David Cummings on Startups

Author: David Cummings

  • Inspired By the Realization Entrepreneurs are Merely Human

    Recently I was emailing with a successful entrepreneur in town and it reminded me of the first time I met him over 15 years ago. Back then, I was involved in a local networking organization for technologists and received an email that this entrepreneur was giving a keynote talk — I immediately signed up. Here was the chance to learn from a serial entrepreneur that had taken his most recent company public and sold it for billions of dollars.

    As I sat in the auditorium and listened to his talk of the struggles, of having to beg friends for money, of being on the brink of bankruptcy multiple times, it dawned on me: entrepreneurs are human like everyone else.

    As a struggling entrepreneur myself, I had this internal myth that successful entrepreneurs were different. It was as if they played by different rules, breathed different air, and were doing unattainable things. Hearing live, for the first time, an entrepreneur share their journey, warts and all, inspired me.

    Seeing him in person and shaking his hand made me feel like if he could do it, I could too. If he got through his struggles, I could too. If he could build something meaningful, I could too.

    Entrepreneurs find inspiration in a number of different ways. For me, seeing, hearing, and touching a successful entrepreneur inspired me and helped stretch my belief in what was possible.

  • Premium SaaS Metrics Required for Premium SaaS Valuations

    When talking to SaaS entrepreneurs, inevitably the topic of valuations come up. Right now, public SaaS companies are trading at all-time highs, so entrepreneurs expect those valuations to apply to their startups. While the valuations of public and private SaaS companies have a direct correlation, it’s important to understand that not all SaaS revenue is created equally, regardless of public or private markets, thus valuations as a function of revenue vary wildly.

    As expected, premium SaaS valuations are driven by premium SaaS metrics. Here are a few of the most important ones:

    • Annual Recurring Revenue – The annual run-rate is the most talked about SaaS metric. Ensure that it’s contracted, recurring revenue as different from other revenue sources like services revenue and payment processing revenue.
    • Gross Margin – The money left after the cost of goods sold are taken out. SaaS company gross margins vary dramatically from the low 60s to the high 90s. Anything below 60% gross margins isn’t SaaS (startups masquerade as SaaS but often aren’t). A SaaS company with 90% gross margins is 50% better than a SaaS company with 60% gross margin, and correspondingly much more valuable per dollar of revenue.
    • Growth Rate – The year-over-year growth rate reflects the potential to continue growing fast, and ultimately achieve a much greater scale in the business. Investors pay a huge premium for high growth.
    • Net Renewal Rate (also Net Revenue Retention) – The gross renewal rate plus upsells and cross-sells represents how the annual recurring revenue will change assuming no new sales. Investors pay a huge premium for high net renewal rates.

    Directionally, the simplest formula for SaaS valuations is as follows:

    • 10 x
    • Annual recurring revenue x
    • Growth rate x
    • Net renewal rate =
    • Valuation

    Here’s a quick example:

    • 10 x
    • $5 million in annual recurring revenue x
    • 50% growth rate x
    • 105% net renewal rate =
    • 10 x $5,000,000 x .5 x 1.05 = $26,250,000

    So, a $5M SaaS company with good growth and good net renewal rates would be worth a bit more than five times annual run rate.

    To make it more complete, you’d add in gross margin and elements to reflect more nuanced variables like the potential size of the market (e.g. a valuation premium for bigger markets).

    One SaaS company might be worth 15x run-rate (due to high growth rate and high net renewal rate) while the next one might be worth 2x run-rate (due to no growth and high churn).

    Premium SaaS metrics are required for premium valuations. Look at the entire picture, not just annual recurring revenue.

  • Entrepreneurs Should Pick a High Growth City

    Last week I was reflecting on different contributors to entrepreneurial success. Topics like luck, timing, hard work, and persistence come to mind. Only, for me, picking a high growth city like Atlanta has been one of the most important decisions I’ve made as an entrepreneur.

    High growth cities, by their very definition, are attracting people. As an entrepreneur, it’s all about recruiting and retaining amazing people to join in the journey (distributed teams are easier to recruit but are harder to work together). Great people are drawn to cities with opportunity and growth.

    One of the big challenges recruiting people to cities that aren’t the pre-eminent hub in their industry is the worry that if the gig doesn’t work out, there won’t be other comparable opportunities. Who wants to move to a new city, realize their new job wasn’t right, and not have similar jobs available? High growth cities represent more jobs, more opportunities.

    High growth cities also represent a changing environment. New construction, new restaurants, new experiences — all part of growth. There’s an energy and excitement being part of something on the rise, city or otherwise. People gravitate to what’s winning.

    Entrepreneurs should pick a high growth city — a city that attracts people, a city with opportunities, a city that’s changing. The entrepreneurial journey is incredibly difficult and a growing city makes it slightly easier.

  • VC Alternative Startup Financing Options

    Back in the Pardot days, we had exactly one alternative financing option to venture capital: bank venture debt. While that was a great option, and we maxed out our line, being a bootstrapped startup we didn’t qualify for venture debt until we had millions of recurring revenue — an extremely high bar.

    Today, there are a number of interesting alternative funding sources that are very different from venture capital, and available for startups at much earlier stages. The big driver here is entrepreneurs want to maintain optionality and/or don’t have a business that fits traditional venture capital (e.g. too small a market). Let’s take a look at a few providers:

    • Lighter Capital – Revenue financing for subscription businesses, Lighter Capital typically collects 2-8% of monthly revenue to pay back the loan until some cap is reached (e.g. 2x the loan). This model is better for a lower payout over time but requires making payments immediately.
    • Earnest Capital – A profit-sharing model where the more profit shared, the lower the equity percentage in the event of an exit with an overall higher target return (e.g. 4x the investment). Profit is defined as any salaries above some modest amount for founders as well as standard distributions/dividends. This model is better for using cash flow to grow in the near-term (payments are only required if profit is distributed) but more expensive in the long term if everything works out.
    • Indie.vc – A hybrid that can be equity or revenue financing where it’s equity if a traditional round of funding is raised but defaults to a revenue based financing model after 12-36 months where 3-7% of revenue is paid monthly until a target return is met (e.g. 3x the investment). This model provides the most direct optionality benefits but could be more expensive depending on the path taken by the entrepreneur.

    Ultimately, these are all great market developments for entrepreneurs as historical venture capital was only suited to a microscopic percentage of startups striving for billion dollar outcomes. More providers serving a larger variety of startups will help grow the number of entrepreneurs that raise money, and, hopefully, help them achieve a greater level of success.

  • Start 2020 With a Simple Strategic Plan

    With the end of the year upon us, it’s a great time to put together a 2020 Simplified One Page Strategic Plan. I’ve written about it many times before and I’ll write about it many more times. After being an entrepreneur for 20+ years, I truly believe it’s one of the best exercises an entrepreneur can do on a regular basis.

    Put these topics in a shared Google Doc and ensure they are no more than one side of one page. Be clear and concise; keep it simple.

    Simple Strategic Plan

    • Purpose – Why does your company exist?
    • Core Values – What values (or virtues) are most important for your actions?
    • Market – What customer base do you serve?
    • Brand Promise – What can customers expect working with you?
    • 3 Annual Goals – What are three SMART goals for this year?
    • 3 Quarterly Goals – What are three SMART goals for this quarter?
    • 3 Quarterly Projects – What are the three highest priority projects that must be accomplished this quarter?

    Share this plan with employees, partners, advisors, investors, and anyone else that wants to help you succeed. Finally, make it a living document that’s reviewed on a weekly basis to align everyone on your team. While simple, it’s incredibly powerful.

     

  • Happy 7th Birthday to the Atlanta Tech Village

    Exactly seven years ago to the day we closed on Ivy Place at 3423 Piedmont Rd and called it the Atlanta Tech Village. At the time, it seemed like a crazy idea. Why take a perfectly good building at one of the busiest street corners in Atlanta, one that’s full of credit-worthy tenants with long-term leases, and parse it up into tiny offices for unprofitable startups with no leases? Simple: we believe in the power of entrepreneurs helping entrepreneurs to increase the chance of everyone’s success.

    Today, the Tech Village has exceeded all expectations. Over 300 companies and 1,000 people call the Tech Village home. Tech Village graduates like SalesLoft, Calendly, Terminus, and others are collectively valued at billions of dollars. The It Takes a Village pre-accelerator program has graduated four cohorts of under-represented founders. Village startups have raised nearly $1 billion in capital.

    Ultimately, the Tech Village’s success comes down to the people. David and Karen set the tone internally. Jewell sets the tone when you walk in the door. And, of course, the entrepreneurs make it the vibrant, thriving community it is.

    Happy birthday Atlanta Tech Village. Here’s to your first seven years, and many more to come.

  • Rule of 40 and Startups

    Last week I was talking to an entrepreneur and he asked what valuation I thought the market would bear for his startup’s next round of funding. I asked for the business state of the union and standard financial metrics like recurring revenue, growth rate, gross margin, burn rate, cost to acquire a customer, renewal rate, and net dollar retention.

    After hearing the metrics, I shared that they’re below the Rule of 40 or better. Confused, he asked what that meant. The Rule of 40 is the growth rate, as a number, plus the burn or profitability percentage, as a positive (profits!) or negative (losses) number, added together.

    If the business is growing 100% year-over-year, and is burning the cash equivalent to 40% of revenue, it would be 100 + (-40) = 60, which is 40 or better.

    If the business is growing 50% year-over-year, and is burning the cash equivalent to 30% of revenue, it would be 50 + (-30) = 20, which is below 40, and not as good.

    Let’s look at a more specific example:

    • $10 million of revenue
    • 50% year-over-year growth rate
    • $1 million in trailing twelve months burn (burn is 10% of revenue)

    Here, the Rule of 40 calculation would be 50 + (-10) = 40. So, they’re in good shape and are right at the Rule of 40.

    Another way to think about the Rule of 40 is that if the startup has a high burn rate relative to revenue, it needs to have a high growth rate. If the startup has a low growth rate, it needs to be profitable.

    If some extreme cases like dramatic user growth (e.g. Facebook in the early days) and amazing net dollar retention (existing customers buy significantly more product every year and outweigh the customers that leave), the Rule of 40 is less applicable. For most startups, it’s very relevant.

    The Rule of 40 is a great way to assess how a startup is performing in an objective manner and should be a regular topic of conversation for entrepreneurs.

  • Compounding Revenue 20% Per Year

    Two years ago one of the most successful software investors in the country told me he’d never sell a SaaS business that was growing 20% per year, especially if it looked like it would grow that way indefinitely. Last month, another extremely successful investor said he just wants to invest in great companies that grow 20% per year, and doesn’t like the current mentality of growth at all costs. Clearly, there’s something more experienced investors see that isn’t appreciated enough: the power of compounding.

    Let’s take a look at a couple of examples:

    $10 million revenue start

    • Year 1 – $12 million
    • Year 2 – $14.4 million
    • Year 3 – $17.3 million
    • Year 4 – $20.7 million
    • Year 5 – $24.9 million
    • Year 6 – $29.9 million
    • Year 7 – $35.8 million
    • Year 8 – $43 million
    • Year 9 – $51.6 million
    • Year 10 – $61.9 million

    $100 million revenue start

    • Year 1 – $120 million
    • Year 2 – $144 million
    • Year 3 – $173 million
    • Year 4 – $207 million
    • Year 5 – $249 million
    • Year 6 – $299 million
    • Year 7 – $358 million
    • Year 8 – $430 million
    • Year 9 – $516 million
    • Year 10 – $619 million

    Growing revenue 20% per year for 10 years results in a 5x overall growth — the compounding effect is impressive, especially in the later years. When looking at these examples, it’s clear that growing much faster in the early years is necessary to get to a larger base by the time the 20% annual growth years set in.

    Now, thinking in terms of SaaS, there’s a secret weapon that can make this compounding revenue phenomenon even more attainable: positive net dollar retention. Net dollar retention is the revenue renewal amount plus upsell/cross sell minus churned revenue. Put another way, ensure that existing customers buy more product than the amount non-renewing customers stop spending so that that the business grows forever, without signing a new customer. If you can grow new customer revenue 10% per year organically, and 10% per year with net dollar retention, that’s 20% growth. Now, do that for 10 years and you’ve quintupled the business.

    Compounding is hard to appreciate for most people, especially many years out in the future. Build a business that grows fast to some level of scale, and work on the underlying fundamentals to compound revenue 20% per year indefinitely.

  • So Many Tries, So Many Entrepreneurial Failures

    Recently, a friend was asking about entrepreneurial endeavors I’d tried over the years, and I realized it’d be fun to enumerate them and reflect on lessons learned. From starting a business, talking to customers, finding solutions, and working to build a sustainable business — every part of the entrepreneurial journey is a learning experience.

    Here are some of the ideas I tried, in chronological order.

    • Lawn maintenance service – Enjoyed the work, only did it passively as jobs came in
    • Shareware software – Loved programming and fascinated by the idea strangers would pay for software over the Internet without talking to anyone
    • Local classified ads – Bought a second phone line and connected an answering machine for people to call in with their ads, placed printed classified ads in two local restaurants, realized quickly there wasn’t much demand
    • Sports cards dealer – Loved tracking the players, buying cards from different markets, and helping people complete their collections
    • Web design – Enjoyed the creative process of designing a site in Photoshop, crafting all the pages by hand (HTML + Dreamweaver), and delivering a finished product to the client
    • College textbook exchange – Provided a quality solution to students and learned there’s a number of structural challenges to changing the textbook market
    • College professor rating service – Students loved leaving ratings and reviews but a number of ethical questions arose and there was a lack of interest scaling it
    • College laundry service – Clear product demand but a number of logistical and pricing/margin challenges
    • College online food ordering – Built a working prototype but couldn’t get adoption from restaurants without point of sale integration (times are different now, 20 years later)

    In hindsight, each idea played on something I was personally interested in and simply translated into a service for the market.

    Every idea was a failure in that I wasn’t able to make it into a sustainable, profitable business.

    Every idea was a success in that I created a product or service, brought it to market, and gained more experience.

    The lesson: it takes a number of failures before a success. Find a problem, create a solution, and start a business — the more you try, the more you learn.

  • Compounding Revenue’s Value in the Future

    When talking to entrepreneurs about revenue growth, I look to emphasize the value of compounding revenue now and how it plays out over an extended period of time. It’s easy to think that it’s no big deal that we missed our sales number for the quarter or had a lower renewal rate than expected. Only, when you really dig in, a lost dollar today translates into many lost dollars of revenue and enterprise value over the long run. Similarly, an extra dollar of revenue sold today translates into much more revenue and enterprise value over time.

    Let’s look at an example. Say you were able to beat the sales plan and the net dollar retention plan adding an additional $1 million in new recurring revenue in a calendar year. With an extra $1 million in recurring revenue:

    • Year 1 after exceeding goals
      • Extra ~$800,000 to grow the business (assume 80% gross margin)
      • Hire two additional sales reps and increase marketing spend (assume 50% of the extra $800,000 goes to sales and marketing)
      • Add $1M of new annual recurring revenue from the new reps (assume the two reps each have a $500,000 quota and hit it)
    • Year 2
      • Extra $1,600,000 to grow the business (year 1 gross margin plus the gross margin added by the new reps assuming 100% net dollar retention)
      • Hire four additional sales reps and increase marketing spend
      • Add $2M of new annual recurring revenue from the new reps
    • Year 3
      • Extra $3,200,000 to grow the business (it keeps layering on the previous year!)
      • Hire eight additional sales reps and increase marketing spend
      • Add $4M of new annual recurring revenue from the new reps

    In this example, by the end of the third year after the year of an extra $1M in annual recurring revenue, the business has added $8M of new annual recurring revenue. $8M of annual recurring revenue pays for dozens of employees and adds $40M – $80M of enterprise value in today’s market (assumes 5-10x run rate multiples).

    The next time someone questions the importance of renewing an existing customer, or signing a new customer, remind them that $10,000 of recurring revenue today is worth up to $800,000 of enterprise value after three years. Every dollar counts.