David Cummings on Startups

Category: Entrepreneurship

Why VCs Won’t Like Fred Wilson’s Valuation Posts
Image by Lachlan Hardy via Flickr

Fred Wilson has a rich history of bringing more transparency and understanding to the venture capital world, including the dynamic with entrepreneurs, via is popular blog avc.com. Recently, there have been two especially interesting posts:
- Pricing a Follow-On Venture Investment
- Determining Valuation Multiples
Valuations for startups, other than outliers published on TechCrunch (see Dropbox’s $4 billion valuation on $30 million in revenue), are often a closely guarded secret. One of the big advantages for traditional VCs is the opaque nature of information and the frequency of negotiating deals. Think about it: a VC might negotiate a couple deals per year while a successful entrepreneur might negotiate a few deals in a lifetime. The more information that becomes available results in a more efficient market for VCs and entrepreneurs. While VCs will always have an advantage the dynamic is much more less heavily favored for them than previously.

VCs won’t like Fred Wilson’s valuation posts because they present examples of high valuations and low VC ownership positions. Entrepreneurs, when they read the posts, are naturally going to think those valuations are representative of their startups. Note that Fred uses terms like category leaders, of which most startups aren’t.

Also, when he talks about investing $3 million at a $30 million post-money valuation, implying a 10% ownership stake, that’s not a high enough stake for most VCs to get out of bed, unless the startup is at a very late stage. Entrepreneurs expecting these valuations and VC ownership positions are going to be very disappointed. And, VCs aren’t going to like having to deal with the push-back and convincing that these aren’t normal.

I like VCs and think they are an important part of the eco-system, but I’m sure these posts are going to cause headaches for VCs and entrepreneurs alike.

What else? What do you think of Fred Wilson’s valuation posts?
September 6, 2011
Use Startup Goals in Passwords
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Keeping goals aligned and top-of-mind in a startup helps increase the likelihood of success. Too often company-wide goals aren’t understood by team members and aren’t discussed on a regular basis. In addition to common best practices like an LCD scoreboard in the lobby here’s another, most subtle technique: set the personal and shared startup passwords to goals. The idea is that there are a fair number of accounts that need to be shared amongst team members as well as used personally and these can be used to reiterate goals (make sure and change them at least quarterly).

Here are some example startup goals encapsulated in passwords:
- 10NCin2011 (10 New Customers in 2011)
- 500kMRRinQ3 ($500,000 Monthly Recurring Revenue Q3)
- 50SQLinSept (50 Sales Qualified Leads September)
The great thing about this approach is that it forces team members to think about the goals more often, much like the new advertising services that use CAPTCHAs to engage with brands.

What else? What do you think of using startup goals in passwords?
September 5, 2011
Notes from the Guidewire Software S1 IPO Filing
Guidewire Software, Inc just released their S-1 IPO filing to raise a proposed $100M. Guidewire provides software for property and casualty insurance companies to run their back-office including underwriting, policy administration, claims management, and billing. Basically, behind-the-scenes software necessary for insurance companies to operate. Now it isn’t as sexy as marketing automation software, but it is a critical component of business.

Here are some notes from the Guidewire Software S-1 IPO filing:
- Average initial client contract length is five years (pg 1)
- Factors driving the industry: (pg 3)
  Aging IT infrastructure and increasing scarcity of experienced workforce
  Increased business risk due to continued reliance on inefficient processes
  Financial loss due to fraud and error in the claims process
  Changing insurance customer expectations
  Continued pressure on underwriting margins
- Growth strategy: (pg 3)
  Continue to innovate and extend our technology leadership
  Expand our customer base
  Upsell our existing customer base
  Deepen and expand strategic relationships with our system integration partners
  Increase market awareness of our brand and solutions
- Revenues: (pg 6)
  2008 – $70.6M (losses of $16.8M)
  2009 – $84.7M (losses of $10.9M)
  2010 – $144.6M (profits of $15.5M)
  2011 first nine months – $121.4M (profits of $33.4M — $24.4 related to a tax issue, so really $9M in profits)
- Q2 and Q4 are best quarters due to fiscal year end with sales rep incentives and calendar year end due to buying patterns (pg 10)
- Some customers get to buy a perpetual license at the end of the contract term (pg 10) — they aren’t a SaaS business
- Top 10 customers accounted for 38% of revenue (pg 10)
- Services revenues were 48% of revenues for this year (pg 11) — that’s extraordinarily high
- Accenture is suing Guidewire over patents (pg 12)
- Product implementation takes 6 – 24 months (pg 15)
- Products are typically deployed in a customer’s environment (pg 25)
- As of April 30, 2011, they had 610 employees, including 93 in sales and marketing, 270 in services and support, 190 in research and development and 57 in a general and administrative capacity (pg 92)
- Co-founders own between 3.9% and 5.1% of the fully diluted equity (pg 127)
This S-1 IPO filing for Guidewire Software represents a fast growing traditional enterprise software company that is doing great. It’s especially impressive to see a company grow revenues so fast while barely increasing sales and marketing expense.

What else? What did you think of the Guidewire Software S-1 IPO filing?
September 2, 2011
Notes from Clayton Christensen’s Disruptive Innovation Talk
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As part of the Dreamforce Executive Summit there was a private lunch with the famous HBS professor Clayton Christensen. Christensen, best known for the book The Innovator’s Dilemma (at Duke I had economics classes with Matt Christensen, Clayton’s son, and remember him to be very sharp). A year ago Clayton Christensen had a stroke and has since gone through rehabilitation to learn how to speak again. His talk was sharp, funny, and insightful.

Here are a few notes from Clayton Christensen’s talk:
- Decentralization is disruptive, and is hard to catch
- Pace of performance improvement outpaces ability to use improvements
- Entrants typically win at disruption
- Disruption generates repeated upside surprise
- Decentralization follows centralization (think about what has happened with computing and how that will happen with healthcare)
- The right product architecture depends upon the basis of competition
Clayton Christensen told great stories, anecdotes, and really drove his point home that innovation is disruptive. The most common story followed the pattern that a big company doesn’t want to compete in a smaller, less profitable market and an upstart figures out how to be successful in the smaller market slowly moving up market until the big company is defeated.

What else? What are your thoughts on Clayton Christensen and disruptive innovation?
September 1, 2011
Thinking About the Marketing Automation Market
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It’s that time of year for the salesforce.com Dreamforce conference at the Moscone Center in San Francisco and I find flying to be a great time to reflect. Thankfully, this year’s conference is early enough on the calendar to align with Q4 budgetting and budget cycles, so we expect an ROI in a shorter period of time compared to previous years that occurred around Thanksgiving. The marketing automation market continues to heat up and serves as a good case study for startup founders to think through when analyzing potential markets for their ventures.

Here are a few thoughts on the marketing automation market:
- Small, fast growing greenfield market with less than 2% penetration (which are my favorite)
- Core group of strong competitors that are increasingly distancing themselves from the rest of the market (here’s an overview of marketing automation vendors at Dreamforce courtesy of @marksmithvr)
- Well-funded competitors in the market are spending heavily on sales and marketing helping create market awareness for all vendors in the space
- Software as a service is the accepted distribution model, providing several benefits like recurring revenue, strong gross margins, and predictable cash flow
- Readily demonstrable return on investment (think about candy, vitamins, or pain-killers)
- Complementary eco-systems around leading CRM vendors like salesforce.com, SugarCRM, NetSuite, and Microsoft Dynamics CRM
Startups should think through these categories and others when identifying market opportunities. One of the most important tasks, and most difficult, is timing the market. The marketing automation market is now saturated, but a few years ago it was wide open.

What else? What other thoughts do you have about the marketing automation market?
August 30, 2011
Pivoting and Iterating in Startups are Different Things
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Pivot entered the startup vernacular a few years ago when Eric Ries popularized it on his blog with Pivot, don’t just jump to a new vision. Previously, I’ve espoused the benefits of iterating and believe it’s important to differentiate between the two. Each term has its place in the startup world and should be used accordingly.

Here’s how I look at pivoting and iterating:
- Pivoting – A wholesale change of the current business model in an attempt to capitalize on a different market opportunity
- Iterating – A minor change of the current business model in an attempt to capitalize on a closely related market opportunity
Pivoting is simply a much more drastic form of iterating. When I talk to entrepreneurs and they tell me how they’ve pivoted recently, most of the time they actually mean iterated. Iterate is something you can roll out quickly and casually. Pivoting is a wholesale change to the business and typically takes much longer to execute.

What else? What do you think of the differentiation between pivoting and iterating?
August 29, 2011
Growing SaaS Companies with Declining Bookings
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With all the recent S-1 IPO filings by SaaS companies it’s great to the see the growth and market awareness expanding for the business model. One area that isn’t talked about frequently is how a growing SaaS company can actually be in bad shape due to declining bookings. That’s right, the business can have its top-line revenue increasing year-over-year while the business is actually eroding.

Here’s how to analyze a growing SaaS company that might have declining bookings:
- Look at each year’s new customers as individual cohorts (e.g. the 2007 cohort, the 2008 cohort, the 2009 cohort, etc)
- Analyze the renewal rates and up-sell/ARPU growth of each cohort
- Look at incremental bookings growth of each year’s cohort (bookings are monies to be received based on customer contracts)
- Understand if once the individual cohort renewal rates are teased out from the overall renewal rate there are trends not seen before (e.g. legacy customers might be sticking around but customers signed in the last couple years are leaving at a significantly greater rate indicating a serious problem not seen by looking at the generic renewal rate)
- The end result, in a bad case, is that the business shows revenue growth due to the layering of new revenue each year, but the underlying business is eroding faster due to customer churn, so declining revenue is on the horizon
The SaaS business model is great due to recurring revenue, strong gross margins, and predictable cash flow. It’s important to understand the lifecycle of more specific customer cohorts and distinguish positive or negative trends that could result in growing SaaS companies with declining bookings.

What else? What other aspects of SaaS companies do you look at to see if there are declining bookings?
August 28, 2011
Notes from the BazaarVoice S1 IPO Filing
Image via CrunchBase

It’s been a great week for venture-back companies filing to go public, especially in the SaaS category. After talking about Eloqua’s S-1 and Jive Software’s S-1, I want to talk about BazaarVoice’s S-1. BazaarVoice provides technologies to help companies manage user reviews and associated content like photos, videos, stories, etc. Think about what Amazon.com provides to build a community of content around their product listings, but now supply everything but the actual ecommerce engine and you end up with BazaarVoice (Amazon.com develops their own social commerce technology and doesn’t use BazaarVoice, but 587 other companies do use BazaarVoice).

Here are some notes from the BazaarVoice S-1 IPO filing:
- Revenues (pg 2):
  2009 – $22.5 million
  2010 – $38.6 million
  2011 – $64.5 million (net loss of $20.1 million)
- Estimate that there are 10,000 companies with at least $50 million in online revenues that can be served by the platform (pg 3)
- A team of people moderates content 24/7/365 in 27 different languages on behalf of clients (pg 4)
- Growth strategy: expand sales force, up-sell clients, greater customer insights, expand internationally, innovate with the platform, selective acquisitions and partnerships (pg 5)
- Accumulated deficit of $40.8 million (pg 5)
- Many potential clients are hesitant to use the software because they don’t want to display negative reviews about products or services (pg 11)
- Client retention rates ranged from 84.4% to 89.4% for 2009 to 2011 (pg 12)
- Largest 100 clients represent 57.3% of total revenue (pg 13)
- 494 full-time employees and 132 part-time content moderators (pg 15)
- Some product development, QA, and system operations are outsourced to Ukraine and Costa Rica (pg 19)
- Only consumed $11.1 million of capital since inception (raised $23.6 million) making them very capital efficient since they are able to use unearned income from clients pre-paying annually to fund the business (pg 42)
- 2008 cohort of new customers acquired represented $2.3 million in 2008 revenue and $17.4 million in 2011 revenue — extremely impressive up-selling (pg 43)
- $10 million line of credit (pg 57)
- VCs and investors own ~63% of the company (pg 124)
- Founder owns 14.3% (pg 124)
The BazaarVoice S-1 was straightforward and detailed without any surprises regarding their business model.

What else? What do you think of BazaarVoice’s S-1 IPO filing?
August 27, 2011
Notes from the Jive Software S1 IPO Filing
Yesterday I went through a few notes from the Eloqua S1 IPO filing. Today I want to look at the Jive Software S1 IPO filling that came out this week. Jive provides business collaboration, community, and social software in both on-demand and installed offerings. The easiest way to describe it is as community forums for places like ESPN.com as well as private Facebook-like communities internal to companies.

Here are some notes from the Jive Software S1 IPO filing:
- Revenues (pg 6):
  2008 – $16.9 million (losses of $11.3 million)
  2009 – $30 million (losses of $4.8 million)
  2010 – $46.3 million (losses of $27.6 million)
  2011 first six months – $34 million (losses of $30.6 million — an impressive amount for six months)
- Growth strategy: Add customers, up-sell customers, add products, extend eco-system (pg 4)
- Q4 is strongest quarter for billings and renewals (pg 11)
- January 2011 hosting outage that affected some customers upwards of 14 hours (pg 13)
- 9-12 months for a new sales rep to be fully trained (pg 17)
- Debt of $29.6 million (pg 31)
- Renewal rates are over 90%, but only measured for customers paying at least $50,000/year (pg 40)
- 15% of billings over the past 18 months have been for contracts greater than 12 months (pg 51)
- OffiSync was acquired for $23.3 million (pg 55)
- Proximal Labs was acquired for $1.2 million (pg 55)
- Filtrbox was acquired for $1.7 million (pg 55)
- Employee count breakdown as of June 30, 2011 (pg 78):
  358 regular, full-time employees
  15 in hosting
  27 in support
  51 in professional services
  122 in research and development
  105 in sales and marketing
  38 in general and administrative
- VCs own ~40% of the company (pg 109)
- Co-founders own 15.8% and 15.8% (pg 109)
Overall, the IPO filing was as expected providing great detail about the Jive Software business.

What else? What other thoughts do you have about the Jive Software S1 IPO filing?
August 25, 2011
Notes from the Eloqua S1 IPO Filing
Image via CrunchBase

Eloqua, one of our main competitors, filed their S1 today to go public and raise a proposed $100 million. Being in the industry, I’m very interested to dive in and learn everything I can. Here are some quick notes from the document:
- Revenues (pg 8 )
  2008 – $32.9 million
  2009 – $41.0 million
  2010 – $50.8 million ($3.6 million from services)
  2011 – $60 million+ run rate currently
- Accumulated deficit of $148.6 million (pg 11)
- Sales seasonality with Q4 being the best (pg 14)
- Single data center in Toronto serving all customers (pg 18)
- Pardot LLC is mentioned as a competitive lead management software vendor (pg 21)
- Two patents pending (pg 25)
- Customer count (pg 67)
  712 on December 31, 2009
  896 on December 31, 2010
- Annual user conference cost $600,000 (pg 72)
- Substantial portion of cash provided by operating activities is deferred revenue (pg 74)
- IDC predicts that the marketing automation market will grow from $3.2 billion in 2010 to $4.8 billion in 2015 (pg 81)
- Each client gets their own database with a common schema (pg 96)
- Executive salaries are between $215,000 and $310,000 (pg 112)
- Executive target bonuses were focused around net monthly recurring revenue, cash balance, customer satisfaction, sales qualified opportunities, and product development (pg 113)
- Equity ownership percentage for the remaining co-founder is 5.5% and investors is ~81% (pg 132)
Overall, there’s nothing too surprising in the filing other than one item: I’m surprised salesforce.com entering the marketing automation market wasn’t listed as a threat.

Reading S1 filings is always interesting, and this one doesn’t disappoint.

What else? What do you think of the above information?
August 24, 2011