Among entrepreneurs there are two common ways to show off: how many employees you have and how much revenue you have. Of course, neither way perfectly accounts for the success of the business. That’s right, a business with $10 million in revenue can be more valuable that a business with $100 million in revenue. Here are some factors that determine company value:
Gross margins (the higher the better)
Net margins (the higher the better)
Equitability of revenue distributed across customers (e.g. a small number of customers representing a large percent of revenue is less valuable)
Percent of revenue that is recurring (the higher the better)
Length of contracts (the longer the better)
Growth rate (the higher the better)
Barriers to market entry (the higher the better)
So, a high growth and ultra profitable recurring revenue $10 million company can be worth more than a no profit, declining $100 million revenue company.
What else? What are some other factors in company value?
Last month I talked to an entrepreneur who’s company was hitting on all cylinders and growing fast. I asked him about his product and how he started the business. He quickly recounted how this was actually their second product as the first product did well but that they expanded into this newer product once he saw a growth plateau on the horizon. Now, growth isn’t the most important thing to all entrepreneurs but many view growth as new challenges and adventures that make the journey fun.
Here are a few questions to think through when there’s a growth plateau on the horizon:
How important is growth relative to profitability and stability?
Does growth mean 5% a year or 50% a year to me?
Is it time to expand geographic markets, new industry verticals, or a new product completely?
What risks and opportunities come with these changes?
My recommendation is to consider expanding when a growth plateau is on the horizon.
What else? What other considerations should be taken into account with a growth plateau?
Twelve years ago I did a summer internship at IBM in RTP. I was an undergrad at Duke and excited about the opportunity to work for a large technology company writing Java code . My role was to build example apps for what would eventually become WebSphere. At the time, my department was writing components and infrastructure objects for a big beta client: the State of Connecticut.
IBM was a study in contrasts. Every morning when I came in and every day when I left I had to log in to a mainframe app on a green screen to record my time. That’s right, I used a mainframe app as a time keeping system while building web-based apps in Java. At the end of each payroll period I’d log in to the same green screen app and double check my hours. I had never used a green screen app before and have never used one since.
One of the initiatives IBM had that summer was asking employees for ideas and ways to innovate. Funny enough, I’m never short on ideas so I submitted what I thought to be an obvious idea: enhance printer drivers to prompt users to not include the last page of the print out if it came from the web and had less than 5% ink coverage. The annoyance that I had encountered many times was printing a web page and having the last page be the copyright date or footer links — something of no value that wasted a piece of paper.
I typed up several pages of examples and rationale around the idea. After submitting the idea I didn’t think anything of it until a month letter I received a letter thanking me for the idea and letting me know it was rejected due to not being useful. Oh well, I tried. The consolation prize was a lanyard to hold my serial number badge. My days of innovating at IBM were over.
Interestingly, I read about a company in Portland last year that was generating millions of dollars a year in revenue by saving companies money on paper by doing the very thing I’d proposed at IBM. This is a small example that shows many ideas are too small for big companies, but big enough to be a small company.
Time and money have a unique relationship in the startup world. The vast majority of startups have significantly more time than money. If you don’t have any money, every penny potentially spent gets scrutinized, as it generally should, and time is sacrificed to save money. Once a startup raises significant capital, the two suddenly flip flop. If you raise $10 million dollars in venture capital, expectations immediately change and the bar for success is significantly raised. The expectation is clear: spend the money to grow the business as fast as possible with the goal to achieve escape velocity and dominate the market.
Some items to keep in mind when thinking about the time and money relationship:
Is this a winner-take-all-market like eBay or is more like email marketing where there are many successful companies
Shifting the mindset from scrappy to putting money on the line faster is hard to do and shouldn’t be taken lightly, especially for bootstrapped companies
Startups that don’t raise money but reach multiple millions in revenue will start to see the time and money relationship change as they make hard decisions around maximizing profits vs maximizing growth
There’s a distinct relationship between time and money in startups. Accordingly, it’s important to understand and be cognizant of it.
What else? What other considerations between time and money should be considered in startups?
After spending a day at Dreamforce it is clear that the SaaS app market, as well as associated salesforce.com AppExchange eco-system, is growing like gang busters. The top sponsorship slot for Dreamforce this year was Platinum for a whopping $250,000. Next year they’ll have two even more expensive slots: Diamond and Titantium. Imagine what those will go for.
Here are a few SaaS app trends I see:
More connectors and off-the-shelf integration between SaaS products (who’s going to win the generic app marketplace e.g. a marketplace that isn’t the Google Apps Marketplace and isn’t the salesforce.com AppExchange marketplace?)
Integration and migration of legacy data continues to be a big challenge (garbage in, garbage out, regardless of industry)
Ease of use continues to be a major focus (design for the novice, customize for the pro)
Pricing and complexity of contracts is starting to decrease, making things better for the customer
All in all, the SaaS market continues to grow fast and I’m very bullish about it. We’re only scratching the surface of SaaS apps changing how businesses operate.
The Wall Street Journal published an article three days ago titled Royalty Financing: An Alternative to Venture Funding, Bank Loans that mentions some of the challenges I talked about in my post on Junk Bonds for Startups a week ago. The general idea is that startups usually don’t have much need in the way of physical assets to take loans out against (e.g. real estate, heavy equipment, etc) and so when it comes to bank loans they really aren’t available unless you have personal collateral to cover the majority of the amount. Royalty financing is generally taking a percentage of the future revenues as a way to finance a loan.
A line of credit is worth considering for revenue-producing startups. Most of the time it’s tied to the current accounts receivables (monies owed) to the business and a bank will provide a line of credit for 75% of those receivables. The challenge for many SaaS businesses is that they are paid monthly on a credit card resulting in little receivables relative to the size of the business.
SaaS businesses should find a bank that understands recurring contract revenue and will set up a line of credit based on the last 90 days monies received from recurring revenue. For example, technology company-focused banks will do lines of credit for 75% of those monies for profitable companies. Thus, if $1 million of recurring revenue was collected in the past 90 days, the business might get a line of credit for $750,000. A bank line of credit or loan, especially with today’s interest rates, is often the cheapest way by far to finance a business. The challenge is getting it.
Pricing is one of the areas that I see first-time entrepreneurs undersell themselves. What I mean is that there’s a tendency to price a product too low. Paul Graham says, “You’ve found market price when buyers complain but still pay.” It’s not that you’re trying to take advantage of customers but rather attempting to determine the optimum price (which often isn’t the highest). Software-as-a-Service (SaaS) is especially interesting due the rental nature of the relationship. The client isn’t buying the software but rather paying a monthly or annual fee for access to the application.
Here are a few things to keep in mind when pricing a SaaS app:
Under $10/month is generally a consumer app that is fully self-service
$20-$100/month is more small business and self-service or limited service to get going
$100-$500/month is no-man’s land where it is too expensive to be self-service and it is too cheap to compensate consultative inside sales reps (the exception is products that replace existing, known quantities like VoIP services replacing phone services)
$500-$1,500/month is the sweet spot for having a quality inside sales team that is well compensated
$1,500+/month enters the territory of an expensive field sales force with significant travel and expense costs
Pricing is one of the more difficult things to do early on and I recommend starting two or three times higher than your initial thinking and always remember that it is easier to lower prices that to raise prices.
What else? What are some other considerations when pricing a SaaS app?
When talking about employee benefits most people think of common things like health, dental, and 401k benefits. Lately, we’ve been talking internally about what other benefits we can provide to our team to make our environment and company that much better. Here are some of the non-standard employee benefits we already have:
Free food and drinks (the regular stuff plus nice coffees, teas, fruit juices, energy drinks, and more)
Catered lunches every Friday
Short term and long term disability with no co-pay
Quarterly off-site celebrations with food and drink
Here are some ideas we’re thinking about:
Company-sponsored personal financial education to help team members interested in things like paying off debt, buying a house, and planning for retirement
Massages and personal wellness clinics
More frequent catered lunches as well as breakfasts
More frequent Friday afternoon happy hours
What else? What are some other non-standard employee benefits that you like?
Everyone loves to try and categorize the most common types of entrepreneurs. I’d like to throw my hat in the ring. Over the past 10 years I’ve found that there are three main types of entrepreneurs:
Sales – spends a good deal of time focused on selling, doing deals, and anything else related to bringing in new business
Product – enjoys the product management, strategy, and vision aspect of the business (I’m personally in this camp)
Operations – loves the organization aspect of growing a business, the metrics, KPIs, and general execution
There’s no right or wrong answer and you can probably think of famous examples for each category (e.g. Mark Benioff, Steve Jobs, and Jack Welch). My recommendation is maximize your talents by focusing on what you’re good at and understand that it is common to excel in one or two areas.
What else? Do you agree with these three categories for entrepreneurs?
With a clean product slate as a startup it’s easy to iterate and add functionality quickly. The key to remember, especially with customer driven development, is that product development should be paced with customer input. It’s too easy to keep adding features without giving adequate time and effort to solicit feedback.
Keep these in mind when considering the pace of development:
Maintain a strong opinion of the product direction independent of prospects, analysts, customers, and competitors
When considering feature requests, always ask if it is applicable to 80% of your desired customers
Don’t be afraid to remove features or unnecessary complexity from the product if they aren’t adding value (this is a delicate area)
Keep a good pace of development and make sure clients know about new features through blog posts, dashboard updates, social media, and newsletters
My recommendation is to pace product development with customer input while maintaining a strong internal product opinion.
What else? What are some other things to keep in mind when considering the pace of development?
David Cummings on Startups 