back my own feelings of missing the Internet wave. For me, I was in college during the dot com boom and subsequent bust. Because there was so much startup activity — tens of thousands of ideas and billions of funding — it seemed like every concept worth trying was already played out.

I had missed the boat, or so I thought.

What I failed to understand was that while many of the first-order startup ideas like buying books online (Amazon.com) and bidding on online auctions (eBay) were immediately doable, the second-order startup ideas would take longer to be viable. Much longer.

Even when it’s obvious there’s a better way, inertia is an incredibly powerful force. People and infrastructure are static by default. Most people don’t wake up thinking how they’re going to make major changes to how they do things. Change is constant but generally avoided.

The biggest second-order wave I’ve been lucky enough to be part of is the Internet as enabler for significant productivity enhancements within sales and marketing. There’s no way I could have seen the wave in college as I had didn’t have any experience in sales and marketing. With time, it became apparent that the “normal” way of acquiring customers was cumbersome and inefficient compared to what the Internet enables. From Pardot (marketing automation) to SalesLoft (sales engagement) to Terminus (account-based marketing) to Calendly (scheduling), these only touch select areas of customer acquisition, but the market is so massive, that these are all meaningful fast-growing businesses.

I missed the first wave, but rode a second wave created from it.

Don’t assume all the opportunities are done and make sure you are in the arena.

Recently an entrepreneur was talking about his new startup and how they were “uncomfortably narrow” with the feature set at product launch. For years we’ve been talking about the minimum viable product and “if you weren’t embarrassed by your product at launch, you waited too long.” Both drive home the point that entrepreneurs often build too many features for too many people before launch, thereby reducing their chance of success (too much capital burned, code base slowing down development, failure fatigue, etc.)

Ever since hearing the term “uncomfortably narrow” it’s been rattling around in my head. Entrepreneurs by their very nature are optimists, ready to resourcefully will their ideas into the world. Something that is uncomfortable narrow is, by definition, less than what is desired.

Fewer features. Fewer modules. Fewer use cases.

Entrepreneurs want to build more. Hence the internal conflict around purposefully limiting the product and making it uncomfortably narrow.

Getting a potential customer to say “yes” is much harder than saying “no.” Thus, the thinking goes that more features are needed to overcome these sales objections. While that can be the case, in the early days that’s often code for “your product doesn’t solve my core issue.”

Instead of adding more features around something that doesn’t solve the core issue, which is the normal approach, the better route is to be uncomfortably narrow and just solve the core issue. Then, once the customer is happy, add new functionality around it. This might mean a modest iteration or a serious pivot to build a valuable core.

Entrepreneurs should be uncomfortably narrow at product launch, and stay that way until it’s clear their limited feature set has provided customers something truly valuable.

With happy customers, and the start of product/market fit, only then is it time to expand the functionality. Start uncomfortably narrow at product launch.

With last week’s news that Calendly raised a $350 million round at a $3 billion+ valuation, the largest venture round in Atlanta’s history, a number of people reached out to say congratulations. Of course, all credit goes to Tope Awotona and his team for building such an incredible business.

After the kudos, the most common question is, “How can the company possibly be so valuable?”

Easy, scheduling is a universal challenge.

Think of every job function that interacts with other people. Wait, that’s nearly every job function. Now, think of the last time it was a challenge to coordinate calendars for a meeting. Hmm, that’s all the time. Software is uniquely suited to make this problem go away. Calendly does this for more than 10 million people every month and that number is growing fast, super fast.

But, naturally, it wasn’t always this way. Every entrepreneur starts the same way — taking that first step. Tope shares his incredible personal and professional journey on How I Built This With Guy Roz — Calendly: Tope Awotona. Devastating family challenges. Lots of trial and error. Great vision. Amazing execution. Growth, growth, growth.

Congrats to Tope on building an iconic business and making millions of peoples’ lives easier.

After a startup has achieved product/market fit and a repeatable customer acquisition model, one of the common entrepreneur questions is “how do I connect software engineering initiatives to revenue?” Demand on the engineering team grows from sales (new features!), from support (fix bugs, make it easier!), from product (beat the competition!), and on and on.

Some questions arise:

• Is our engineering team working on the most important things?
• Do we have enough engineering output to meet our goals?
• What new features will increase our win rate, generally? By how much?
• What new features will increase our win rate against certain competitors? By how much?
• What new features and bug fixes will increase our renewal rates? By how much?

Unfortunately, I haven’t found a solution to this challenge. What I have found is that connecting engineering to revenue goals is critical. Sure, everyone knows that adding certain functionality and fixing bugs makes the product better. Now, take it one step further.

We’re adding this feature to increase our win rate by X% to hit our revenue goal of Y this year.

We’re fixing this user experience to increase our renewal rate from X% to Y% to hit our recognized revenue goal of Z this year.

We’re doing _________ to achieve _________.

The more everyone is aligned, the more team members make micro, incremental decisions that help achieve the goals. While it’s hard to definitively guarantee engineering initiatives to revenue, it’s straightforward to tie goals to projects, and enhance the chance of success.

Last week I was talking to an entrepreneur and the topic of finding a startup idea came up. It got me thinking about the different ventures I’ve been a part of and where the ideas originated. Let’s take a look at a few.

Freelance Consulting

When I was in high school and college the dot com boom was in full effect. As a self-taught programmer, I built dozens of websites and received a recurring question: how do I update my site? The aha moment was to solve this problem and build a web content management system — Hannon Hill.

Internal Business Opportunity

At Hannon Hill, it was a journey in scalable entrepreneurship with an emphasis on building, selling, and servicing a product. Eventually, I focused in on sales and marketing in an effort to accelerate growth and realized the B2B marketing tools were insufficient. This lead to the idea for Pardot and building a marketing automation platform.

Business Challenge

At Hannon Hill and Pardot, we’d move subleases every 18-24 months in an effort to save money and have short lease terms as we didn’t know how fast we’d grow. A desire for more community, plus the fact that moving offices is a huge headache, inspired the idea for the Atlanta Tech Village. The Tech Village has now been home to thousands of startups over the years.

Customer Request

At SalesLoft, Kyle’s first product was lead intelligence whereby the system provided information about contacts changing jobs. While this product didn’t work out, customers said they really wanted leads, and then a way to authentically communicate. This feedback lead to the current SalesLoft Platform, and, eventually raising a $100M round at a $1.1 billion valuation.

Personal Friction

In the How I Built This interview about Calendly, Tope shares his personal story and frustration scheduling appointments with prospects as an enterprise software sales rep. This personal friction around meetings sparked the idea for Calendly, and now it’s one of the most widely used scheduling tools in the world.

Conclusion

Clearly, startup ideas come from many different places. Ultimately, the best ideas come from simply listening and looking at friction personally and professionally. Opportunities are all around us. Quality selection, and excellent execution, are the most difficult challenges.

An area I’m especially fascinated with is the future of work. Of course, the pandemic significantly broadened that interest through forced remote/virtual work and many discussions of how the office will change going forward. Last week I read one of the most incredible examples of a high growth startup scaling successfully with zero employees. Yes, no employees, eight figures of revenue, and almost a triple digit growth rate. So, how does it work? Let’s dive in.

No Meetings, No Deadlines, No Full-Time Employees by Sahil Lavingia, founder of Gum Road, is fascinating. A few of the highlights:

• Overarching personal goal for the founder is “freedom at all costs”, meaning he runs the business, the business doesn’t run him
• No meetings — everything is done via extensive writing in tools like GitHub and Notion
• Everything is managed as Tasks in Notion
• No goals or OKRS, just a single North Star: maximizing how much creators earn (Gumroad is a platform for creators to get paid)
• Product roadmap is public
• Minimum viable culture with no “forced” socializing
• Everyone is a contractor paid highly competitive hourly rates ($50/hr – $250/hr)
• Hiring is done via a form, multi-hour unpaid assessment doing a hypothetical project, then a paid few-week trial
• Internal document for all employees that shows hourly pay and hours worked
• No perks — just cash and flexibility (no healthcare, no technology stipend, etc.)
• Many of the contractors were found as they were already Gumroad users and part of the creator economy
• “Anti-overtime” rate of 50% of the hourly rate if a person works over 20 hours in a week (goal is for everyone to work 20 hours a week or less)

Reading the post, several questions come to mind:

• How doable is this without the amazing pipeline of potential contractors that are already in the community of customers?
• What type of person values flexibility above all else? What approximate percentage of the population?
• Does a digital, asynchronous-only culture matter over the long haul for continued success?
• What does contractor turnover look like? How similar or different is turnover to normal tech startups at a similar stage?

The “anti-overtime” rate really gets me thinking as it’s a catalytic mechanism to align the internal expectations with the contractor‘s wallet. We’re here to work no more than 20 hours/week. If you need more time to do whatever, go for it, but it’s at your discretion and at a significantly reduced rate.

Thinking about contractors working no more than 20 hours week, it likely aligns with how much “real” work gets done in a normal 40 hour week. Time spent in meetings, going to lunch, socializing at the water cooler (virtual or otherwise), etc. likely isn’t “creator” time but does have social value and cultural importance. When it’s stripped away and time is only spent on the desired output, what changes?

Overall, No Meetings, No Deadlines, No Full-Time Employees is an incredible read that feels like a new type of business where the working style fills an unmet need for some (many?) people. I believe the trend of contractors, freelancers, gig workers is only accelerating and a company like Gumroad is the logical extreme. The big question: when does something that seems extreme today become commonplace?

Most conversations I have these days with entrepreneurs has some component about virtual teams, remote employees, return to the office timeline, etc. While great work is getting done virtually, there’s still a strong desire to have an in-person element, whether it’s a few days a week or a few days a year, humans crave face-to-face with other humans.

Personally, I don’t believe there’s one right answer. I believe most startups will have both people working in offices (some dedicated, some co-working) and people working from anywhere they choose (virtual). The big difference now is that the in-office aspect of the future will be a much smaller number of weekly hours, on average, and much greater worker flexibility. Overall, a huge net benefit to society.

As entrepreneurs continue to navigate this new approach, there’s one resource for virtual/remote startups that stands out:

GitLab Team Handbook

• 8,400 pages of text
• Open and usable by anyone
• Incredibly detailed and thoughtful

While it is geared towards an all-remote business, there are a number of excellent resources applicable to all businesses like managing KPIs and doing OKRs.

Every entrepreneur should bookmark the GitLab Team Handbook and know that whatever scenario they’re contemplating, it’s likely been addressed in the handbook.

Ten years ago I was talking to a tech entrepreneur in town with multiple startup wins. We were talking about the startup journey and how much effort is required to make it work — so many ups and downs, unknowns, and long hours.

Then, we got to talking about outcomes and levels of success and he offered up a comment that has stuck with me ever since:

It’s the same amount of effort to build a $30M business as it is to build a $300M business, so only pursue the biggest ideas.

Anonymous

Having held that thought in the back of my mind for many years, and seeing different entrepreneurial ventures play out, I’ve found that statement even more prescient. All successful startups take a tremendous amount of work. Whether it’s five years of effort (low end) or 10 years of effort (much more common), it takes an incredible amount of time and energy such that it’s best to pursue the biggest, most audacious ideas.

So, the next time you’re evaluating startup ideas, remember that it’s the same amount of work to produce a good outcome as it is to produce a great outcome, so think big.

One of my hobbies is learning how other entrepreneurs and investors think about ideas, markets, opportunities, etc. I proposed a simple theory in Team, Stream, and Not a Meme for entrepreneurs at the earliest stages to find a trend accelerating (stream) with a must-have product (not a meme). I recently heard an excellent interview that offered up four key weights for investing.

Ted Seides interviewed Chamath Palihapitiya about The Social Capital Flywheel on his podcast Capital Allocators. Chamath’s thoughtfulness and conviction really resonated with me, especially as he described what he looks for as an investor. Here are his four key weights for investing, starting at the 45 minute mark:

1. Product/market fit –
   How strong or weak is the product/market fit? It doesn’t matter how old or young the business is, it matters how much the offering matches up to the market demands.
2. Integrity of management –
   What’s the integrity of the management team? High, medium, or low? Again, doesn’t matter how old the business is, but rather how much integrity there is on the management team.
3. Headwinds or tailwinds –
   What are the future prospects for this industry and this business? How strong or weak are they? How poorly described were they in the past?
4. Internal corporate politics –
   How much do internal politics play a role in the business? What are the Glassdoor reviews like? The lower the internal corporate politics, the better.

The first three are pretty common but I hadn’t seen the fourth — internal corporate politics — as a factor in investing. Now, I’m going to pay more attention to it, especially in later stage startups where it’s relevant.

Keep the weights of these four characteristics in mind when considering an investment opportunity.