David Cummings on Startups

Category: Investing

  • Three Ways VCs Value Investments for LPs

    Scott Kupor of Andreessen Horowitz has a great post titled When Is a “Mark” Not a Mark talking about a recent WSJ article and the different ways venture capitalists internally value their investments for their investors. One of the biggest challenges being an investor in a private company is that there’s no market to readily sell the shares, thus it’s hard to know the value, and even harder to turn value into cash (ready about the Dry Bubble).

    Here are three ways VCs value investments when reporting their data quarterly to the limited partners:

    • Last round valuation/ waterfall – Take the valuation for the last round of financing, take the percent ownership, and report the value of that percent ownership.
    • Comparable company analysis – Take the current metrics of the business (especially revenue), take publicly traded companies that are similar, and base the valuation off those comparables with a ~30% discount for being private
    • Option pricing model (OPM) – Run the different potential exit scenarios through a complicated statistical model (made easy by software) and use the resulting output

    Go read When Is a “Mark” Not a Mark and better understand some inner workings of the venture industry.

    What else? What are some more thoughts on three ways VCs value investments for LPs?

  • Notes from The Trade Desk S-1 IPO Filing

    The Trade Desk, a demand side advertising platform, just filed their S-1 IPO filing to go public. Demand side advertising is where ads are purchased to be then served by supply side advertising platforms. One of the big benefits is having one system to buy ads that then integrates with dozens of other systems.

    Now, let’s take a look at the S-1 from their recent filings. Here are a few notes:

    • Our platform provides access to approximately 3.2 million ad spots on average every second for our clients to bid on across millions of different scaled media sources—websites, shows, channels, stations and streams. (pg. 1)
    • In 2015, approximately $14.2 billion was transacted in the 1 Table of Contents programmatic advertising spot market via real-time marketplaces, according to Magna Global. (pg. 2)
    • Financials (pg. 2)
      • Revenue
        • 2015 – $113.8 million
        • 2014 – $44.5 million
      • Net income
        • 2016 1H – $6.6 million
        • 2015 – $15.9 million
        • 2014 – $5,000
      • Gross billings (pg. 11)
        • 2015 – $530 million
        • 2014 – $201 million
    • Trends (pg. 3)
      • Media is Becoming Digital
      • Fragmentation of Audience
      • Shift to Programmatic Advertising
      • Automation of Ad Buying
      • Increased Use of Data
    • Approximately 389 clients, including the advertising industry’s largest agencies, as of December 31, 2015 (pg. 5)
    • Clients can easily buy targeting data from over 80 sources through our platform (pg. 5)
    • Average days sales outstanding, or DSO, of 88 days, and average days payable outstanding, or DPO, of 64 days at June 30, 2016. (pg. 18)
    • Approximately 7% of our gross spend in 2015 was derived from outside of the United States. (pg. 29)
    • Access to borrow up to $125.0 million aggregate principal amount of revolver borrowings (pg. 31)
    • Accumulated deficit of $28 million (pg. 48) (Note: it’s really impressive to achieve this scale and growth rate on this relatively small accumulated deficit).
    • Between our inception in November 2009 and June 30, 2016, we generated aggregate proceeds of $88 million from the sale of convertible preferred stock (pg. 68)
    • Ownership (pg. 124):
      • VCs – 34%
      • Founder / CEO – 26.7%
      • Founder / CTO – 1.5%

    Congratulations to The Trade Desk for building a great business in seven years and for heading towards an IPO as their next milestone. This IPO will be well received based on scale, growth rate, and profitability.

    What else? What are some other thoughts on The Trade Desk IPO filing?

  • 2 Answers to the Valuation Question

    One of the questions investors like to ask is “What’s your target valuation for this round?” Sometimes they’re calibrating to see if the valuation is in their typical range, sometimes they’re fishing for information, and sometimes they’re seeing if there’s a logical answer. As an entrepreneur, there are two correct answers:

    1. We’re going to let the market decide.
      This should be the most common answer (it isn’t) as it shows that the entrepreneur is both flexible and looking to create an auction process to find the best combination of terms and valuation.
    2. We’re thinking of the range $X to $Y.
      Now, it’s best to keep it open ended but some investors press for a number. Don’t give a single number. Instead, give a range and sound flexible since it depends on a variety of factors. Never forget the old investor saying: you decide the valuation and I’ll decide the terms (it always holds true).

    When an investor asks about valuation, provide one of these two answers and keep it simple. Valuations are much more subjective than they might seem.

    What else? What are some more thoughts on the two answers to the valuation question?

  • 4 Reasons for a Lack of Local Institutional Capital

    Continuing with yesterday’s post on Rating the Atlanta Startup Scene, several people have asked how we get more local institutional capital. Institutional capital, like it sounds, is capital provided by institutions like university endowments, pension funds, etc. Generally, institutional capital is a much larger source of capital, as compared to angel capital, and thus an important part of a thriving startup scene, especially for startups that hit the growth stage (see Scaling a Startup is Expensive).

    Here are four reasons there’s a lack of institutional capital in Atlanta (and all areas outside the Bay Area, Boston, and NYC):

    • Track Record – New funds are forming all the time but most of them only have high net worth individuals and family offices as limited partners since institutional investors always require an investment track record of one or two funds (e.g. get started with a small fund from personal investors, show great results, and then raise money from institutions).
    • Pedigree/Background – There’s a certain resume and pedigree that institutional investors look for, often including a name-brand college, work on Wall St., etc. that’s not as common outside the money centers.
    • Big Exits – The goal of any fund is to make great returns, and that requires big exits, yet there are so few exits, let alone big ones, that the story of low cost of living and low valuations doesn’t resonate. Meaningful returns and exits resonates.
    • Dot Com Bust – Many regional funds that had institutional capital went out of business after the dot com bust as they didn’t have strong enough returns to raise another fund. A whole generation of funds were wiped out and it’s 7+ years to build a new fund that gets to the point that fits the institutional capital model.

    As expected, the answer to having more local institutional capital is to have more successful startups with solid exits that generate returns for first-time funds so that they can then raise another fund with institutional capital. It’s a multi-stage process that requires a decade or more to see results. The best thing we can do as a community is to help produce more successful startups.

    What else? What are some other reasons for a lack of local institutional capital?

  • 20+ Fundraising Tips from First Round Capital

    First Round Capital has a great new article up titled The Fundraising Wisdom That Helped Our Founders Raise $18B in Follow-On Capital. Every entrepreneur that’s raising money, or considering raising money, should head on over and read it. Here are 20+ tips from the post:

    1. First, Fix Your Timeline
    2. Target the Right Investors
      1. Vet the portfolio, pick the partner
    3. Generate Scarcity
      1. Fundraise like a surfer — plan to take on investors in sets.
      2. Make it a race
    4. The Wins and Sins of Pitching
      1. Surface all the burning questions
      2. Frame your problem in an original way
      3. Anticipate and address any objections
      4. Don’t bury your lead
      5. Explain the customer pain point faster with emotion
      6. Don’t just have a dedicated competition slide
      7. Put your team slide toward the end of the deck
      8. Keep your slides simple and rely more on what you say
      9. Make your appendix your arsenal
      10. Don’t stress about slide numbers
      11. Don’t roll with an entourage
      12. Pitch to your personality
      13. Sync your timeline and your mindset
      14. Exhibit unapologetic confidence
      15. Build credibility through vulnerability
      16. Don’t trigger the bullsh*t meter
    5. Rehearsal Required
    6. Putting it all Together

    Read the post and soak in the fundraising wisdom — it’s worth your time.

    What else? What are some more fundraising tips?

  • Economics of a Software-Focused Private Equity Strategy

    A few weeks ago I had the chance to spend time with a general partner from a large private equity firm. This particular partner was focused on software companies in the middle market. Naturally, I wanted to learn how the model works, so I drilled in.

    Here’s the general idea:

    • Buy the majority of a “platform” software company with modest growth for 10x EBITDA (e.g. find a software company with $40 million in revenue generating $10 million/year in EBITDA and purchase 70% of it for $70 million)
    • Spend 3-4 years helping the platform company acquire 5-10 smaller, complementary software companies for 5x EBITDA (sub-scale companies sell for a much lower multiple e.g. a $5 million software company doing $1 million in EBITDA might sell for $5 million)
    • Build up the company to $30 – $40 million/year in EBITDA and sell it for 10x EBITDA (likely to another private equity firm)

    Pretty interesting. This makes sense and is a standard roll up strategy, only applied to software companies. The next time you read about a private equity firm buying a software company with modest growth, there’s a good chance this is the strategy.

    What else? What are some more thoughts on the economics of a software-focused private equity strategy?

  • Lack of SaaS Consolidation

    Villi Iltchev has an interesting post up titled Why SaaS Consolidation is Not Happening. As more and more money has been invested in SaaS over the past 10 years, the logical expectation is that there would be a corresponding number of exits. Only, the number of material SaaS exits has been relatively small.

    Here are a few of the challenges with SaaS consolidation as enumerated by the author:

    • Supporting and scaling multiple clouds is daunting.
    • Customer Success is the vendor’s responsibility in SaaS.
    • Distribution in SaaS is much less impactful.
    • Sales productivity does not get better.

    I agree and expect to see a number of small-to-medium SaaS companies rolled up over the next five years (see What Happens to Small SaaS Companies). Once the 10 year horizon is done for venture funds, and a number of their SaaS investments are only growing modestly, look for a number of exits to private equity firms that will roll them up and maximize cash flow.

    What else? What are some other thoughts on the lack of SaaS consolidation?

  • Notes from Twilio S-1 IPO Filing

    Twilio just released their S-1 IPO filing to go public after a tech IPO drought for much of the year (except Atlanta-based SecureWorks). Twilio provides a cloud-based communications platform for phone, text messaging, video, and more (think of it as an easy API for communications). I remember first learning about Twilio back in 2010 when we integrated it into Pardot. We made a connector such that when a lead filled out a form on a site, Pardot would trigger Twilio to call the sales rep assigned to that new prospect, read out the prospect’s information, and say press 1 to connect to the person at which point Twilio would call the new lead with the sales rep on the phone. We used to pitch it as “sales reps hate dialing out but love answering the phone.”

    Here are a few notes from Twilio’s S-1 IPO filing:

    • Our Programmable Communications Cloud software enables developers to embed voice, messaging, video and authentication capabilities into their applications via our simple-to-use Application Programming Interfaces, or APIs. (pg. 1)
    • As of March 31, 2016, over 900,000 developer accounts had been registered on our platform (pg. 2)
    • Revenue (pg. 3)
      2013 – $49.9 million
      2014 – $88.8 million
      2015 – $166.9 million
      2016 Q1 – $59.3 million
    • Losses (pg. 3)
      2013 – $26.9 million
      2014 – $26.8 million
      2015 – $35.5 million
      2016 Q1 – $6.5 million
    • Our platform has global reach, consisting of 22 cloud data centers in seven regions. (pg. 4)
    • We define an Active Customer Account at the end of any period as an individual account, as identified by a unique account identifier, for which we have recognized at least $5 of revenue in the last month of the period. (pg. 14)
    • In the three months ended March 31, 2016, we had nine Variable Customer Accounts, which represented 16% of our total revenue. (pg. 15)
    • Headcount has grown from 386 employees on March 31, 2015 to 567 employees on March 31, 2016 (pg. 17)
    • We believe that our corporate culture has been a critical component of our success. (pg. 17)
    • We also experienced increased expenses in the second quarter of 2015 due to our developer conference, SIGNAL, which we plan to host annually. (pg. 19)
    • We outsource substantially all of our cloud infrastructure to Amazon Web Services (pg. 22)
    • In 2013, 2014 and 2015 and the three months ended March 31, 2016, we derived 9%, 12%, 14% and 15% of our revenue, respectively, from customer accounts located outside the United States. (pg. 23)
    • In 2013, 2014 and 2015 and the three months ended March 31, 2016, WhatsApp accounted for 11%, 13%, 17% and 15% of our revenue, respectively. (pg. 25)
    • WhatsApp has no obligation to provide any notice to us if they elect to stop using our products entirely (pg. 25)
    • Accumulated deficit of $151.8 million (pg. 57)
    • Equity ownership (pg. 143)
      Founder/CEO – 11.9%
      Bessemer Venture Partners – 28.%
      Union Square Ventures – 13.6%
      Fidelity – 6.1%

    With a $240+ million run-rate, Twilio is poised to have a great IPO. As there are telecom fees that lower gross margins and a fair amount of variable revenue, Twilio won’t be priced like a true SaaS company but will still get a healthy multiple due to the great growth rate.

    What else? What are some more thoughts on Twilio’s S-1 IPO filing?

  • Demonstrate Growth Momentum, Even at Modest Scale

    This week I’ve already had conversations with multiple seed stage entrepreneurs that are having a hard time raising money. In each case they have some modest metrics that show progress but don’t have enough revenue to get investors excited. Now, with limited capital, it’s a catch-22 where they need more money to get to the point investors where investors want to invest but can’t get there without investment. My advice: figure out how to show a growth momentum story, even if it’s a modest scale.

    The goal is prove momentum and show month-over-month growth for the last 4-6 months. Here’s what that might look like:

    • Annual recurring revenue started the year at $100,000 and is now at $175,000 five months in growing 15% month-over-month (e.g. $100,000 in month 1, $115,000 in month 2, $132,500 in month 3, $152,000 in month 4, $174,900 in month 5, etc.)
    • Daily active users started the year at 100,000 and are now at 207,000 five months in growing 20% month-over-month (e.g. 100,000 in month 1, 120,000 in month 2, 144,000 in month 3, 172,800 in month 4, 207,360 in month 5, etc.)

    In both of these examples the metrics are still in the seed territory (e.g. institutional investors want to see at least $1 million in annual recurring revenue for a SaaS startup) but there’s a clear story of sustained growth at a modest scale over several months. That sustained growth proves something is working and helps an investor believe that there’s opportunity for even more growth in the future.

    What else? What are some more thoughts on demonstrating growth momentum as a way to get investors interested?

  • Thoughts on Boston’s New Pillar Fund

    Yesterday I was reading about a new $100 million venture fund in Boston called Pillar in an article titled With Pillar and Other Newcomers, Boston’s Venture Scene Shifting. The pitch: an experienced VC is building a new, modern fund that’s much more entrepreneur friendly.

    Here are a few of the new ideas in the fund:

    • Only buys common stock in startups so that they’re always aligned with entrepreneurs (no preferences, no anti-dilution, etc.).
    • Cash out opportunity for the founders to sell some of their equity (up to $1M) after three years and certain milestones so that they don’t feel pressure to sell the entire company too soon.
    • Limited partners that are local entrepreneurs with a range of expertise and are willing to help the investments

    The big idea is that venture funds make their money on the investments that go well, not by getting some of their money back from ones that go poorly. Thus, be as desirable as possible to the entrepreneurs so that the fund gets the best investment opportunities.

    I’m looking forward to seeing how it plays out and if the model works.

    What else? What are some more thoughts on Boston’s new Pillar fund?