David Cummings on Startups

Category: Entrepreneurship

  • 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?

  • Escape Velocity for Startups

    Hockey stick growth curves are a desirable path for startups. The idea is that growth is slow and steady, much like the base of a hockey stick, and then at some point it really starts to take off, much like the long part of a hockey stick. There’s another concept, escape velocity, that isn’t talked about as much but is still important.

    According to Wikipedia, escape velocity is the speed at which the kinetic energy plus the gravitational potential energy of an object is zero. You can think of it as the point where something breaks free from whatever is holding it back, and thus  carries on indefinitely. For startups, escape velocity has to do with becoming the dominant vendor and growing indefinitely. All too often, a startup goes through the hockey stick growth path, only the fast growth eventually plateaus and the startup has slow or no growth. The startup didn’t fully achieve escape velocity.

    A company like Salesforce.com that’s still growing at double digit rates, even with billions of dollars of recurring revenue, achieved escape velocity and shows no signs of slowing down. Few startups achieve the hockey stick growth curve and even fewer achieve escape velocity. Pay attention to the growth paths of other startups and ask yourself if it achieved escape velocity.

    What else? What are your thoughts on escape velocity?

  • The Value Multiplier to Raise VC Money is 5

    Recently I was meeting with an entrepreneur who’s out raising a Series A round from VCs. He’s already raised an angel round, built an almost complete version one of the product, and has a handful of customers. Personally, his goal is to build a large successful company, on someone else’s dime, and then do it again on his own timeframe without investors in the future. The clock is ticking now.

    When the founder started asking questions about raising money from VCs I quickly asked what his value multiplier was to raise VC money. That is, how much money would he make on his current growth path with an exit in five years vs raising multiple rounds of money from VCs and also exiting in five years. Now, I believe the best companies don’t have an exit strategy but I understand that’s not the standard view.

    Here’s a super simple way I think about the value multiplier to raise VC money from a spreadsheet jockey perspective:

    • 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 VC financing (roughly one every 18 months). VCs buy approximately 33% of the business with each round of financing and assume the option pool grows by 10%, so multiply the ownership stake by .57 (representing the amount sold to the VCs and the amount for the new option pool, not taking into account liquidity preferences). Here’s the math: .4*.57*.57*.57 which equals 7.4%.
    • Assume everything else is equal, which it isn’t, the value multiplier to raise VC money is 5.4. That is, it makes financial sense to raise VC money if the business will be significantly greater than 5.4 times more valuable in five years.
    • A quick example: if you can build a company worth $10 million with no VCs, the same company would have to be worth $54 million for the personal gain to be financially equivalent.

    Raising VC money creates a number of other opportunities and challenges and shouldn’t be viewed just as money. If it is viewed purely to create more personal wealth then the approximate value multiplier is 5.4 for a five year window.

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

  • All Startups Should Use Google Hangout

    For years I’ve been a Skype user — not a heavy user but a regular one. With Skype video a few years ago it became even stronger because conversations are better when you get to see and hear the person on the other end. With our daily check-ins we had a standard call-in number for anyone not at the meeting. After Skype came out with group chat we started trying to use it for our daily check-ins but the friction was too high as one person had to initiate the connection to the other people potentially on the call, which was too time consuming for a daily 10 minute meeting.

    Google Hangout came along and solved our problems.

    Google Hangout is great because you can make a private room, XYZ Startup, and then share it as a link with other members of your team. Everyone can bookmark that link and then whenever a meeting occurs anyone invited can join the hangout room and have full voice and video capabilities. There’s also screen sharing and other collaboration tools right in the virtual room.

    Oh, and the best part is that it’s free.

    What else? What are your thoughts on Google Hangout?

  • Always Over-Communicate in Startups

    Have you ever worked on a project and felt like there wasn’t enough communication? Now, have 100 projects going on around you with a small group of people — that’s how it is in a startup. If there wasn’t enough communication with one project imagine how it is with 100 simultaneously. You should always over-communicate in startups.

    Over-communicating is different than micro-managing. I’m a big fan of empowering people through autonomy, mastery, and purpose where autonomy comes partly from trust. Now, with so many things going on in a startup it can be difficult to find time to communicate. Don’t let that happen.

    The most effective communication tool I’ve found is the daily check-in. Daily check-ins are simple — everyone on your team meets for 10 minutes in-person and/or over Skype Video to answer three simple questions. The questions are what did you accomplish yesterday, what are you going to do today, and do you have any roadblocks. Simple and powerful. And, yes, you do this every single day.

    What else? What are your thoughts on over-communicating in startups?

  • Being the Pretty Startup at the Party

    The startup community is great because it’s both tight-nit and inviting. Every year a handful of startups break out of the noise and become the pretty startup at the party with heaps of attention pilled on. It’s an amazing feeling to be recognized, especially after all the hard work necessary to get things off the ground.

    As an entrepreneur there are a few things to remember when you hit the limelight:

    • External validation is great for PR and should magnified through social media, SEO, etc
    • Winning an award does not equal more revenue from customers
    • Requests for your time for coffees, lunches, etc will go up and can take away your most precious asset — time
    • Don’t get a false sense of progress from recognition when happy customers are the true measure

    Being the pretty startup at the party is great fun but be cognizant of the demands on time and what’s truly necessary to be successful.

    What else? What are your thoughts on being the pretty startup at the party?

  • A Startup’s Purpose

    In the book Drive: The surprising truth about what motivates us by Daniel Pink he talks about the three most important areas necessary to maximize success with knowledge workers: autonomy, mastery, and purpose. Autonomy and mastery are straightforward to promote in a startup whereas purpose is more complicated. Sure, the purpose might be to create great XZY software but I don’t think that’s inspiring to team members outside engineering.

    A startup’s purpose is much more powerful when it involves improving society or making an impact beyond a profit. Here’s Starbuck’s purpose:

    To inspire and nurture the human spirit – one person, one cup, and one neighborhood at a time.

    A startup’s purpose doesn’t have to be as grandiose. For us we have a simple one: provide a platform for good work, good people, and good pay. Our purpose is centered more around being a great place to work and a great place to be a customer with corporate culture as the driving force.

    Spend time on your startup’s purpose and make it relevant and motivating.

    What else? What are your thoughts on a startup’s purpose?

  • ExactTarget in the 8x Revenue Club

    ExactTarget had a very successful IPO last week pricing above it’s expected range and then promptly gaining 32% in value the first day. ExactTarget is one of the most impressive SaaS companies due to their strong corporate culture (Orange Culture), growth rate north of 40% at scale, and headquarters in Indianapolis (outside the Silicon Valley echo chamber). It’s a small group of Software-as-a-Service companies that have had successful IPOs and the market has rewarded them handsomely in terms of valuations (SaaS IPOs are sexy article).

    Based on today’s stock price of $26.32 for ET, the company is valued at $1.7 billion. At a little more than $200 million in recurring revenue that puts them in the 8x revenue club (the company is valued at more than eight times their revenue, which is extremely high). Bill Gurley, a famous venture capitalist and long time blogger, has a great post All Revenue is Not Created Equal: The Keys to the 10x Revenue Club where he talks about factors that contribute to extremely high multiples of revenue (think LinkedIn, OpenTable, etc).

    Here are the factors Bill Gurley lists:

    1. Sustainable Competitive Advantage (Warren Buffet’s Moat)
    2. The Presence of Network Effects
    3. Visibility/Predictability are Highly Valued
    4. Customer Lock-In/High Switching Costs
    5. Gross Margin Levels
    6. Marginal Profitability Calculation
    7. Customer Concentration
    8. Major Partner Dependencies
    9. Organic Demand vs. Heavy Marketing Spend
    10. Growth

    ExactTarget has most the factors including #2 (The Presence of Network Effects), #3 (Visibility/Predictability are Highly Valued), #4 (Customer Lock-In/High Switching Costs), #5 (Gross Margin Levels), #6 (Marginal Profitability Calculation), #7 (Customer Concentration), #8 (Major Partner Dependencies), and #10 (Growth). A sustainable competitive advantage is there but not as obvious as lower cost providers continue to proliferate. In addition, there isn’t organic demand but rather very heavy marketing spend ($30 million in losses last year due to sales and marketing). With eight of the 10 factors readily identifiable, and the stock trading at 8x revenue, it’s squarely in the 8x revenue club.

    What else? What are your thoughts on ExactTarget in the 8x revenue club?