David Cummings on Startups

Category: Entrepreneurship

  • One Way Government Can Help the Startup Community

    One of the regularly debated topics is government’s role in the startup community. According to the Bolder Thesis, successful startup communities have to be entrepreneur-led, and not government- or nonprofit-led. A common government initiative is to try and help with capital (see the Invest Georgia Fund). Except more capital doesn’t create more investable opportunities. More successful startups creates more investable opportunities.

    There’s one immediate way government can help the startup community: connecting local businesses with entrepreneurs. Customer acquisition is the number one challenge for startups. Local businesses, especially larger employers, actively work to maintain strong ties with the government to help keep the region moving forward. These relationships between government and influential employers are perfect to parlay into a “Buy Local” campaign.

    Imagine events similar to the ATDC Industry Connect whereby select businesses are assembled to hear pitches from a curated group of startups. Much like Y Combinator’s Demo Day, a combination of product demos and networking enables a more efficient exchange of information so that buyers and sellers can connect. Even a tiny percentage of the purchasing power of local businesses has the potential to create more jobs and help successful startups.

    What else? What are your thoughts on government helping connect local businesses with local entrepreneurs so as to help the startup community?

  • Tech Square Labs: Billion Dollar Startups

    Paul Judge set the stage earlier this week with Unicorns in Atlanta: A Look at Atlanta’s Billion Dollar Exits and Current Promising Startups. Atlanta has had a number of billion dollar exits over the years but there’s a desire to have more. Many more. Today, Urvaksh announced that Paul Judge and Allen Nance are launching Tech Square Labs in his article Atlanta techpreneurs launch “studio” to turn ideas into billion-dollar exits.

    Tech Square Labs, no relation to Tech Square Ventures, is a hybrid incubator and private coworking space. It’s an Incubator in the true sense of the word where Paul and Allen role up their sleeves and help other entrepreneurs commercialize and launch their ideas. As compared to the dot com days, this model is different in that it’s only capital from Paul and Allen, combined with serious sweat equity. With up to six companies at a time, it’ll be an exclusive group.

    From a coworking perspective, it’s a free hacker space with the twist that the software engineers have to prove they are super talented as a prerequisite for admittance. Smart people want to hang out with other smart people. Overall, the goal is to get the best technical people together and start companies.

    Tech Square Labs has an audacious stated goal: produce billion dollar exits. The kernel of the thesis is that most of the billion dollar exits come from companies with serious, sophisticated technology at their core combined with massive, fast-growing markets. Billion dollar companies are difficult to build, but there’s clearly been a pattern in the past.

    Tech Square Labs is great for Atlanta and I can’t wait to see it succeed.

    What else? What are your thoughts on Tech Square Labs?

  • Notes from the Box S-1 IPO Filing

    The much anticipated Box S-1 IPO filing was just released and it’s filled with a ton of interesting data. Box was co-founded by Aaron Levie, purveyor of the some of the most astute 140 character quips Twitter has ever seen (see 10 Awesome Startup Tweets from Box’s Aaron Levie). Another reason the S-1 is so interesting is due to how it lays out how a Software-as-a-Service (SaaS) company can raise $400+ million in capital and already burn through $300+ million of it in pursuit of amazing growth.

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

    • Box provides a cloud-based, Enterprise Content Collaboration platform (pg. 1)
    • 34,000 paying organizations and 225,000 total registered organizations (freemium model, so they have an astounding 15% conversion rate at the organization level to go from a free user to a paid user – pg. 2)
    • Revenue (pg. 2)
      2011 – $21.1 million
      2012 – $58.8 million
      2013 – $124.2 million
    • Losses (pg. 2)
      2011 – $50.3 million (wow!)
      2012 – $112.6 million (wow!!)
      2013 – $168.6 million (wow!!!)
    • Industry trends (pg. 2)
      Shift from On-Premise to Cloud-Based Applications
      Increased Functionality and Proliferation of Mobile Devices
      Explosion of Content and Data
    • Accumulated deficit of $361.2 million (pg. 14)
    • Grew from 369 employees as of January 31, 2012 to 972 employees as of January 31, 2014 (pg. 15)
    • Retention rate calculated as of a period end by starting with the annual contract value (ACV) from customers with contract value of $5,000 or more as of 12 months prior to such period end (Prior Period ACV) and a subscription term of at least 12 months (pg. 48)
    • Non-U.S. customers represented 20% of revenue (pg. 50)
    • Interesting quips from Aaron Levie’s letter (pg. 75)
      So with some free time and online poker winnings, we set out to change how people could access, share and collaborate on information…
      Neither Dylan nor I had storied careers at IBM or Oracle (though I did use Lotus Notes once in an internship)…
      We’ve seen companies that were once wildly successful become shadows of their former selves.
    • Current ownership (pg. 126)
      Named VCs – 63% (VCs own more than this but weren’t explicitly named)
      Co-founder/CEO – 4.1% (5.7% if you count unexercised stock options)
      Co-founder/CFO – 1.8%

    Outside the amazing amounts of money burned and the growth rate, the S-1 filing was pretty vanilla. No patent trolls. No private jets. Nothing. Box is growing incredibly fast in a massive market which will result in a successful IPO.

    What else? What are some other thoughts on the Box S-1 IPO filing?

  • The Difference Between a 3x and 10x Multiple for SaaS

    Software-as-a-Service (SaaS) valuations continue to be high, and I believe they’ll be cut in half over the long run. Now, some SaaS companies, even in our current climate, trade in the 2-3x revenue multiple range (see Constant Contact). As startups pitch institutional investors, the inclination is to shoot for the big valuations, as that’s human nature, often referencing the public market multiples as a basis. Only, when making the comparisons, and thinking about valuations, there’s one major driver: growth.

    Think about it this way. If a startup is growing at 9% per year, according to the rule of 72, it’ll take eight years for the business to double (72/9 = 8). If a startup is growing at 40% per year, it’ll take almost two years for the business to double. So, the valuation multiple is driven by the historical and expected future growth rate, all else being equal. With a super high growth rate, it doesn’t take long for the business to be substantially larger, and thus significantly more valuable.

    When an entrepreneur talks about valuations in the 10x revenue range for SaaS companies, find out the growth rate and see if the math makes sense. Big multiples require big growth rates.

    What else? What are your thoughts on growth being a major driver for SaaS valuations?

  • What’s Required to Raise a Seed Round

    As the cost to build a software prototype has plummeted over the past 10 years, the number of tech startups has grown dramatically. Only, the number of active venture capitalists has actually shrunk, and it’s still super expensive to scale a business as growth requires serious cash (see 5 Hidden Challenges with SaaS). After putting together a working product, it’s often time to raise a seed round in the $300,000-$500,000 range (see Death to the $700k Seed Round).

    Here are a few thoughts on what’s required to raise a seed round:

    • Enough customers to prove product/market fit (often in the range of 10 to 50 paying customers)
    • $10,000 or more in annual recurring revenue
    • 3 reference customers that aren’t friendlies (e.g. customers that didn’t come from prior relationships)
    • Strong alignment and rapport between the entrepreneurs and angel investors

    Raising a seed round outside of the major startup regions is hard but readily achievable with enough traction and market opportunity. Entrepreneurs that pitch an idea without serious progress will have a difficult time raising money.

    What else? What are some other thoughts on what’s required to raise a seed round?

  • Lead Generation as Side Effect of Pitching VCs

    Back in the summer of 2009 we were pitching VCs all over the country. At the end of each meeting, one of the next steps was for the VC to introduce us to a few of their portfolio companies so that marketers in the field could try out our software and report back on the effectiveness. Of course, marketers from fast-growing, venture-backed companies were right in our sweet spot to use the Pardot software. Here are a few thoughts on lead generation as a side effect of pitching VCs:

    • Products that are more broadly applicable, like a B2B marketing platform, will get more leads from VCs
    • Testimonials and other forms of social proof will be required for the leads, so have them ready in advance
    • VCs that don’t offer to make intros to other portfolio companies or other potential prospects, aren’t interested in investing
    • Positive feedback from portfolio companies is critical as part of building a story for VCs to invest

    Even if VCs don’t end up investing in the startup, just developing a relationship with them and getting relevant introductions is a positive by-product of the process. Pitching VCs is more than just trying to raise money.

    What else? What are some other thoughts on lead generation as a side effect of pitching VCs?

  • Do the Math on the Stock Option Cost to Purchase Equity

    One of the common tenets of the startup community is the importance of equity to align interests and share in the value created. There are a number of different ways to provide equity with stock options, restricted stock units, and profit interests. Stock options are still popular but one aspect of them that isn’t well understood is the concept of the strike price and how that plays into exercising the options to buy the equity.

    The strike price corresponds with the value of the company at the time the equity was issued. So, if the company is worth $1 million, and there are 1 million shares of stock, each share of stock is worth $1. Thus, joining a startup with these characteristics and receiving stock options for 1% of the business would represent 10,000 shares at a strike price of $1 per share. Once the options are vested, to get the equity would require the employee to pay $10,000 to the company and now the employee would own the 10,000 shares (whereas before they had the right to buy the shares at that specified price but didn’t own anything else).

    If the company is acquired, immediately exercising the options and then receiving the acquisition value for the equity is an easy decision (assuming it’s above the strike price). Things get much more difficult when deciding to leave a company as option agreements almost always require exercising the options within 1-3 months of departure, otherwise the options are forfeited. Now, it’s a case of paying cash for some equity that is illiquid (assuming the company hasn’t gone public) and might not ever be worth much.

    Bigger strike prices combined with bigger option packages can be great for potentially having a nice chunk of a valuable startup, but they can also require paying a large amount of cash to turn the options into equity. Do the math on the stock option purchase cost when joining a startup.

    What else? What are some other thoughts on stock options and the cost to purchase the equity?

  • Finding a Startup Idea

    One of the more common refrains I hear is “I want to be an entrepreneur but I don’t have a good idea.” Yes, it’s true that an idea is important, but it’s also true that it isn’t as hard as it seems to start systematically evaluating ideas. Ideas come in all shapes and sizes and most entrepreneurs pivot at least once before hitting on something that works.

    Here are a few thoughts on finding a startup idea:

    • Look at operational challenges or technical inefficiencies at work and ask if a new product or solution could help
    • Ask friends and coworkers what problems they run into on a regular basis
    • Read Sand Hill’s list of recent venture fundings
    • Write down a list of the top five trends in your industry and how they’ll play out over the next 5-10 years
    • Research the top five trends in technology and evaluate how they’ll affect your industry (top 10 tech trends for 2014)

    Now, start collecting ideas your ideas in a Google Spreadsheet and refer back to it on a regular basis. Finding an idea can take time but with effort something strong will emerge. Of course, once an idea is in place, the hard part is customer development and proving there’s a real need in the market.

    What else? What are some other ways to come up with startup ideas?

  • Startups are Messy

    Startups are messy. Very messy. Everything is harder and more convoluted than expected. Stories of success outnumber the stories of difficulty 100:1.

    The timing was wrong.

    The market didn’t care for the product.

    The team member didn’t work out.

    The funding fell through.

    The site went down.

    The mobile app crashed.

    The partner didn’t deliver.

    The passion died.

    The customer didn’t sign the contract.

    And, in the end, things were still successful. Adversity was conquered. Everything worked out.

    Startups are messy, and that’s a big part of the fun.

  • SaaS Company Valuations Will be Cut in Half

    Earlier today Jason Lemkin tweeted that a 50-70% correction is coming to Software-as-a-Service (SaaS) companies:

    I agree.

    Last week Fred Wilson wrote a post The Bubble Question about it where he attributes overvalued tech stocks to interest rates near zero and the desire for growth companies.

    Today, many SaaS companies are trading at 10-12x trailing twelve months revenue, and have no profits. So, why do I think they’re 50% overvalued? Easy. SaaS companies typically spend 40-60% of revenues on sales and marketing to acquire customers (growth is incredibly important). Assuming these sales and marketing costs could be pared back relatively quickly, the theory goes that these companies would quickly achieve 30-40% profit margins.

    The average historical price to earnings (PE) ratio is around 15 for a public company. That is, the company is worth roughly 15x profits (right now the average PE ratio is almost 20).

    If a public company is worth 15x profits, and a SaaS company can quickly achieve 33% profit margins, that results in the same valuation as 5x revenues (15*.33 = 5). 5x revenues is half of the 10x revenues many SaaS companies are trading at now, thus long term, the valuations should be cut in half.

    Of course, this is simplistic in that it isn’t accounting for growth rates, gross margins, renewal rates, total addressable market, premiums for a public company over a private company, etc. But, as an example, if a company is valued based on a function of its future profits, and SaaS companies can become extremely profitable due to the nature of the business model, making a guess as to profit margins results in a straightforward valuation.

    What else? What are your thoughts on SaaS company valuations being cut in half?