David Cummings on Startups

Category: Entrepreneurship

  • Entrepreneurs Should Find a Peer Group

    One of the most beneficial things I’ve done as an entrepreneur is to join the Entrepreneurs’ Organization (EO), and, more specifically, join a forum within EO. A forum is a small group, typically 7-9 entrepreneurs, that meet once per month in a specific format. Here are some of the benefits I’ve found from having a peer group that meets regularly:

    • Always have a group of entrepreneurs that are there to help each other and who genuinely care
    • Constantly learning how other businesses operate including what works well and what doesn’t
    • Ability to develop deeper relationships compared to other professional colleagues

    I’m the membership chair for EO Atlanta for 2010-2011, so please reach out to me for more information. We have EO for entrepreneurs with revenues over $1 million and we have Accelerator for entrepreneurs with revenues under $1 million. Our goal is to assemble the most influential entrepreneurs in Atlanta that have a thirst for learning and peer-to-peer experience sharing.

  • Will Future Venture Funds Include a Dividend Component

    There’s been quite a few articles and blogosphere discussions over the past two years about the impending decline in the number of active venture capital funds (TechCrunch, WSJ, NY Times). Several trends cited for the decline of the size of the venture industry include:

    • Negative returns for the venture industry over the past decade
    • Asset allocation size readjustment due to overall asset value decrease (e.g. if a University endowment allocates 5% of assets to venture investing, and the value of the endowment drop 20%, which has happened to many schools, the original 5% allocated to venture is now significantly higher as a percentage of overall assets resulting in a need to reduce the amount put into venture on an absolute basis)
    • Fewer liquidity events where a company is acquired or goes public (IPO)
    • Lower cost to get a web company off the ground (but still expensive to scale)
    • Longer time frame to exit a business of 7-10 years instead of the previous 3-5 years, requiring larger exits to get the same desired rate of return
    • Lack of liquidity becomes significantly less desirable during times of market turbulence

    A typical venture investment in a company is for preferred shares of stock, with protections for downside scenarios, as well a seat on the board of directors. Venture capitalists then make money for their limited partners when the company is acquired, the shares are purchased by another investor, or the company goes public. Generally, VCs will say they are shooting for an 8x-10x return on their investment (e.g. get eight times the money they put in).

    In the public markets, a really simplistic way to think about the types of companies is to divide them into two camps: one type of company is focused on growth, doesn’t pay a dividend, reinvests profits, and is valued on its future potential whereas the other type of company pays a dividend, and is based on the value of future dividends. Usually technology companies are valued on future potential and companies that have a dividend, like banks, are valued on dividends (e.g. here’s a history of BB&T bank paying dividends).

    Venture capitalists often invest in technology companies and the investment is based on the potential growth and eventual sale of the business. Therein lies the challenge: if fewer companies are exiting for nice returns, it doesn’t take as much money to build a technology company, and exits are taking twice as long, something has to change. Thinking about the two simplistic types of public companies outlined above, it makes sense for some future venture funds to take a hybrid approach where they have a dividend component on investments in order to provide smaller amounts of liquidity back to the limited partners earlier than normal, while still generating the majority of their returns from the sale of portfolio companies.

    Let’s a take a look at an example:

    • The VC invests $1,000,000 into a company for preferred shares representing 20% of equity and a 15% dividend starting after 12 months that can be converted to equity at investor’s discretion but is assumed to paid annually.
    • If the company is growing fast, the dividend is converted to equity.
    • If the company isn’t growing as fast as desired, a $150,000 per year dividend is paid. As an example, after five years, with no dividend in the first year, $600,000 would be paid, and 20% of equity still owned (assuming no new investors).
    • If the company is sold for $20 million after the fifth year, the 20% is worth $4 million, plus the $600,000 dividend, results in a $4,600,000 aggregate return on the $1 million invested.
    • The $600,000 dividend doesn’t move the needle for the total return but does provide liquidity and mitigates complete write-off potential for the investors.

    My guess is that we’ll continue to see the trends that caused the decline in the size of the venture capital industry and by providing new approaches, like this one, investors will be more interested in participating.

    What do you think? Will a hybrid venture capital approach that provides dividends make it more appealing for some investors?

  • Best Exit Strategy Response

    People like to ask entrepreneurs “what’s your exit strategy”  as a nice conversation question. In fact, I like to ask it to get a gauge for an entrepreneur’s approach to the business. An exit strategy is simply what someone wants to do with the business when/if they are done with it. A typical exit strategy would be to get bought out by a larger, complementary company or to go public with an IPO (rare these days).

    My preferred exit strategy response is neither of the above. Here’s my favorite exit strategy response:

    My goal is to build the coolest, most innovative and profitable company I can. If an acquirer comes along I will consider it, but I’m focused on making something that is built to last.

    I believe that building a sustainable, enduring company is the highest form of entrepreneurship.

  • Employee 1% Community Time

    We value our corporate culture as one of the most important aspects of the company, and one way we give back is by employing 1% community time. What that means is all employees get to spend 1% of their time helping a non-profit in the community, fully paid for by the company. With a typical 50 week year, and 40 hours per week, for a total of 2,000 hours, 1% comes out to 20 hours, or 2.5 days of community service time. Yes, it is optional, but a good number of team members take advantage of it.

    What are some advantages of 1% time? Let’s take a look:

    • Great for employee morale
    • Powerful for team building and cross team rapport building
    • Positive impact for the community
    • Helps put things in perspective

    We’ve had events with Junior Achievement, helped clean up a park in South Atlanta, and have an event with the Boys & Girls Club coming up.

    My recommendation is to consider 1% community time for your company.

  • What Percentage of Startup Success is from What

    My views on the ingredients for startup success have changed significantly over the years. Originally, I believed that the management team was the overriding force. Now, the management team is still important, but I believe the market, including timing, for the idea is even more important. Here’s my gut allocation on how important different factors are for how I define a successful company:

    • Market – 40%
    • Team – 30%
    • Timing – 20%
    • Idea – 10%

    Notice that a great market with great timing represents the majority of the opportunity for success and that the actual idea is the least important. We’ve all heard the saying that ideas are a dime a dozen and that it’s the execution that counts. Combine all the pieces together and you have a winner.

  • The Healthy Department Symbiosis in SaaS Companies

    With Software-as-a-Service (SaaS) products, the operative word is service, not software. The service element, when done well, fosters a healthy symbiotic relationship between the company departments. Let’s look at the common departments:

    • Sales – Sets expectations with prospects and turns them into customers
    • Services – Gets clients successfully up-and-running
    • Support – Answers questions and continually helps clients
    • Engineering – Continually improves the product and fixed bugs

    By excelling in these departments, clients will renew their service and likely purchase additional services over time. Successful SaaS companies need to develop a service-oriented culture and exceed client expectations.

  • The “Don’t Know All Your Customers” Milestone

    Last week I was talking to a well regarded local entrepreneur who’s on his second venture. Near the beginning of the conversation, as we were talking about sales traction with his business, he said, “For the first three years I knew every customer, company name, and user at the company. Now we’re growing so fast, I don’t know all the customers anymore.” He’d reached the “don’t know all your customers” milestone in the business lifecycle.

    A key takeaway from the statement was just how close the entrepreneur was to his customers to know every single one, and that is over 200, for the first three years of the business. Being close to the customer is a significant business advantage that startups have over larger companies, and as the business scales it becomes much more difficult, which is why hiring the right people is so critical.

    My recommendation is to stay close the customer as long as you can and recognize the milestone that occurs when you no longer know every customer. It’s a bittersweet but significant milestone.

  • Why have the Shotput Ventures Requirements

    After publishing a post yesterday stating that the main reason applicants to Shotput Ventures are turned down is due to not meeting our published requirements, some people naturally defended the entrepreneurs as rule breakers (e.g. here). Thinking about it for a bit, I believe it is important to note that there is a serious difference between a rule breaker and fitting our thesis.

    Is the reason we have the requirements for Shotput Ventures to make it easy to turn away applicants? No.

    The reason we have the requirements is that we have a specific investment thesis that goes something like this:

    • We’re only scratching the surface as to how the Internet is going to change our lives
    • Never in history has it been so cheap to create a technology company
    • There is a segment of entrepreneurs that can afford to live on next to nothing and would like a group of mentors, and a small amount of money, to help see them through getting a prototype built

    We have the requirements in place because we’ve already funded eight companies and have learned from that experience. Things we require, like having a technical co-founder, and preferably two, have directly correlated with company success. Combine our experience with our investment thesis and you have why we enforce the requirements.

  • #1 Reason Applicants are Rejected by Shotput Ventures

    A friend yesterday was asking me questions about Shotput Ventures. Five minutes into the conversation he posed a good question: what’s the number one reason applicants are rejected by Shotput Ventures? Immediately, I knew the answer.

    By far, the main reason applications for Shotput Ventures are turned down is due to not meeting our stated requirements for the team. Within this generic reason, here are several specific examples:

    • Not having a technical co-founder that is an experienced programmer
    • Not having all co-founders able to work 100% on the new venture (e.g. one has to keep his or her day job)
    • Not having all co-founders in the same city (e.g. one is based in D.C. and wants to stay there during the program)

    Applying for Shotput, and meeting the published requirements, is just part of the process for choosing companies in which to invest. My recommendation is to read the Shotput Ventures site and apply once the criteria have been met.

  • The Cash on Cash Equation for Investors

    One way investors analyze a potential deal is to look at the cash on cash potential outcomes. Cash on cash (CoC) refers to the amount of money returned divided by the amount put in. So, if you invest $10,000 in a company and end up with $50,000 at time of exit, it was a 5x CoC deal. This is a much easier number to contemplate when compared to the more commonly used internal rate of return (IRR) as the IRR takes into account the amount of time the investment required to get to exit (e.g. getting 3x the investment in two years vs getting 3x the investment in eight years makes for a vastly different IRR).

    Generally, VCs have a goal of any one investment having a CoC outcome of 8-10x. So, for every dollar they put in they expect to get back eight to ten dollars. Lately it has taken an average of seven years from VC investment to exit, so the process takes significant time. I would argue that it is worthwhile to start talking in terms of CoC relative to time with a simple equation. This approximates IRR, but is easier to compute mentally when compared to saying we had a 20% IRR on that day. A simple equation might be something like add 1x for every year the investment is outstanding starting at 2x CoC (double the investment). If the investment takes three years, a great outcome would be 4x CoC, if it it takes seven years, a great outcome would be 8x CoC (which equates to the average VC investment length and desired outcome of eight times the investment).

    What do you think? Is cash on cash relative to timeframe worth talking about more frequently?