Recently a startup founder was asking me questions about how to architect his new web application so as to scale with millions of users. I told him that’d be a high class problem and he shouldn’t even worry about it right now as a minimum viable product is most important focus. Here are some high class problems in startups:
Scaling the web app due to so many users
More qualified job applicants than you can hire
Funding round oversubscribed by investors
More leads than your sales team can follow-up with in a timely manner
My recommendation is to not worry about high class problems and instead focus on what you can control and warrants attention.
What else? What are some other high class problems for startups?
At today’s Atlanta technology community lunch the featured guest was Promod Haque, one of the most famous VCs in the world. One of the stories that stood out to me was when Promod recounted when it was first emphasized to him that customer intimacy was a major key to success.
10 years ago Promod was chairman of a company where the CEO was actively recruiting a VP of Engineering. The VP of Engineering was almost ready to join the company but stipulated that he had to talk to the chairman in person first. Promod, curious about this request, met with the prospective VP of Engineering, and was posed one single questions: is there money in the budget to hire a VP of Product Management? After saying, yes, of course, that they were actively recruiting a VP of Product Management, Promod inquired as to why this gentleman was concerned. The prospective VP of Engineering said that he can build anything but that he needs a VP of Product Management that is truly connected to the customers and can distill down what needs to be done. The yin to his yang would be critical to the success of the company.
My recommendation is for one of the company co-founders to own product management and make it one of his or her top priorities. Product management is one of the more difficult skills to hire for and is best done by someone who is truly passionate about the product and builds great rapport with customers.
Many people talk about how much hard work it is to build a company. I particularly enjoy the phrase “an overnight success takes 10 years.” One aspect of entrepreneurship that isn’t talked about very often is burnout in startups. Michael Arrington, the founder of TechCrunch, recently cited burnout as one the of main reasons he just sold his company to AOL. A startup is often all-consuming, and after five years, can be difficult to maintain the pace.
After the company has achieved a level of success and stability I believe it is important to start moving towards a work/life balance. Here’s a few of the things I’ve found useful:
Daily thinking time (I walk a mile every other day)
Building a sales team is one of the more difficult things to do as an entrepreneur. You see, sales people are a great type of person that can sell themselves better than anybody, but it isn’t easy to determine if they’ll be effective for your product and prospects. Another challenging aspect of building a sales team, in addition to finding the right people, is determining who gets what leads. The traditional approach, especially with field reps, has been territories or geographic regions. The biggest challenge with territories for fast growing companies is that as you hire more sales reps territories inevitably shrink leading to disillusionment among sales reps, especially if their sales volume goes down after being a high performer.
We have an inside sales team and don’t do territories. Here’s what we do:
Two different lead queues for round robin assignment of leads
The first queue is for regular leads that come from standard sources like white paper downloads, campaigns, etc
The second queue is specifically for test drive sign-ups as those are our best and highest qualified leads
Both queues are round robin and by having two different queues we solve the problem of the highest quality leads getting passed out in an equitable manner. This avoids the situation where all leads go to the same queue and certain reps having bad luck with the leads that come their way.
My recommendation is to think through these challenges early in the process of building a sales team as it can help the moral and effectiveness during fast growth periods.
Most entrepreneurs start a company based on an idea that they are passionate about without regard to some of the more optimal financial ingredients in a business model. Let’s take a look at the trifecta of financial attributes for the perfect business model:
Recurring revenue — revenue that recurs on a monthly, annual, or multi-year basis is the best as it provides predictable cash flow
High renewal rate — going hand in hand with recurring revenue, renewal rates at 90% plus provide future enterprise value and contribute to the predictability of the business
High gross margin — revenue that has little to no marginal cost for each additional customer provides more room for profitability and investment in the business
A couple examples of businesses that typically meet these criteria include private wealth managers and software-as-a-service providers. My recommendation is to consider these three attributes when thinking through a business model.
What else? What are other attributes of a perfect business model?
Last night EO Atlanta had an event on positioning a business for sale including how to value it. Typically a business that is bought by an acquirer actively browsing is worth more than when a company shops itself around to other companies. Let’s look at a few more factors in valuing a business:
Concentration of customers (e.g. one big customer or lots of little customers where more customer variety usually is worth more)
Gross margins (percent of revenues after only product/service costs are taken out with high gross margins being more valuable)
Recurring revenue (percent of revenue that comes from monthly or annual fees with higher percentage of recurring revenue being more valuable)
Profits over the last twelve months (a simple formula for an average company is that the company is worth 4-6x the previous year’s profits)
Growth rate over the last twelve months (faster growth rate is more valuable)
Liquidity of the shares (more liquidity like with publicly traded companies is typically much more valuable e.g. 50%+ more valuable)
As you can see there are many different factors in determining the value of a business. It comes down to what another company or person is willing to pay for it with the more profitable and faster growing businesses being more valuable. An example would be a company with $1 million in trailing twelve months revenue with $200,000 in profit (assuming founders and management had market rate salaries) might be valued at 5x the profit, or $1 million. Some companies with no profits are bought for many times revenue due to their strategic value whereas other companies with significant revenues are bought for only a fraction of revenue due to significant debt, losses, and a decline in the business (e.g. Newsweek for $1).
Valuing a business is tough as the market of buyers is usually very small. These guidelines can help you come up with a rough idea of what a business might be worth.
There’s a term used to describe startups that have raised money from venture capitalists (VCs), been around for several years, built sustainable businesses, but don’t have the hockey stick growth necessary to raise more money or provide a venture quality return: zombies. Zombie startups are actually more prevalent than you might think and represent one of the more difficult situations for VCs. Here’s a few reasons why these are so tough:
VCs often have more money than time and can only sit on a limited number of boards and still be effective
Once a VC believes an investment is a zombie they want to sell it and move on
Valuations are down significantly compared to three years ago and companies that try to sell themselves often don’t command as much money as when a strategic buyer comes knocking
The VC still has a personal reputation and brand to maintain thus needing to provide significant energy to sell the company and get the highest price as part of their fiduciary responsibility to the limited partners in the fund
Now, if the startup was bootstrapped and in the same position it could still be a great business for the managers and employees to continue indefinitely. It is very unlikely for a VC to sell his or her stake back to the company or co-founders due to the difficulty of the buyer coming up with enough money. Zombies are part of the startup community and should be understood by entrepreneurs.
Customer service as a competitive advantage is one of the more difficult ones to sell as most people are jaded by companies that say they have good customer service but don’t deliver on the promise. Great customer service has to be experienced for people to believe it and therein lies the challenge: you have to convince them enough to even try it out. More tangible differentiators like we’re the only company with feature X or position Y are easier to defend and point to, but are also easier for competitors to adopt. Customer service is difficult to do well if it isn’t built into the culture from day one.
What companies do you think of when it comes to great customer service? Zappos.com, USAA, Amazon.com, etc. It’s really hard to do customer service well and the handful of companies that do it well are perennial growth stories.
Here’s what I’ve found works for making customer service a competitive advantage:
Mention that you pride yourself on customer service but don’t spend too much time on it as people won’t believe it
Work hard to get existing customers to do video testimonials and have them articulate why your company is so good
Think of ways to get qualified prospects to use your support team as part of your customer acquisition strategy (e.g. proof of concepts, trials, etc)
Know that the benefit of high quality customer service will come from long run customer retention and employee satisfaction (employees want to work in organizations that truly care about their customers)
What else? What are other things to keep in mind when using customer service as a competitive advantage?
Much of the tech startup media is obsessed with big exits, which make for fun-to-read stories. In a blog post today Jason Cohen writes about his new WordPress startup and provides a good answer as to his exit strategy in the comments:
Success for me is defined as: Creating a company that generates at least $30k/month in profit after paying everyone reasonable salaries, while it’s still growing.
Jason is building his company to last, as most entrepreneurs do, and will likely sell his business if the right offer comes along. The key is that he defines success as getting to a certain level of profitability while still growing. Today I brought up that blog post with three entrepreneurs and asked about their exit strategy. Every single one said they don’t have an exit strategy and want to build up their company to a point where they can hand it over to someone else to run it while still growing. That sounds like a great plan.
Earlier this week my friend sent me a quick email saying he had just finished Michael Lewis’ 2004 book Moneyball and that I should read it. Right away I replied saying that was one of my favorite books and that all startup founders should read it.
The short gist of the book is that professional baseball players were historically measured against traditional stats like batting average, on base percentage, etc. The Oakland A’s didn’t have the resources of teams like the New York Yankees but perennially did well in their division despite a significantly lower cost structure. They were able to do this by being scrappier with their players, farm system, and trades looking at long tail statistics and really focusing on past performance as the best predictor of the future.
Atlanta startups should be like the Oakland A’s in the book Moneyball.
David Cummings on Startups 