David Cummings on Startups

Category: Entrepreneurship

  • SaaS Churn Rates With Early Exit Customers

    Whenever I talk with Software-as-a-Service (SaaS) entrepreneurs, the topic of growth rates, and corresponding churn rates, always come up (see Quantifying the SaaS Valuation Growth Rate Multiplier). After talking about churn rates, I like to ask the following question: how long do customers have to stay with you to know they’re in it for the long haul?

    For the first few years of Pardot, most customers were month-to-month without an annual contract. At first, we paid commissions out to our sales reps at a rate of roughly 12% of the first year’s revenue. Quickly, we realized that if customers weren’t a good fit, they’d leave within the first four months. Customers that stayed longer than four months would be customers indefinitely. To make things more aligned, we changed our commission with sales reps to be 50% of the first four months of customer revenue, paid monthly as revenue came in, so that the sales reps would sign good-fit customers.

    Now, there’s a debate in the SaaS metrics world about calculating churn. Do you count all new customers signed or do you only count new customers that have made it past the critical starting period (e.g. the first four months in the early Pardot example)? As a course of business, it’s easier to count all new customers as that makes it easy to track and measure the critical SaaS metrics. For the health and long-term view into the business, I prefer not counting customers that churn in the critical starting period. Cost of customer acquisition, renewal/churn rates, lifetime value of the customer, etc all have to take into account not counting early churn customers, if that’s the route the entrepreneur chooses to take regarding metrics.

    Some variances of this practice include analyzing cohorts on a weekly/monthly/quarterly basis as well as only counting customers if they meet certain size requirements (e.g. it’s usually the smallest of businesses that have the highest churn rates, so if you exclude any customers below a designated size when tallying the metrics, they don’t negatively affects the startup’s real numbers). Put another way, don’t assume that all new customers should be tracked the same way from a metrics perspective.

    What else? What are some more thoughts on measuring customers that churn early as part of the overall customer metrics?

  • Product-Market Fit Before Raising Venture Capital

    Andy Rachleff, founder of Benchmark Capital (one of the top venture firms), has a great new article up titled Why You Should Find Product-Market Fit Before Sniffing Around For Venture Money. In it, he argues that entrepreneurs should approach venture capitalists once it’s clear that there’s a set of users that truly value the product. Just because someone has tried a product doesn’t mean they love it.

    Here are a few choice quotes from the article:

    • Growth without value to the customer is likely to lead nowhere–or worse, to a big flameout.
    • In my experience the best enterprise entrepreneurs pull trials after 30 days to determine if customers really need their product.
    • Data tells us the ultimate size of market addressed is the single greatest determinant of outcome.
    • In contrast to the majority of VCs, the best are riveted on product/market fit and want to invest before the growth hypothesis has been resolved.

    Most startups fail to achieve product-market fit, then try to raise venture capital, and fail at that as well. Entrepreneurs should read Why You Should Find Product-Market Fit Before Sniffing Around For Venture Money and increase the chances of raising institutional capital by first achieving product-market fit.

    What else? What are some more thoughts on product-market fit before raising venture money?

  • Have an On-Going Dialogue with VCs

    Even if there’s no short-term desire to raise venture capital, it’s still important to develop relationships with venture capitalists if you eventually plan to raise institutional money. The best relationships with potential investors start well in advance of a financial desire. Much like any sales process, it’s best to come up with a plan and iterate as necessary.

    Here are a few thoughts about an on-going dialogue with VCs:

    • First, figure out how to start the relationship (this is often the hardest part — see Getting Access to the Old Boys’ Club)
    • At the end of the first meeting, ask permission to keep them abreast of the progress of your startup
    • Decide on an update rhythm (e.g. every 60 days or every quarter) and reach out like clockwork on that schedule
    • Create a potential investor update template and send the update as part of the rhythm (see the Monthly Advisor Update Email as an example)
    • Ask to catch up in-person or over the phone at least twice a year, or more frequently as appropriate
    • Remember to pay it forward and seek out ways to provide value to the investor (see VC Access Via Helping a Portfolio Company)

    Entrepreneurs would do well to have an on-going dialogue with VCs so that when they do want to raise money, a relationship and track record is already in place.

    What else? What are some other thoughts on the best ways to build relationships with investors?

  • Settling in for at Least Five More Years

    Recently I was talking to an entrepreneur that was starting to make some early progress in his startup. With several dozen paying customers, it was clear that product-market fit was in place (see 5 Ways to Identify Product-Market Fit). The next step, a repeatable customer acquisition process, was still a ways out, but deals were coming in at a steady pace, albeit in low volume. Then, he said something that stuck with me:

    I now know this business is going to work, and I’m settling in for at least five more years.

    Steve Blank defines a startup as a “temporary organization searching for a repeatable and scalable business model.” For this entrepreneur, achieving early traction and gaining visibility into a repeatable sales model gave him the confidence to know the business is going work. Oh, and it’s taken over two years to get to this point. Only now, he knows it’s time to settle in for the long haul.

    What else? How do you know when you’re on to something special that’s going to take many more years to materialize?

  • The Market Opportunity for Marketing Automation in 2009

    Back in 2009 we tried to raise venture capital for Pardot. While we didn’t end up raising any money, we did pitch dozens of venture capitalists and had a great experience doing it. One of the things potential investors were most skeptical about was the market opportunity. Even though we had over $1 million in annual recurring revenue and customers said it was a must-have (a painkiller), investors didn’t think it was a big enough market opportunity. Now that the space has three unicorns (billion dollar companies), it’s clear the market is massive.

    Here’s how we presented the market opportunity for marketing automation in 2009:

    • Marketing teams don’t have a central platform to run their campaigns and track ROI (e.g. accounting has QuickBooks, sales has Salesforce.com, etc)
    • B2B online marketing, while smaller than B2C online marketing, is growing fast and benefits from the shift in offline to online advertising
    • Roughly 150,000 companies pay for a modern, web-based CRM (Salesforce.com, SugarCRM, Netsuite, and Microsoft Dynamics)
    • The vast majority of companies that pay for a modern, web-based CRM need a marketing automation system, yet less than 3% of the market is vended (we cited publicly available customer counts from each CRM vendor and marketing automation vendor)

    Thankfully, our market analysis proved to be correct and marketing automation is now a huge market that’s still growing fast.

    The next time investors ask about the market opportunity, figure out how to present it in a way that’s compelling and incorporates social proof beyond something written in a Gartner report.

    What else? What are some more thoughts on framing a market opportunity and the marketing automation example?

  • 7 Questions Every Entrepreneur Needs to Answer

    Earlier this week I finished Peter Thiel’s new book Zero to One (see my previous post Creative Monopolies on the Mind). My favorite part in the book is where he talks about the seven questions every entrepreneur needs to answer. He provides details for each question and then goes through a few example companies with one that can positively answer the majority (Tesla) and one that can’t (Solyndra).

    Here are the seven questions every entrepreneur needs to answer:

    1. The Engineering Question
      Can you create breakthrough technology instead of incremental improvements?
    2. The Timing Question
      Is now the right time to start your particular business?
    3. The Monopoly Question
      Are you starting with a big share of a small market?
    4. The People Question
      Do you have the right team?
    5. The Distribution Question
      Do you have a way to not just create but deliver your product?
    6. The Durability Question
      Will your market position be defensible 10 and 20 years into the future?
    7. The Secret Question
      Have you identified a unique opportunity that others don’t see?

    While it isn’t critical to be able to answer every question in the affirmative, it is critical to answer a majority of the questions in the affirmative. One of my favorite lines from the book:

    If you don’t have good answers to these questions, you’ll run into lots of “bad luck” and your business will fail.

    Entrepreneurs would do well to answer these seven questions and revisit them on a regular basis.

    What else? What are some more thoughts on the seven questions every entrepreneur needs to answer?

  • Run the 10x Scenarios

    Dreaming about the future — it’s one of my favorite things. As a thought exercise, I enjoy going through growth scenarios. Here are some questions I like to ask:

    • What will happen when everything in the company is 10x larger? How will things work? What will break down? Where are we strong? Where are we weak?
    • What will happen if we make our engineering team 10x larger? What engineering projects would we accelerate? What new products or initiatives would we go after?
    • What will happen if we make our sales team 10x larger? How much larger will other departments have to be to support them?
    • What will happen if we started generating 10x the number of leads every month? What would the sales and marketing departments look like with that type of volume?

    At the next management strategy session or off-site retreat, run 10x scenarios and get everyone thinking about the future and major growth.

    What else? What are some more thoughts on running 10x scenarios?

  • Career Paths in Startups With Limited Visibility

    Back in 2009, we made it our stated goal at Pardot to be one of the best places to work. Excitedly, we applied to be a best place to work with the local business newspaper, had employees fill out the anonymous surveys from the third-party administrators, and waited patiently for the results. After six weeks the results came back and we weren’t even considered to be a finalist. We had failed on several categories, with the most prominent being employees not understanding the future of the company, specifically their roles and career paths.

    Startups are inherently unstable and have limited visibility. So, then, how do career paths fit in? Here are a few thoughts on career paths in startups:

    • While it’s difficult to predict the future, it’s possible to outline the company’s desired scale and size over time, assuming things go well, and to plan out potential roles and positions
    • Managers should meet with team members and talk about career interests at the quarterly check-ins such that potential career paths and timelines are well understood
    • Individual contributor roles and managerial roles should be treated with similar weight such that all the emphasis isn’t on becoming a manager (many companies have roles like Distinguished Engineer or Director of Strategic Accounts, which are individual contributor roles for high achievers with significant experience)
    • Multiple career options should be available whenever possible (e.g. as the company grows, there will be more specialization, and more opportunities to “own” certain areas)

    While career paths aren’t fixed and perfect timelines aren’t available, entrepreneurs would do well to lay out an operational vision for the next three years and team members should be able to see an opportunity to progress within the company. Career paths are important and team members with better career path visibility enjoy greater satisfaction.

    What else? What are some more thoughts on career paths in startups with limited visibility?

  • Dreamforce 2014

    This week is the annual Super Bowl of Software-as-a-Service (SaaS) with the Dreamforce 2014 event in San Francisco. It’s the biggest event of its kind and draws 100,000+ people from all over the world. While I’m not attending this year, I’ve been many times in the past.

    Here are some thoughts from previous years:

    If you’re a software entrepreneur and haven’t been to a Dreamforce event, I’d highly recommend it.

    What else? What are some other thoughts on Salesforce.com’s annual Dreamforce event?

  • Doing the Dilution Dance with Investors

    Entrepreneurs love talking about fundraising announcements from other startups. Fundraising, while it’s much too celebrated, is the most dramatic and firm number that’s readily associated with many startups. Whenever a fundraising announcement comes out, it’s fun to speculate on things like pre-money valuation, participating preferred vs non-participating preferred, stock option pool size, and other stipulations.

    From an entrepreneur’s perspective, too much effort is focused on raising a specific dollar amount and not enough on dilution. After building a financial model, and plugging in imaginary numbers, it’s easy to get fixated on a specific amount as the must-have number. Only, with that number in mind, investors have more leverage in negotiating the pre-money valuation and other terms as the conversation is centered around the amount of money the entrepreneur wants to raise.

    Instead, when raising money, it’s best to give a range (e.g. we want to raise $2-$3 million for our Series A) and make the conversation more focused on valuation and key terms and less about a specific amount. When we tried to raise money for Pardot in 2009, we received one verbal offer to invest $1 million at a $2 million pre-money valuation and a separate verbal offer to invest $5 million at a $7 million pre-money valuation. Both offers came from venture capitalists, and both were at the same time for the same business (we had slightly over $1 million in annual recurring revenue at the time). In one case we could sell 33% of the business for $1 million and the other case we could sell 40% of the business for $5 million. We passed on both offers.

    When doing the dilution dance with investors, focus on the key terms and less on the actual dollar amount raised.

    What else? What are some more thoughts on entrepreneurs focused on raising a specific dollar amount instead of more important terms like valuation and control provisions?