David Cummings on Startups

Category: Entrepreneurship

Rental Car Companies, Shady Consumer Tactics, and Company Values
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Recently I rented a car from one of the major rental car companies, and just like every other time, they had their shady consumer tactics. Here are two of the most common shady tactics used:
- They ask if you would like basic or premium insurance without letting you that ‘none’ is an option and most major credit cards provide rental car insurance at no charge (I know about this credit card coverage first hand as my wife got into an accident with our rental car a couple years ago and the credit card company took care of everything).
- They offer for you to pre-pay for gas at a reduced rate and casually say to bring back the tank empty if you do. They mention this because they’ll charge you for an entire tank even if you have gas in it. Unfortunately, they aren’t straightforward that you’re pre-paying for an entire tank regardless of usage if you go with this option.
As a startup, it’s important to articulate your values and outline it for everyone to see. If you want trust and respect, tactics found at this rental car company wouldn’t be part of your organization.

What else? Have you seen other shady tactics used at rental car companies?
October 18, 2011
Factoring Liquidity Preferences in Startup Valuation
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Great, so you’ve received a term sheet from an awesome VC, but it asks for 3x participating preferred equity. 3x participating preferred means that the investors get 3x their money back first, and then split the remaining monies based on their ownership percentage. So, as an example the investors might put in $3M at a $7M pre-m0ney valuation, for a post-money valuation of $10M and a 30% stake in the business. With a 3x participating preferred position, example exit outcomes are as follows:
- Startup sells for $10M, investors get $9.3M (3x their investment (3 times $3M) and then 30% of the remaining value (.3 time $1M)), and other shareholders get $700k
- Startup sells for $20M, investors get $12.3M (3 times $3M plus 30% of $11M), and other shareholders get $7.3M
- Startup sells for $50M, investors get $21.3M (3 times $3M plus 30% of $41M), and other shareholders get $28.7M
How do you factor that type of liquidity preference into the startup’s pre-money valuation? As you can see by the three scenarios participating preferred equity (sometimes called double dipping) makes for dramatically different outcomes. On the surface it appears the investors own 30% of the business and invested at a $7M pre-money valuation but the numbers above show that with an exit at $50M or less, the actually percentage investors get is really in the 40 – 60% range assuming a decent exit.

One extremely simplistic way to think about participating preferred equity is that for outcomes less than 10x the pre-money valuation, every 1x of participating preferred takes the investors ownership position up 10-20% above their current position (e.g. from 30% ownership to 36% ownership for 1x participating preferred).

What else? What are some other ways you factor liquidity preferences in the startup valuation?
October 17, 2011
Is the fifth employee of a startup an entrepreneur?
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Recently I met a gentleman that said he was an entrepreneur. After talking for a bit he said he joined a startup as the fifth employee and hadn’t started a company. Does that make him an entrepreneur or an entrepreneurially-minded employee?

Here are some ways I think of the difference between an entrepreneur and entrepreneurially-minded team member:
- Low or no salary vs a salary slightly below market rate
- Personal guarantees on the business loan and office space vs no personal guarantees
- Sweated a payroll period vs not having the stress
- Co-founder of the business vs an early employee
Of course, entrepreneurs can be early employees in a startup they didn’t co-found. Differentiating between the two doesn’t matter nearly as much as being a valuable team member and helping make the startup a success.

What else? Is the fifth employee of a startup an entrepreneur?
October 16, 2011
Inside Sales Rep Comp Model for Startups
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Most B2B SaaS startups should start with an inside sales rep model. The idea is that a consultative inside sales model is significantly less expensive when compared to a traditional enterprise field rep model. Prospects still need to talk to a knowledgeable sales person to help them make a decision.

When thinking about the inside sales rep compensation model, I like to have the majority of the comp be the commission with a common split being 40% salary and 60% commission. Here are some ideas when thinking about the inside sales representative compensation model in a startup:
- Base salaries in the range of $25k – $50k
- Commissions in the range of $25k – $60k (e.g. $40k base salary and $60k in commission for an on-target earnings of $100k)
- Commissions would be 10% – 20% of first-year’s revenues (e.g. $1,000/month SaaS product is $12,000/year with a 15% commission would be an $1,800 commission)
- Commissions should be paid out after the customer’s payment has been received by the startup
Sales rep comp should align closely with the interests of the startup and be win-win for everyone.

What else? What are some other thoughts on inside sales rep comp models in startups?
October 15, 2011
Equity Best Practices for Co-Founders in a Startup
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An entrepreneur approached me recently to ask for advice around equity sharing with his co-founder. There’s no “right” answer for percent ownership but there are a few general best practices that all co-founders should follow.

Here are equity-related best practices all co-founders should follow:
- Require a four year vesting schedule where the equity vests monthly (another option is milestone-based vesting, which is also worthwhile — the key is to always have vesting)
- Require a one year cliff where if any co-founder leaves in the first year they get no equity
- Incorporate a buy/sell agreement that spells out what happens to equity owned by a co-founder once an owner leaves the business, if anything (e.g. does the startup have the option to buy back the equity? at what price?)
- Document what each co-founder brings to the table in terms of time commitment, IP, networks/contacts, etc
These best practices help set ground rules in the event things don’t go well or a co-founder decides to leave. People have the best of intentions when starting a company but it’s hard to know how personality styles and work ethics match or don’t match.

What else? What are some other equity-related best practices co-founders should follow?
October 14, 2011
Determining When a Startup is Financially Ready for a New Hire
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At today’s EO Accelerator accountability group, one of the discussion topics was centered around how to determine when a startup is financially ready for a new hire. Many entrepreneurs are concerned with increasing their cost structure and want to be prudent when adding new people, especially if they are bootstrapping the business. It isn’t always obvious when the financial wherewithal is in place for that next hire.

There are two simple ways to determine when a startup is financially ready for a new hire:
- Growth Plan Assets (GPA) – for companies that sell products or services with limited or no recurring revenue, growth plan assets is the ratio of current assets (e.g. money in the bank plus accounts receivable) divided by the average monthly operating costs over the past 90 days (e.g. all expenses in the past 90 days divided by three). The GPA should be in the three or four range (like a good GPA in college) to know that the business is ready to hire (the GPA can be lower as the percent of revenues that are recurring go up).
- Recurring Revenue Greater than Expenses – for companies with most or all revenue recurring things are much simpler: once the recurring revenues are greater than the current expenses plus the expenses of a new hire, then the startup is good to go. This equation changes slightly if the startup has a bank line of credit and is able to hire in advance of revenue knowing that it will quickly catch up and surpass expenses.
Determining when a startup is financially ready for a new hire is a combination of current financials, sales pipeline, and gut instinct.

What else? What other factors should be included when determining financial ability for a new hire?
October 13, 2011
What’s in a Feature Name
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After the startup’s name and the product’s name (which should usually be the same as the startup’s name) the next most important thing to name is individual features/modules in the product. Coming up with great names for features is critical because that value carries over into several areas like:
- User experience / ease of use
- Marketing content, especially for search engine optimization purposes
- Other marketing content like blog posts, white papers, and social media
- Sales demos and support
The next time you go to name a new feature/module, stop and think through the many different ways it’ll be used and get feedback from a few people as to the best available name.

What else? What are some other reasons the name of a feature/module is important?
October 12, 2011
Candy, Vitamins, or Painkillers for Startups
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At a Flashpoint event several weeks ago one of the startups was giving their pitch. After the pitch was done there was two minutes for questions. Not quite understanding what they did I asked a simple question: is your product like candy, vitamins, or pain-killers for your market?

After a long pause with no response, I volunteered a quick definition of each:
- Candy – a nice-to-have that people enjoy and can be wildly successful if it becomes a fad (like Beanie Babies)
- Vitamins – used to help augment and improve things but sometimes harder to quantify
- Pain-killers – critical problems that need to be alleviated
Startups need to think through this question early on and incorporate thoughts around it in their strategy and marketing.

What else? What do you think of the candy, vitamins, or pain-killers analogy for startups? Read Stephen Flemming’s post on painkillers from four years ago.
October 11, 2011
Startups Need Bottom-Up Forecasts
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A startup last week told me their goal was 100,000 active users in three years. Great, I told them, that sounds like a nice round number. Then, I asked where the number came from. Naturally, they pulled it out of the air with no basis. Wrong, I told them — a bottom-up forecast is the way to go.

Here’s how a bottom-up forecast might look:
- 1% conversion rate from unique visitors (so, 100 visitors to get one user)
- Publish three blog posts per week with 100 unique visitors per post (so, three users per week)
- Send two tweets per day with 50 unique visitors per tweet (so, one user per day)
- Earn one PR placement per month that drives 5,000 unique visitors (so, 50 users per month)
- Assume this is constant for one year and you have about 1,100 new users (~150 + 365 + 600)
With this brute force inbound marketing approach it’s going to take a significant amount of time to reach 50,000 users (note there’s no word of mouth, viral co-efficient, etc).

Startups needs to do bottom-up forecasts for sales, users sign-ups, etc to better understand what it takes to be successful.

What else? What do you think of bottom-up forecasts?
October 10, 2011
3 Ways to Develop Focused Focus Groups for B2B Startups
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I’m not a fan of focus groups — I’m a fan of focused focus groups. Steve Jobs famously said that he didn’t use focus groups or market research because customers don’t know what they want. Well, for B2B tech startups that are solving customer problems (ideally providing the equivalent of pain-killers) the good news is that customers do know what they want.

Most focus groups are an assembled set of semi-filtered people (e.g. people in IT) whereas a focused focus group is one where relevant leads are generated and those leads are used as a focus group (e.g. CIOs in healthcare companies with over 10,000 employees deploying iPads to doctors).

Here are three ways to develop focused focus groups:
- Buy Google AdWords and drive the visitors to a simple landing page
- Reach out to your LinkedIn network and ask for one referral from each contact to someone in a relevant industry and position
- Ask your friends on Facebook and followers on Twitter for recommendations of people that can help
- Bonus: Go to the most applicable networking or professional association event for your audience and start talking to people
Building a focused focus group to ask questions is hard, just like acquiring customers is hard. Doing the extra work to talk to these people on the front-end significantly increases the likelihood of startup success.

What else? What are some other ways to develop a focused focus group for B2B startups?
October 9, 2011