Start Thinking in Systems, Stop Thinking in Goals

Last week I was asked about my personal goals, what keeps me going at this point in life. My answer was simple: I don’t have any goals. Instead, I have systems that I believe will lead to positive outcomes. I want to help spread the magic of entrepreneurship, and make an impact on the world. My systems will help me do my best, not striving for goals.

Start thinking in systems, stop thinking in goals.

I can control the systems. I can control the effort I put in. I can control where I spend my time.

I can’t control if I hit the goal of creating 100 successful startups. I can’t control if I hit the goal of creating 10,000 high paying jobs.

This type of thinking really crystallized for me while at Pardot when we did our quarterly and annual planning. Yes, we had goals. Yes, we cared about hitting the goals. Only, we couldn’t guarantee that we’d hit the goals. This idea of control, or lack thereof, made me go deeper. Primarily, what can we control?

We can control the required number of sales activities to likely achieve quota.

We can control the on-boarding steps necessary to ensure customers have a successful experience.

We can control the product planning process to ensure the most important enhancements.

So, we set goals and focused our energies on the systems we could control.

When I see goals, and talk to entrepreneurs about their goals, I try to tease apart if the goal is within his or her control. If it isn’t, I work at helping reshape the goal to something that is more controllable, and share the idea about systems.

Control what you can control.

Start thinking in systems.

Rise of the Startup Studios

Last week I read about the new Share Ventures startup studio and realized we might be at a tipping point for this newish type of venture. Startup studio is the modern name for what was called an incubator back in the dot-com days. Thankfully, the tech infrastructure and scale of Internet users make startup studios more viable now, 20 years later.

For startup studios, the big idea is to have a core team help create and grow multiple companies at the same time using shared resources and expertise.

I’ve followed startup studios for years and have personally been doing a form of it for 13 years now (see Atlanta Ventures). Today, the largest and most well-known in the SaaS world is High Alpha out of Indianapolis. High Alpha has already launched dozens of companies and has built a tremendous team.

Locally, I’m excited to see more entrepreneurs launch startup studios. Here are two of the newest:

Rule 1 Ventures – Founded by serial entrepreneur Todd Erlich (FactorCloud, Kill Cliff, Triserv), Rule 1 focuses on B2B SaaS, an area of local strength. Todd and his team have a background in SaaS, FinTech, and consumer. Look for a number of new startups to emerge from Rule 1.

Outlander Labs – Founded by Leura and Paige Craig, Outlander Labs positions their firm as an investing incubator with a hands-on program. Leura and Paige have long startup backgrounds with investments in over 100 startups. Look for a broad range of startups to emerge from Outlander Labs.

My prediction: startup studios are going to be even more prevalent as it costs next to nothing to test ideas and entrepreneurs realize more at-bats will increase their chance of homeruns.

Startup studios are an excellent advancement in the startup world and will have a major impact over the next 10 years.

Start It Up Georgia Kick-Off

We announced Start It Up Georgia last month as a way to jump start entrepreneurship in the state and help with the many dislocations in our world. The response was overwhelming. Over 700 entrepreneurs signed up for the program — 706 to be exact. Amazing! We never knew there would be this much demand.

Now, for the fun part. The program kicks off tomorrow with the first of 12 lesson labs:

Jermaine Brown – Entrepreneurship: Do You Have What It Takes?

Dr. Lakeysha Hallmon – Turning an Idea and Skill Into a Business.

Rachel Ford – Testing Your Idea: Will Someone Pay You For It?

Christina DeVictor – Company Creation: The Practical Steps Required to Establish a Business.

Jacey Lucus – Developing Your Online Presence: Creating a Website and Social Media.

Lauren Patrick – Marketing Your Business and Developing Your Brand.

Matthew May – Financial and Accounting Basics for Business Owners.

A.T. Gimbel – Pricing and Product: Creating a Profitable and Sustainable Business Model.

Ethan King – Operation Management: How to Run Your Business.

Kyle Porter – Company Culture and People Management.

Amy Zimmerman – Hiring: Sourcing, Training, and Leading a Team.

Kim Seals – Funding Opportunities and Raising Capital.

In addition to the 12 lesson labs, taught live over Zoom and available as recordings, we have small accountability groups for the entrepreneurs. With a cohort this large, we had to find a significant number of volunteer mentors. Of course, the community stepped up and we have 44 mentors to lead the small groups. It’s incredible to see so many people helping entrepreneurs realize their dreams.

Finally, the program culminates with a demo day where the entrepreneurs present their ideas and progress. Donors have already donated over $10,000 in grant money to help the demo day winning entrepreneurs continue their journey and grow even faster.

Start It Up Georgia is a grand experiment with lofty goals. I’m sure we’ll have bumps along the way but we’ll do our best to help hundreds of entrepreneurs start and grow new companies. We believe entrepreneurship is one of the greatest forces for good, and we’re working hard to increase the chance of success of everyone involved.

SaaS Generations 1, 2, and 3

Last week I listened to an interview of Benchmark partner Eric Vishria where he talked about the three generations of Software-as-a-Service (SaaS). I like how he framed the idea and wanted to capture the concept here. I’ve thought deeply about the first and second generations of SaaS, but haven’t spent enough time thinking about the third. Let’s dive in.

1st Generation SaaS

The 1st generation of SaaS is defined as moving legacy enterprise applications into the cloud and delivered as a service. Sometimes the technology is literally the legacy solution (previously called Application Service Provider) but more often it’s a new product that’s natively SaaS. Like traditional enterprise software, it’s sold by salespeople, typically with contracts and the usual enterprise process. The huge innovation is the ability of the software vendor to abstract away most of the customer headaches that come with managing software and deliver it as a monthly or annual fee. This, combined with more efficient product development, due to customers always being on the same version, makes for an excellent business and customer model.

Examples: Pardot, Salesforce

2nd Generation SaaS

The 2nd generation of SaaS reimagines business software as more of a consumer product where you can sign up for a free trial or a free, limited version without talking to a salesperson and become productive immediately. This category is often called bottoms-up or freemium as it starts with functional business users getting a job done and spreads in organizations without I.T. involvement. 2nd generation SaaS is bought differently than 1st generation SaaS and feels more natural as both a buyer and user of the product.

Examples: Calendly, Slack

3rd Generation SaaS

The 3rd generation of SaaS is SaaS delivered exclusively as APIs — a way for software programs to talk to other software programs without a user interface. APIs are the building blocks of modern software development representing re-usable components that make programming faster and more productive. APIs can now power many aspects of software that 5-10 years ago would have been custom including user authentication/oAuth, sending/receiving email, video conferencing, payment processing, recurring billing, testing, visualizations, reporting, analytics, and much more.

Examples: Twilio, Sendgrid

All three generations of SaaS are growing fast and have tremendous runway ahead. Look for the 2nd and 3rd generations to grow even faster and become more commonplace.

SaaS is an incredible segment of the software industry and understanding the three generations helps frame the thinking about product types.

Ask Investors How They Think About Zeroes

Over the years I’ve invested in a number of venture funds as a way to learn about venture in general, dive deeper in selected startups, and see what’s out there. One topic that’s popular now in VC fundraising decks, but was non-existent five years ago, is the firm’s historical loss ratio.

A historical loss ratio is represented as the number of previous investments that the venture firm has lost money on, most commonly going to zero (an investment that’s completely worthless). I’m not an insider in the venture and limited partner industry, so my guess is that a paper became popular arguing that the better venture returns came from firms that didn’t lose money very often on individual deals (update: here’s a paper). Venture capitalists that have to work hard to raise money from LPs (most firms!) have glommed on to this theory and worked hard to paint themselves as good at not losing money.

Of course, more focus on limiting the downside can be inverted as more focus on limiting the upside. The greatest returns in venture don’t come from limiting the downside, they come from the positive outliers — the power law of distributions.

Personally, it’s more interesting to attempt something with a 1 in 50 chance of succeeding as opposed to something with a 9 in 10 chance of succeeding, assuming the upside is correspondingly larger. Yes, we want to control our own destiny, but we also want to take big risks that have the opportunity for big impact.

Humans are conditioned to feel more pain from losing money than gaining the same amount of money. Losing hurts more than winning.

As an entrepreneur, it’s important to understand where a potential investor stands. Is the investor more oriented towards maximizing upside, or minimizing downside? Don’t know? Just ask.

There’s nothing wrong with having a low or zero loss ratio — there are many paths to success. I know a number of excellent investors and entrepreneurs than minimize the zeros and execute incredibly well.

Ask investors how they think about zeroes and you’ll understand a critical part of their core psychology.

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.