Build an Entrepreneurial Ecosystem The Startup Community Way

Last week I had the opportunity to join an Endeavor Zoom meeting with Brad Feld to talk about his updated and revised book The Startup Community Way: Evolving an Entrepreneurial Ecosystem. Brad’s predecessor book, Startup Communities, was excellent and something that I read back in 2012. For the previous book, my main takeaway was that startup communities must be lead by the entrepreneurs. Top-down government- lead entrepreneurial efforts don’t work, getting bogged down by different agendas and struggle to ignite the necessary sparks. Entrepreneur-lead communities work because entrepreneurs are more resourceful and innovative — as expected.

From Brad’s talk, the biggest addition to the new book is a focus on startup communities as complex systems, and digging into to what it means to be a complex system in the ecosystem context.

From Wikipedia on complex systems:

A complex system is a system composed of many components which may interact with each other.

Complex systems are systems whose behavior is intrinsically difficult to model due to the dependencies, competitions, relationships, or other types of interactions between their parts or between a given system and its environment.

Thinking about startup ecosystems in the complex system theory feels right. An event over here, groups over there, entrepreneurs everywhere, and without prompting it, magic happens.

A startup is formed by people who met through the community.

A startup achieves a breakthrough with the help of a stranger.

Personally, I’ve seen this so many times that I know it works.

I’m looking forward to reading Brad Feld’s new book when it comes out next week.

SaaS Valuations as a Rule of 40 Multiple

In the past I’ve argued that a quick and dirty SaaS valuation was 10 times the annual revenue run-rate times the trailing twelve months growth rate. This formula is a good proxy for valuation but misses a major characteristic: profitability.

Profitability, or lack thereof, is a huge factor in valuing a SaaS business, especially in the age of a pandemic when private investors are more conservative.

The Rule of 40 is a metric that adds the past 12 month growth rate to the past 12 month profitability rate with a value of 40 being good. A value higher than 40 is even better and a value lower than 40 is OK, or even bad depending on how low (or negative) the number.

Personally, I’m a huge fan of the Rule of 40 as it captures the tradeoff between growth and cash burn for startups. Put another way, it presents executives and investors with a simple formula and target using the two most important startup metrics: growth rate and cash consumption.

So, if growth rate and profitability/cash burned combined with revenue run rate are the biggest drivers of valuation, there’s another, more nebulous factor that fluctuates called market sentiment. Take the BVP Cloud Index which has an enterprise value to revenue multiple of 17.3x right now. Wowza, SaaS is hot! This says that for the public SaaS companies, their enterprise value (valuation less debt and cash on hand) divided by their revenue over the last twelve months is 17.3x. Put another way, a company with $100 million of trailing twelve months revenue and no debt or cash would be worth $1.73 billion. The average growth rate for these public SaaS companies is 35.5%. Very impressive. Let’s assume a free cash flow percentage between 5 and 10% and public SaaS companies, on average, are right around the Rule of 40 as a collection.

Now, we know that public SaaS companies at the Rule of 40 are worth 17x trailing 12 month recognized revenue (a lower number than revenue run-rate because there’s growth). Assuming a 35% growth rate, to calculate the rough enterprise value to revenue run-rate multiple, we’ll go back to our example and do $1.73 billion divided by $135 million ($100 million times 1.35 to reflect the 35% growth rate, which isn’t exact as growth usually slows with time) to get a multiple of 12.8.

With the public market average right at the Rule of 40, and the public market average revenue run-rate multiple of 12.8, we can use that are our market sentiment number.

A simple SaaS valuation is the annual revenue run-rate times the Rule of 40 number times the market sentiment. As an example, a $10 million revenue run-rate SaaS company right at the Rule of 40 would be valued $128 million, less some discount for lack of liquidity being a private company.

Long term, I believe the market sentiment will be more in the 4-8 range based on how valuations have fluctuated over time. Pick a market sentiment value here, say six, and a $10 million revenue run-rate SaaS company right at the Rule of 40 would be valued at $60 million. If in this example the company is growing 60% per year and negative 20% free cash flow resulting in a Rule of 40 value of 40, this hits our previous SaaS valuation formula perfectly. In the previous formula, companies burning cash were overvalued and company printing cash were undervalued.

Using the Rule of 40 to think about SaaS valuations captures how growth and cash burn contribute to the value of the business and is a simple, albeit powerful tool.

The Freedom of Profitability in a Startup

Last week I was catching up with an entrepreneur that had turned his startup profitable due to the uncertainties around the Covid pandemic. Then, something unexpected happened: a newfound freedom and unexpected sense of calm emerged from being profitable.

Controlling your own destiny, as impossible as it is, is magical.

Turning profitable, and jumping off the fundraising treadmill, is the right course of action for most startups. Yes, there are some winner-take-most/capture-the-market startups where VC makes sense. But, for the vast, vast majority of startups, VC doesn’t make sense.

Once on the venture treadmill, getting off is extremely difficult. The burn rate is aligned for the next funding event. The board composition is aligned for raising more money. The extra office space rented is aligned for raising more money. The promises made to existing investors are aligned for raising more money.

There’s no easy solution once venture money has been raised to change directions.

Raising more money isn’t freedom.

Achieving profitability is freedom.

Start It Up Georgia – Go Time For Entrepreneurs

Two months ago we were talking about ways to help jump start Georgia economically. With unemployment at an all-time high and the pandemic still raging, the answer was clear: entrepreneurship. Entrepreneurship is one of the greatest forces for good in the world. Inventing a new product or service and taking it to market isn’t a zero sum game — a new widget to help save time, a new medicine to improve the quality of life, a new material to make the world safer — all of these are possible and everyone benefits.

With this backdrop, we just launched Start It Up Georgia as a free, 12-week program to start and launch a new company.

Start It Up Georgia is a combination weekly lesson labs, small accountability groups, and demo day. Everything is virtual and everyone is welcome. Thanks to sponsors, there’s no cost and we even have tens of thousands of dollars available in grant money available to the top startups at demo day.

Please help us spread the word.

Please consider applying.

Please tell a friend.

It’s go time for entrepreneurs — start it up, Georgia.

The Honorable Zombie Startup Trap

In the past few weeks I’ve talked with several startups that are severely impaired by the pandemic. Before the pandemic their companies were doing well enough to raise venture money, but not well enough to be obvious winners in meaningful markets. Then, the pandemic hit and it exposed their businesses in a way that showed they weren’t great businesses to begin with, and raising money wasn’t the appropriate route to go. 

Now, the founders are in the honorable zombie startup trap.

These founders aren’t willing to shut down their companies and move on. No, they’re too honorable and are going to do everything in their power to at least return the investors’ money. Only, the startup is a zombie.

There’s enough revenue and gross margin to keep the lights on, but with revenue declining there’s no clear path to reverse course and accelerate growth. Unfortunately, with declining revenue and a suffering business, if they were to raise money, it’d be a down round, if at all possible. Down rounds are almost always the kiss of death, due to a number of reasons.

While this desire to eventually return investors’ money is in fact honorable, it actually makes all parties worse off. From a time perspective, investors are better off moving on and focusing their energies elsewhere. Startup investing in its purest form is a game of maximizing upside, not minimizing downside. Some investors would struggle with recognizing the loss if they have limited partners or are trying to raise a new fund, but that shouldn’t be an issue with successful investors.

Founders are often better off shutting the startup down, or going into harvest mode, so as to return some capital to investors and prepare for their next endeavor. Time and energy are two of the most important components of successful founders, and running a zombie startup for years beyond what makes sense depletes both.

Look out for the honorable zombie startup trap, and ensure all parties involved are aware of what’s happening. The best path forward is often moving on from the startup.

2021 Will be a Banner Year for Private Equity SaaS Acquisitions

Earlier this week I was talking to a SaaS entrepreneur and he brought up how much better his financials were now. Curious, I asked what made the difference.

This is a business that was growing modestly while burning cash. With the onset of the pandemic a few months ago, they made the difficult decision to let go of staff, cut all travel expenses, and change the overall focus to profitable growth. Instead of trying to squeeze out a slightly higher growth rate, they’d focus on gross margin and grow at the rate of the market.

The business has grown through the pandemic, albeit more slowly, but the swing from losing money to making decent money has been dramatic.

This is not an isolated case. Hundreds, if not thousands, of SaaS startups that were losing money at the start of the year are cashflow breakeven, if not nicely profitable.

Private equity, as a potential exit route for SaaS startups, has been growing rapidly over the years. Whenever I talk to a private equity investor, they lament that too many SaaS startups are losing money, making them undesirable as acquisition targets. PE is happy to fund growth, but has almost no appetite to fund losses. 

Now, a tremendous number of SaaS startups have made hard changes, and those hard changes have made them much more attractive to PE acquirers.

Look for a large percentage of SaaS startups to stay the new profitable course and next year to be a banner year for private equity SaaS acquisitions.

MarTech Madness and the Secret Staying Power

Just this past week I learned of two MarTech companies I hadn’t encountered that are north of $2M in annual recurring revenue and growing fast. We’ve all seen the crazy Marketing Technology Landscape Supergraphic: Martech 5000 that visually highlights what a crowded space it is out there. A number of people have speculated that massive consolidation in MarTech is imminent — I don’t agree. Yes, Terminus has acquired BrightFunnel, Sigstr, and Ramble Chat, but that’s the exception.

So, what’s the secret staying power resulting in so many MarTech startups?

Simple: good software with a clear return on investment makes for a sustainable business even with modest scale.

If you’re a marketer making money using the product, why switch? Combine that with the amazing components of SaaS — recurring revenue, cash flow predictability, strong gross margins — and you have a ton of niche companies. Add in some modest scale, like $1 million of annual gross margin, and you have the recurring cash to pay a team indefinitely. Good recurring cash flow, happy customers that renew, and decent employee salaries makes for a business that will never go away. 

More acquisitions will happen in the future due to investor fatigue and fund-life dynamics rather than companies gobbling up other companies to achieve more scale. If a venture investment in a MarTech company isn’t performing, it’s often better for the VC to hold onto the investment, assuming they have time, rather than push for a sale that results in recognizing a loss. Put another way, there are a ton of zombie MarTech companies out there that are sustainable businesses, but will sell for less than their last valuation, creating a scenario where it’s better to do nothing and hope something will improve.

MarTech fragmentation, and proliferation, is here to stay. The secret staying power is a combination of software that helps marketers make money and the beauty of SaaS.

5 Immediate Ways to Support Atlanta’s Black Tech Founders

America is hurting. Atlanta is hurting. We can do better. We must do better.

This past week I was asked what we can do to support Atlanta’s black tech founders. Start with action.

Here are five immediate ways to support Atlanta’s black tech founders.

Startup Runway – Focused exclusively on introducing under-represented entrepreneurs to investors. Donate immediately to the 501 c(3), volunteer to help, get involved.

It Takes a Village Pre-Accelerator – Free 4-month program for under-represented founders providing direct access to community, education, mentorship, and capital. Volunteer, mentor, become a customer. Cohort five just wrapped up and cohort six is accepting applications (apply now).

Valor Ventures – Only venture fund in the region focused on under-represented founders. Become a limited partner (write a big check!), refer a potential investment, help. Contact Valor now.

Atlanta Founders Academy by Google – A series of hands-on programs from Googlers, experts, and investors to support under-represented Atlanta startup founders on topics such as sales, strategy, hiring and fundraising. Get involved, give back.

Become a Customer – Check out Calendly, LeaseQuery, Storj, Patientory, Goodr, and many more. Use your resources and buying power to purchase software and subscriptions from our local black tech founders.

With so many challenges and injustices, on so many fronts, it’s daunting where to begin.

Start small, start now.

EO and YPO for Entrepreneur Peer Groups

Last week I was talking to a local entrepreneur about peer groups. This particular entrepreneur has built a multi-million dollar revenue business with dozens of employees after years of high growth. Now, the business is much larger than him and he’s spending more time as a business manager, and less as a scrappy, growth-oriented entrepreneur. He wants to scale to the next level, and is looking for a peer group to share ideas and grow as a leader.

My recommendation was to consider the Entrepreneurs’ Organization (EO) and the Young Presidents’ Organization (YPO), both of which have been immensely valuable to me. In addition to strong programming and networking, the heart of each organization is the small group (usually eight members) forum experience. Forums meet monthly for four hours in a setting of strict confidence and high commitment. The confidentiality is serious — nobody, nothing, never.

Forums often have a consistent agenda:

  • Opening
  • Lightning round
    • Short questions for every person in the group to answer
  • Monthly updates (10 – 15 minutes per person, inclusive of questions)
    • Business
      • Last 30 days
        • Highlights
        • Lowlights
      • Next 30 days
        • Most looking forward to
        • Least looking forward to
    • Family
      • Last 30 days
        • Highlights
        • Lowlights
      • Next 30 days
        • Most looking forward to
        • Least looking forward to
    • Personal
      • Last 30 days
        • Highlights
        • Lowlights
      • Next 30 days
        • Most looking forward to
        • Least looking forward to
  • Presentations
    • Member does a deep dive on a topic, the groups asks questions, the group shares experiences, and the presenting member closes with any takeaways
  • Closing

A small group of people committed to helping each other and meeting on a regular basis is one of the most powerful things I’ve ever experienced.

Entrepreneurs would do well to seek out a peer group like EO or YPO. For me, it’s made a tremendous impact.

Remote Work’s Role in the Future of Work

Remote-first companies, once an odd side-show with few household names (Automattic is likely the best known), has now become a daily topic with major companies like Shopify, Twitter, Square, most of Facebook, and more announcing that they’re moving to a remote work model permanently. The world was slowly moving this way, and Covid-19 accelerated it by 20 years — that’s a good thing.

Now, I’m not a fan of the name “remote work” to explain that employees don’t have to work in a corporate office, but I understand the rationale. Other terms like “work from home” don’t capture the freedom of being able to work anytime, anywhere (wanna work from the beach? go for it!). Shopify’s CEO, Tobi Lutke, calls it “digital by default“, which is interesting, but too difficult to understand for it to win the naming game. My favorite choice: work.

Work is work, regardless where you want to do it. “Work” becomes the default and “office work” is going into the office to do work. We’re already working at home, at the coffee shop, on the train, etc. even if we have a traditional office job. Work has been detached from an office for years.

With work moving away from being office-centric, how do offices fit in? Offices are still critically important. Only their size and design needs to dramatically change. Face-to-face collaboration is superior to digital collaboration, but most collaboration doesn’t need the overhead of in-person meetings. Office space, whether shared or dedicated, becomes primarily for collaboration, meetings, and the subset of employees that don’t have access to a high quality work setup (e.g. poor internet connection or kids at home).

Some companies will want dedicated offices that have their own style and feel. One CEO described it as wanting to have 10 cities each with one floor of office space instead of having 10 floors in one building in one city. Employees still don’t have to be in one of those 10 cities. Work is work. If an employee does like going into an office (hello extraverts!), plenty of cities are available.

Co-working spaces are going to get even more popular. As companies move to the modern work arrangement, and away from traditional, dedicated offices, co-working fills the space need for in-person meetings and collaboration, but in a way that is 10x more flexible and affordable. Need five desks for employees that have a six-month project? Done. Need an event center to have a 100-person all-hands meeting once a month? Done. The company’s needs are met with lower cost and greater flexibility.

The human-to-human connection has never been more important, yet now has to be more intentional than colleagues sitting together in the same place.

Remote work is now just work. The future has arrived and we’re better off for it.