David Cummings on Startups

Category: Entrepreneurship

  • An Easy Way Out Makes More Challenging Opportunities Harder

    Two nights ago I realized a phenomenon that’s more prevalent than I expected. As I was sitting down to write my daily blog post I knew I had the topic of Organizational Health as the Next Corporate Frontier readily available since I had just read the start of a book. My thinking was that this was a topic I felt passionately about but that it was an easy one, so I should write about something harder or more timely, and come back to this one when I was at a loss. Only, by having the easy topic sitting there it made it even harder to come up with something else.

    Having an easy way out makes it even harder to do the more challenging opportunity.

    Thinking about it for a few minutes made me realize that this happens all the time. People go to grad school instead of traveling the world because it’s more of a known quantity. People join a big company instead of a startup because it’s perceived as safer. The easy way is easy for a reason but it’s important to think hard about whether it’s the best.

    What else? What are your thoughts that an easy way out makes it harder to do the more challenging opportunity?

  • How Much Profit Should be Reinvested in a Startup

    Recently I was discussing with an entrepreneur an interesting question: how much profit should be reinvested in a successful startup? Of course, if there are VCs or institutional investors, the answer is all of it as the focus is to get as big as possible as fast as possible. Now for bootstrapped startups and some angel-backed startups, once the startup is profitable it’s up to the co-founders to decide how much profit to reinvest in the business.

    If the startup is growing fast, ideally all the profit would be reinvested. Here’s a simple formula I like to use:

    Pay yourself 25% more than your lifestyle calls for until you have two years of savings then just pay the minimum to maintain your lifestyle

    The idea is that there’s some peace of mind for having sufficient personal savings while at the same time maximizing the investment in the fast growing startup.

    What else? How do you determine how much profit should be reinvested in a startup?

  • Organizational Health as the Next Corporate Frontier

    Yesterday I started reading The Advantage: Why Organizational Health Trumps Everything Else in Business by Patrick Lencioni, one of my favorite authors. So far, it’s another must-have book in an entrepreneur’s collection.

    Lencioni uses the term “organizational health” and explicitly says he doesn’t like the term “corporate culture” because it’s over used. I disagree. He uses the subtitle “Why Organizational Health Trumps Everything Else in Business” and corresponding book content is nearly identical to my favorite saying that corporate culture is the only sustainable competitive advantage completely within the control of the company.

    Another interesting point he makes is that management teams are so strong, on average, with strategy, operations, marketing, etc that those are much less of a differentiator than they used to be. Talent is still extremely important but for companies of size the managers are good enough in the main functional areas. Now, the real differentiation comes from organizational health and the softer, internal people side of the business.

    I’m looking forward to reading more of the book and can already recommend it to entrepreneurs that believe a strong corporate culture is critical to success.

    Note: The Six Critical Questions for Every Entrepreneur.

  • Large Customers as Edge Cases with SaaS Products

    Software-as-a-Service (SaaS) is an extremely efficient model for product development since the delivery components and upgrade cycles are controlled by the vendor (an inordinate amount of time is spent supporting configuration environments with installed applications). There’s one edge case with SaaS product that isn’t talked about much: unusually large customers.

    In the installed software world, unusually large customers typically require more expensive or exotic hardware and the problem is somewhat solved. With SaaS it isn’t as easy because SaaS applications are often sharded whereby clusters of customers are grouped on the same database, but individually delineated. As the customer base of the product grows, the SaaS company adds more and more shards. This breaks down with an unusually large customer when the customer is so large as to not fit in an isolated shard or with the standardized hardware used to power the other shards is not powerful enough.

    Modern technologies like Cassandra and HBase provide amazing scalability across a cluster of machines and solve the scale problem. Unfortunately, the tools to develop against them aren’t as simple and powerful as tools for standard databases like MySQL and PostgreSQL, but they are rapidly improving.

    Some ideas to deal with the unusually large customer edge cases with SaaS products include the following:

    • Data size allotments with fees for additional storage
    • Setting upper-bound limits for certain categories of data and not allowing overages
    • Isolating the account to a dedicated shard

    My recommendation is to think through scalability limits early on and address them in advance of customers reaching them.

    What else? What thoughts do you have on large customers as edge cases with SaaS products?

  • The Value Multiplier to Only Raise Angel Money

    After the post last week outlining an example value multiplier of 5 to raise VC money, an entrepreneur pointed out to me that some startups choose a middle ground between bootstrapping and raising institutional money: exclusively raising angel money. Comparing angel investors to VCs is relatively straightforward but there isn’t much talk about startups that only raise money from angels.

    Only raising money from angels would be considered for a more capital-light business with the idea that there might be three rounds over five years raising amounts more modest than from VCs (e.g. $500k, $750k, and then $1 million for a total of $2.25 million). By raising money from angels it’s likely that there wouldn’t be the typical 1x participating preferred liquidity preference and that the angels wouldn’t require selling roughly 1/3rd of the company for each round (the 10-20% range would be more likely).

    Let’s look at the math from purely a co-founder’s financial return for only raising angel money vs bootstrapping:

    • As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
    • At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
    • As a co-founder that owns 40% of the business, assume you raise three rounds of angel financing (roughly one every 18 months). Assume angels buy approximately 15% of the business with each round of financing and assume the option pool grows by 5% (less hiring with less money), so multiply the ownership stake by .8 (representing the amount sold to the angels and the amount for the new option pool). Here’s the math: .4*.8*.8*.8 which equals 20.5%.
    • Assume everything else is equal, which it isn’t, the value multiplier to raise angel money is 2. That is, it makes financial sense to raise angel money if the business will be significantly greater than 2 times more valuable in five years.
    • A quick example: if you can build a company worth $10 million with no angels, the same company would have to be worth $20 million for the personal gain to be financially equivalent.

    Raising angel money, depending on the terms, is likely to be slightly more entrepreneur-friendly than institutional money, but still requires the full commitment of a board and other fiduciary responsibilities.

    What else? What are your thoughts on the value multiplier to only raise angel money?

  • Maximize Upside or Minimize Downside

    I know some people that focus on minimizing the potential downside of an initiative, project, idea, etc. It isn’t that they have negative personalities, it’s that they worry about what could go wrong as part of their core being. They can’t turn it off, no matter how hard they try.

    I know some people that focus on maximizing the potential upside of an initiative, project, idea, etc. It isn’t that they are ignorant of the challenges, it’s that they focus on the potential and inherently have blinders on to all the nuances. They often hate the details.

    The world needs all types of people. Startups often do well having both types of people on the co-founding team, with a healthy give and take relationship. Someone needs to think big and maximize the upside while someone else needs to counterbalance and look for ways to minimize the downside. Dreamers and worriers go well together.

    What else? What are your thoughts on maximizing the upside and minimizing the downside?

  • Publicly Traded SaaS Company Valuations

    In December of 2010 I wrote a post titled Publicly Traded SaaS Companies detailing the companies, market cap, quarterly revenues, and number of employees. Since that post the numbers have moved upwards nicely along with a couple being acquired (SuccessFactors and Taleo) and a few new ones going public (Responsys, ExactTarget, and Demandware). Let’s take a look at the current numbers:

    • salesforce.com (NYSE:CRM) – customer relationship management SaaS company.
      Market cap: $21.52 billion
      Last reported quarter’s revenues: $631.9 million
      Employees: 7,785
    • NetSuite (NYSE:N) – enterprise resource planning (accounting, inventory, etc) SaaS company.
      Market cap: $3.45 billion
      Last reported quarter’s revenues: $64.09 million
      Employees:  1,265
    • Constant Contact (NASDAQ:CTCT) – email marketing for small business SaaS company.
      Market cap: $873.79 million
      Last reported quarter’s revenues: $57.53 million
      Employees: 926
    • SuccessFactors – human resources SaaS company.
      Bought by SAP for $3.4 billion
    • Taleo – human resources SaaS company.
      Bought by Oracle for $1.9 billion
    • LogMeIn (NASDAQ:LOGM) – remote machine access SaaS company.
      Market cap: $846.84 million
      Last reported quarter’s revenues: $32.32 million
      Employees: 482
    • LivePerson (NASDAQ:LPSN) – live chat SaaS company.
      Market cap: $899.43 million
      Last reported quarter’s revenues: $36.51 million
      Employees: 524
    • Responsys (NASDAQ:MKTG) – email marketing SaaS company.
      Market cap: $587.27 million
      Last reported quarter’s revenues: $37.24 million
      Employees: 693
    • Demandware (NYSE:DWRE) – ecommerce SaaS company.
      Market cap: $774.98 million
      Last reported quarter’s revenues: ~$15 million
      Employees:  215
    • ExactTarget (NASDAQ:ET) – email marketing SaaS company.
      Market cap: $1.62 billion
      Last reported quarter’s revenues: ~$50 million
      Employees: ~1,100

    The companies that get the largest premium are the leaders in their space and have the fastest growth rates. In almost all cases market cap, quarterly revenues, and employees have grown since the last report 16 months ago. Software-as-a-Service continues to be hot.

    What else? What are your thoughts on publicly traded SaaS company valuations?

  • Existing Markets and New Markets for Startups

    Some startups operate in existing markets where they take customers from a legacy vendor and migrate them to a new solution. Some startups operate in new markets where customers don’t have a vendor (they’re unvended) and the solution is the first one they’ve used. It’s important to be cognizant of the differences when building a startup.

    Here are some ideas to keep in mind when thinking through existing markets vs new markets:

    • Unseating an existing vendor is going to be more difficult and require a longer sales cycle than new markets
    • Startups in new markets are often dependent on how fast the new market grows whereas existing markets have a more predictable market size
    • New markets require more of a missionary sales process where the prospect has to be educated why they need it at all vs an existing market where the conversation is more on why one thing is different and better than something else
    • New markets benefit more from agressive sales and marketing as those efforts help grow the market whereas existing markets still need sales and marketing but it’s more about positioning and differentiation

    Existing markets and new markets each present their own challenges and opportunities. Startups need to recognize their type and play to their strengths.

    What else? What are your thoughts on existing markets and new markets for startups?

  • Startups Need a Weekly Cash Review

    Cash is king when it comes to young startups. The only reason startups go out of business is because they run out of cash. Because cash is so important, one of the startup’s co-founders needs to be responsible for reviewing the cash in the bank on a weekly basis. Yes, it’s that important.

    What I like to do is to get a report, either manually or automated, every Friday afternoon, that shows our cash in the bank, the amount of our short-term accounts receivables, and the amount of our short-term liabilities. This helps me assess where we are as a business from an operational perspective.

    If you aren’t profitable, and have a burn rate, it’s also important to review the number of months you have left until you run out of cash. Some startups use the number of months left as a motivator and put it up on a big screen or big whiteboard so that everyone can see and rally around it. Some startups aren’t as open with their burn rate for fear it’ll scare some of their less risk-loving employees (perhaps the startup environment isn’t right for them?). Regardless, the co-founders need to know where they stand with cash, burn rate, and amount of runway left on a weekly basis.

    What else? What are your thoughts on startups needing a weekly cash review?

  • Successful SaaS Startups Grow Slower Than a Hockey Stick Curve

    The proverbial hockey stick-like growth curve for startups has been talked about many times, including yesterday. That growth curve is rare, and even more rare over extended periods of time. In reality, startups that experience the hockey stick growth curve often do so for a limited period of time, while the market adoption is at it’s peak, and then the growth abruptly slows down or goes away. So, instead of a hockey stick over a short period of time (< 7 years) it is really an ‘S’ like curve slanted to the right where there’s slow growth, hyper growth, and finally slow/no growth.

    Crazy hockey stick-like growth is more often attributed to companies with truly revolutionary products or strong network effects where the value of the system keeps building on itself indefinitely (e.g. Facebook). Software-as-a-Service (SaaS) or cloud-based software products that are successful have growth curves flatter than a hockey stick. Here are a few reasons why:

    • SaaS revenue layers on itself year after year which makes it easier to keep growing but harder to keep accelerating growth due to the law of large numbers.
    • SaaS contracts are often annual with the payments made quarterly, making payments of the lifetime value of the customer stretch out over several years whereas installed software products get most of the value up-front, and thus installed software products can have a sharper revenue growth curve, everything else being equal.
    • Customer churn for SaaS companies (read about the leaky bucket number) eats away at growth and even if the renewal rate stays constant, the number of new customers needed to grow at the same rate continues to increase.

    SaaS companies that break out are likely to have a growth curve flatter than a hockey stick but continue to grow as a business for longer periods of time due to the layering of recurring revenue.

    What else? What are your thoughts on successful SaaS startups growing slower than a hockey stick curve?