David Cummings on Startups

Category: Entrepreneurship

  • Understanding Investor Pro-Rata Rights

    One area that doesn’t seem well understood is how investor pro-rata rights work. When an investor buys a portion of a startup, whether as an angel or VC, they almost always also get the right to invest in subsequent rounds to maintain their same percentage of ownership. If the investor doesn’t continue to put in more money each time the company raises a round, the percentage of ownership in the business goes down. Here’s how it might look:

    • Angel investor puts in $100,000 for 5% of a startup as part of the seed round ($2 million post-money valuation)
    • Startup raises a $3 million Series A at a $7 million pre-money valuation and a $10 million post-money valuation
    • If the angel investor doesn’t invest any additional money at the Series A, the 5% ownership is reduced to 3.5%
    • If the angel investor does want to participate pro-rata, the angel investor has to put in $150,000 (5% of the $3 million), and thus still own 5% of the company, but has now invested a total of $250,000

    This process of needing to invest more money in each subsequent round to maintain ownership continues until the company goes out of business, is acquired, or goes public. Additionally, ownership, as a percentage, is still likely to be reduced, regardless of subsequent rounds, by things like new stock option pools. Ownership, as a percentage of a startup, is a moving target, and investors participating pro-rata, or not, is an important component.

    What else? What are some more thoughts on investor pro-rata rights?

  • Bronto and the Big Bootstrap Exit

    Back in 2002, a year after I started Hannon Hill for content management software, I was introduced to Joe Colopy, CEO of Bronto, as he had just started a new email marketing company with Chaz Felix. Both of us were based in Durham, NC, and even with the Duke/UNC rivalry, entrepreneurs enjoy connecting with entrepreneurs. After talking briefly on the phone then, we connected again in 2008 as Bronto was one of the first Pardot customers.

    Well, last week, Bronto announced that NetSuite was acquiring them for $200 million, making it a huge exit, especially for a bootstrapped company.

    Here are a few notes on Bronto:

    • 271 employees on LinkedIn (source)
    • 2013 revenue of $27 million (source)
    • 2014 revenue of $38 million (source)
    • 18 billion emails sent per year (source)
    • Definitive agreement signed but actual closing of deal not expected until end of 1H 2015 (source)

    It’s awesome to see another big bootstrap exit and congratulations to Joe, Chaz, and the whole Bronto Nation!

  • Uber Burning $750 Million in a Year

    Recently, I heard an astounding piece of information: Uber is going to burn $750 million in capital this year as part of their expansion. Considering their most recent funding announcement of $1.2 billion in equity and $1.6 billion in debt, and the idea that most funding rounds are for 18-24 months of runway, the math makes sense. Still, burning $750 million in any context, let alone 12 months, is truly incredible.

    $750 million over 12 months is $62.5 million per month (the burn rate won’t stay constant month to month, but let’s assume it does). As a fun mental exercise, here’s how $62.5 million might be spent per month:

    • $5 million on legal – With all the local and state regulation battles, I bet Uber has an army of in-house and third-party lawyers.
    • $5 million on lobbying – States and local government aren’t going to change their laws based on simple requests, hence lobbyists are hired to help accelerate the process.
    • $30 million on market managers – Each market has local staff and regional staff that manage a territory. Assuming each market costs $30,000/month, on average, for fully burdened staff compensation, that provides for 1,000 new cities, which includes international expansion.
    • $2 million on office rent – Rent is super expensive in San Francisco, and Uber now has 113,000 square feet there, not counting other cities (this amount references all cities).
    • $4 million on insurance – Even though the drivers are independent contractors, Uber still has to carry huge amounts of insurance as things, inevitably, can go wrong.
    • $10 million on driver support – Screening drivers, running background checks, training, and ensuring a great consumer experience for hundreds of thousands (millions?) of drivers is no small feat.
    • $10 million on technology – While the Uber app is straightforward, a company with such scale and complexity needs a variety of internal tools to ensure continued success, and many of them are custom.

    Other potential categories include marketing, administrative costs, financing cars, more staff, etc.

    Uber is one of the fastest growing companies of all time, and on a mission to be one of the largest logistics marketplaces in the world. Burning $750 million in a year is incredible, and, a sign of the times.

    What else? What are some other thoughts on Uber burning $750 million in a year?

  • Do VCs Add Value?

    Charlie O’Donnell from Brooklyn Bridge Ventures has an interesting piece up titled VC Value add: Why it probably doesn’t matter, but I try anyway. Charlie, having been at First Round Capital and Union Square Ventures, which are two of the premiere venture firms, talks about how he believes 99.999% of billion dollar exits are due to the founders, and nothing to do with the investors. That’s an impressive statement from someone who’s been around the best in the business.

    Personally, I haven’t seen a billion dollar exit, so I don’t know what it’s like at that scale. As for going from idea stage to seed to early to growth, I have seen a number of good examples. Here are a few areas where investors should add value:

    • People – Great talent is one of the top challenges for entrepreneurs, and investors should have a strong network of people.
    • Psychologist – Building a great company requires making a number of hard decisions, and sometimes the best help an entrepreneur needs comes from a good listener that asks the right questions.
    • Processes – Growing a business is hard, especially as more employees are brought on. Putting in processes and procedures, like a Simplified One Page Strategic Plan every quarter, is part of every entrepreneur’s maturation process.
    • Fundraising – One round of funding doesn’t guarantee another, and helping portfolio companies raise the next round of funding is an important role.
    • Introductions – Making introductions is the most important value add for investors, especially in regards to helping find customers, partners, and employees.

    I do believe the right investors can add significant value. Can they influence the outcomes on billion dollar exits? I don’t know. Can they be the difference between building a successful business and not building a successful business? Absolutely. Some investors add value and some don’t, and as an entrepreneur, the key is to figure that out in advance of partnering.

    What else? What are some more thoughts on VCs adding value?

  • The Delta Between a Startup’s General Value and the Value to a Strategic Acquirer

    Last week I was talking to a gentleman that previously ran corporate development for a large tech company. During his tenure, the firm acquired dozens of companies and spent billions of dollars on acquisitions. After talking about a few experiences, he explained one of the things people have the hardest time understanding: why strategic acquirers buy companies for much more than what it seems like a company is worth.

    Actually, the answer is very simple, especially when the company being acquired has a real business with customers and revenues. The delta between a startup’s perceived value and the value to a strategic acquirer comes down to distribution. In a word, sales. Large tech companies have massive sales teams and partner channels whereby they can add new products and significantly grow product revenue.

    Imagine a software or hardware company doing $20 million in revenue with 50 sales reps and 10 channel partners. Depending on the overall economy, size of the market, growth rate, gross margins, etc, the company might be worth 3-10x revenue. Now, an acquirer comes along and sees the startup as strategic. The acquirer has 10,000 sales reps and 10,000 channel partners. Instead of the startup being worth ~$100 million, to the strategic, based on a model that shows the the product doing ~$100 million in sales in 24 months, the startup might be worth $400 million. That’s a big delta between a $100 million valuation in the general market vs $400 million for a strategic acquirer.

    The next time you see a big valuation multiple for an acquisition, ask yourself how much faster revenue will grow under the new owner, and how that changes the value equation.

    What else? What are some more thoughts on the delta between a startup’s general value and the value to a strategic acquirer?

  • YC Asset Stripping Entrepreneurial Talent

    Over the past year at the Atlanta Tech Village, I know of at least three top notch startups that applied to Y Combinator, got interviews, and didn’t get accepted. That’s not to say these startups aren’t going to be successful. Rather, the bar is so high, and there are so many applicants, the chance of any startup getting accepted is incredibly small. But, still, there were 120 amazing startups in the most recent Y Combinator class, and there are two classes per year.

    An entrepreneur-turned-investor described Y Combinator’s ability to attract entrepreneurs from around the world as asset stripping talent from other regions. Here are a few thoughts on YC attracting amazing talent:

    • With a three month program, entrepreneurs from other cities, that might not want to move to California permanently, have a chance to try before they buy, making it much easier to see oneself staying there indefinitely
    • YC’s alumni network, from what I’ve heard from friends that have gone through the program, is powerful and valuable, such that the instant credibility and access to people is a major benefit for an entrepreneur moving to the Bay Area
    • Valuations and the size of seed rounds for YC companies are considerably higher than the market average, making access to the program even more valuable, and more desirable, as a draw for talented entrepreneurs to move from a different region

    The ability to attract incredible talent at scale is one of biggest reasons why Silicon Valley will continue to thrive, and Y Combinator is a serious contributor to that net import of talent.

    What else? What are some more thoughts on YC asset stripping entrepreneurial talent from other regions?

  • Sales Resources for Startups

    With so many startups reaching out and asking for help as they implement an inside sales team based on SalesLoft and the Predictable Revenue book, it’s a good time to highlight a few posts and notes for entrepreneurs. Building a successful inside sales team isn’t easy, but there are a number of proven strategies and tactics.

    Here are a few sales resources for startups:

    To start, most entrepreneurs should hire a sales assistant to get going and then expand from there. Sales and sales teams are the lifeblood of many startups, yet take time to understand and scale.

    What else? What are some other sales resources for startups?

  • Notes from the Shopify S-1 IPO Filing

    Earlier today Shopify announced that they had filed for an IPO and released their S-1 document with the SEC. Shopify is the top Software-as-a-Service ecommerce provider powering over 160,000 online stores. Personally, I’ve talked with a number of ecommerce entrepreneurs and Shopify always comes up as one of the best solutions.

    Here are a few notes from the Shopify S-1 IPO filing:

    • 900 apps in the Shopify App Store (pg. 1)
    • Revenues (pg. 2)
      2012 – $23.7 million
      2013 – $50.3 million
      2014 – $105.0 million
      2015 Q1 – $37.3 million
    • Net losses (pg. 2)
      2012 – $1.2 million
      2013 – $4.8 million
      2014 – $22.3 million
      2015 Q1 – $4.5 million
    • 162,261 customers with an annualized revenue of $1,000/year (pg. 3)
    • Company started September 28, 2004 in Ottawa, Canada (pg. 5)
    • 632 employees (pg. 13)
    • Accumulated deficit of $33.6 million (pg. 13)
    • Stripe powers the payments processing (pg. 15)
    • Separate Class A and Class B shares where the Class B shares have 10 votes, meaning the executives control the company (pg. 31)
    • Subscription revenue accounted for 63.5% of revenue (pg. 53)
    • Payment processing fees accounted for 36.5% of revenue (pg. 54)
    • Payment processing solutions are for both online and offline sales (pg. 54)
    • Most revenue collected is in U.S. dollars but most expenses are in Canadian dollars, so exposed to currency fluctuations (pg. 56)
    • U.S. represents 68.7% of revenues (pg. 61)
    • 85.5% gross margins (pg. 63)
    • Shopify started as an online snowboarding store and then became a software company when no ecommerce system could be found to the CEO’s liking (pg. 82)
    • Core values (pg. 97)
      Get shit done
      Build for the long-term
      Focus on simple solutions
      Act like owners
      Thrive on change
    • Founder ownership – 14.6% (pg. 127)
    • Bessemer Venture Partners ownership – 30% (pg. 127)

    To clear a $100 million run-rate while only having an accumulated deficit of $33.6 million is incredible — super capital efficient. Combine the capital efficiency with scale and a growth rate that’s still over 100%, and you have an amazing story that’s going to do well in the public markets. It’ll be interesting to see how public investors discount, or don’t, the payment processing fees as they aren’t as valuable as the subscription fees, but are still valuable nonetheless. Shopify is a major success story.

    What else? What are some more thoughts on the Shopify S-1 IPO filing?

  • When to Pitch at Startup Events

    With a number of startup pitch events scheduled over the next few weeks, it’s a good time to think through when it’s best to go on the pitching tour. Most events have an element of startup theatre, so the first thing to do is to evaluate the opportunity cost of attending another event vs. making more progress on internal goals and priorities. Assuming there’s an overall fit, here are a few items to think through when considering applying to pitch at a startup event:

    • Fundraising – Is there a desire to raise money and the corresponding metrics to warrant investment? Too often, entrepreneurs head to pitch events in an effort to raise money, but don’t have the corresponding business metrics. If the metrics are strong, pitch events are a good way to showcase them and tell a compelling story.
    • Lead Generation – With a broadly applicable product, pitch events can be a great way to generate leads. Similar to the idea of asking VCs for intros to portfolio companies, ask the audience for leads.
    • Recruiting – Finding great talent is always a challenge, especially during high growth stages. Pitch events can be a good way to spread the word and find new candidates.

    If you ask an entrepreneur why they do pitch events, outside of trying to raise money, the most common answer is networking. Entrepreneurs, generally, are pretty social and want to meet other people, especially other people that can help them achieve their dreams. Naturally, there are a number of other networking events beyond pitch competitions.

    For entrepreneurs considering pitch events, evaluate the current business goals, and make sure that the time commitment is worthwhile.

    What else? What are some other thoughts on when to pitch at startup events?

  • Comparing SaaS Against the 7 Better Business Model Ideas

    Continuing with yesterday’s post 7 Ideas for Better Business Models, I wanted to take it one step further and compare Software-as-a-Service (SaaS) to the seven ideas and see how it stacks up. I’ve been a huge fan of SaaS for 8+ years now since the co-founding of Pardot, and want to help other entrepreneurs understand why it’s such a great model.

    Here’s how SaaS compares to the seven better business model ideas:

    1. Switching Costs – This varies depending on the type of product. Basic email marketing tools have low switching costs whereas heavily customized enterprise resource planning products have high switching costs. Generally, this is neutral for the average SaaS product.
    2. Recurring Revenues – SaaS, by its very definition, has recurring revenue, making for tremendous predictability. This is a strong positive for SaaS.
    3. Earning vs Spending – Most SaaS products are monthly pre-pay with a good number of annual pre-pays. Monthly pre-pay is a slight positive for SaaS and annual pre-pay is a strong positive for SaaS.
    4. Game-Changing Cost Structure – Having one version of the product that’s automatically updated for all customers is more cost effective compared to installed software for engineering. But, most of the revenues are spent on sales and marketing, so it isn’t a large cost structure difference from the overall point-of-view. This is neutral for the average SaaS company (the cost structure for the buyer is much better for SaaS as it’s more of a pay-as-you-go model as opposed to a large lump sum up front).
    5. Get Others to Do the Work – This isn’t applicable for SaaS.
    6. Scalability – The nature of the SaaS is that it’s massively scalable and there are minimal marginal costs to add more customers. Market scalability is driven by the actual product and target audience, so this is neutral for the average SaaS product.
    7. Protection from Competitors – Products that have more customization and/or more of a network effect have greater protection from competitors. This is neutral for the average SaaS product.

    SaaS really excels in the recurring revenue and earning vs spending categories, and is often very scalable. Other better business model ideas are hit or miss depending on the actual product and market.

    What else? What are some more thoughts on comparing SaaS to the seven better business model ideas?