David Cummings on Startups

Category: Operations

  • Meaningful Metrics When Industry Metrics Don’t Make Sense

    Recently an entrepreneur was lamenting that his cost of customer acquisition (CAC) was significantly higher than the first year’s revenue for a customer (and even higher than the lifetime value for a customer). Naturally, I started asking more questions and digging into the situation. Turns out, it was a classic case of applying industry metrics to a business that was still in its infancy. Metrics like the cost of customer acquisition being less than the first year’s revenue is a great standard, but isn’t relevant when signing up the first 10-100 customers (unless the customers pay an unusually large sum).

    Imagine having two sales reps ($4,000/month each), a marketing manager ($4,000/month), modest pay-per-click spend ($1,000/month), and a tradeshow ($5,000 one-time) one quarter. Over the course of three months, that’s a sales spend of $24,000 (no commissions) and a marketing spend of $20,000. Now, say it was a good quarter and 20 new customers were signed paying an average of $1,000/year. $20,000 is new annual recurring revenue was added (no churn), yet $44,000 was spent on customer acquisition, resulting in a business with a poor magic number. Only, assuming this was early in the life of the product, say within the first 12 months, it’s too soon to definitively say that the customer acquisition model isn’t going to work.

    When industry metrics don’t make sense yet, the focus should be on growing 10% every week. Weekly metrics, especially as a percentage, work well because the absolute numbers are so small. Eventually, after things go well, the absolute numbers get bigger and industry metrics become applicable. Apply the right standard to the right situation.

    What else? What are some other examples when industry metrics don’t make sense?

  • Make Funding Last 18 Months

    A popular question in the entrepreneurial fundraising world is “How long should I make the money last before raising another round?” Of course, my advice is to raise as little money as possible until there’s a repeatable customer acquisition process (then, outside capital will have a dramatic ROI). Now, that’s not always possible, and fundraising is a part of life for many tech startups.

    After making a number of angel investments and working with entrepreneurs, my recommendation is to make funding last 18 months. Here are a few reasons why:

    • Fundraising, when it goes well, typically takes six months, so 18 months provides for 12 months of focusing on the business
    • Milestones often take twice as long and cost twice as much to achieve, so more time is ideal to figure things out
    • Hiring is a major effort once fundraising is done, and it takes serious time to find the right people and train them, so a sufficient timeline is needed for the startup to execute

    The next time an entrepreneur is building a budget for investors, push for making the money last 18 months. Fundraising requires a significant amount of time and takes away from growing the business.

    What else? What are some other thoughts on making funding last 18 months?

  • Entrepreneurs and Cash in the Bank

    Entrepreneurs love to spend money on an opportunity and opportunities abound. Every day I meet entrepreneurs that are putting all their saving into their idea in hopes of making it work. Some use their personal funds and some raise money from investors. The old adage that you have to spend money to make money still rings true.

    Only, there’s a major downside to spending the cash too quickly — not making enough progress to get to breakeven or be able to raise another round. Unfortunately, the cash in the bank will be spent, it’s only a matter of time for a growth-oriented entrepreneur.

    The solution: find the optimal core metrics for the startup and pace yourself until those are met. Once the metrics are in place, ramp things up. One of the most common mistakes is investing heavily before the business is well understood (I’m personally guilty of this).

    Entrepreneurs love having cash in the bank. And, inevitably, it’ll be gone quickly if there isn’t a repeatable business model. Figure out the right rhythm for the startup and invest accordingly. Don’t be afraid to be patient until the right metrics are solid.

    What else? What are some other thoughts on entrepreneurs and cash in the bank?

  • Gross Margin and SaaS

    One important aspect of Software-as-a-Service (SaaS) that isn’t well understood to first-time entrepreneurs is the role gross margin plays into the business. Gross margin is defined as the percent of revenue left over after the cost of servicing that revenue is taken into account (see SaaS cost of goods sold). For example, with a SaaS company, things like application hosting costs, customer on-boarding costs, customer service costs, and any third-party fees like software licenses or data fees that are required to use the product are included in the calculation.

    Gross margin is also a reflection of how valuable a dollar of revenue is to the business. If the company is an ecommerce business with 20% gross margins (commodity products) vs a SaaS business with 80% gross margins, every additional dollar of revenue for the SaaS business is equivalent to four dollars in the ecommerce business (due to the much higher contribution margin). Margin is one of the main reasons a $10 million revenue company can be more valuable than a $100 million revenue company.

    Early on, a startup shouldn’t worry too much about gross margin. It’s most important to find product/market fit and build a repeatable customer acquisition process. Over time, economies of scale will start to kick in and most SaaS companies will be able to achieve gross margins in the 70-80% range, if not higher. Gross margin, subscription revenue, and great growth opportunities all come together to drive high valuations for SaaS companies.

    Pay attention to gross margin in SaaS companies and understand why it is so important.

    What else? What are some more thoughts on gross margin and SaaS?

  • Economics of Customer Onboarding Programs

    After talking about The Importance of a Customer Onboarding Program, it’s now time to talk about some of the economics of customer onboarding. Many Software-as-a-Service (SaaS) entrepreneurs don’t realize that customer onboarding costs have to be amortized over some period of time and that they affect the cost of goods sold (here’s a separate primer on SaaS cost of goods sold).

    Let’s say the customer onboarding costs are as follows:

    • 10 hours of manual labor and hand-holding, on average, for each new customer onboarding
    • $60 per hour fully burdened cost for the implementation team
    • $600 in total onboarding costs for each new customer
    • One year amortization period for the customer onboarding costs (this length of time is debatable)
    • $600 total cost, divided by 12 months, equals $50 per month for the first year in additional cost of goods sold

    So, if the SaaS service is $1,000 per month, the gross margin is reduced by 5% per month for the first year due to the onboarding program costs. Of course, customer success and happiness is much more important than gross margin, but it’s important to understand how onboarding programs play into the economics of the business.

    What else? What are some other thoughts on the economics of onboarding programs?

     

  • The Importance of a Customer Onboarding Program

    Early on in the life of Pardot we realized that many customers would sign up for the product only to struggle implementing it. Seeing this, we started requiring a $2,500 quick start package so that we could ensure the client had a successful onboarding. Unfortunately, it added serious friction to the sales process since the up-front fee often required multiple signatures. The solution: raise the monthly fee from $500 to $1,000 and include a quick start package at no additional charge for all customers. Sales took off dramatically and we never looked back.

    Here are the categories of the Pardot Quick Start Onboarding Package:

    • Project Planning
    • CRM Integration
    • Technical Setup
    • Marketing Asset & Integration Setup
    • Training

    After 30 days, the Pardot client is up and running with their core sales and marketing tools integrated, prospects tracked, and emails blasting.

    Customer onboarding is critical to the success of many Software-as-a-Service products and should be treated as a key part of the customer experience.

    What else? What are some other thoughts on the importance of customer onboarding?

  • Revolving Door Transactions and Strange Coincidences

    Back in 2005 I was talking to a friend’s uncle who had previously worked in the technology industry for a number of years. He shared with me a story that during the 1990s he worked for a software company in Atlanta where the owners of the business bought a building that was 50% occupied, signed a lease so that their own company would use the remaining 50% of the building, and then sold the building to new investors, all in the same day. This is known as a revolving door transaction where entrepreneurs buy a building in the morning and sell it in the afternoon for a significant personal profit.

    After almost 10 years that story has stuck with me and represents an opportunity that many entrepreneurs don’t consider. Only, it gets more interesting. I bumped into my friend’s uncle last night at an event at the Atlanta Tech Village after not seeing him for several years. We caught up for a few minutes and then he tells me that the Atlanta Tech Village is the building he worked in 20 years ago for American Software (NASDAQ:AMSWA). Not only that, the Atlanta Tech Village is the building that the entrepreneurs did the revolving door transaction!

    Life is full of strange coincidences and this is another interesting one.

    What else? What are some more strange coincidences you’ve encountered?

  • Characteristics of a Salable Business

    Many entrepreneurs paint a picture in their mind of a strategic acquirer swooping in one day and paying an outrageous amount of money for their business. In reality, most businesses are of little value until one of two things happen: a) they have multiple years of sustained profitability, or b) they are growing fast and have at least $5 million in revenue (see The Magic of $5 Million SaaS Run Rate). Unfortunately, most startups won’t be able to find a strategic buyer.

    Here are characteristics of a salable business:

    • Large, established base of customers
    • Repeatable customer acquisition process
    • Proven management team
    • Little reliance on any one person
    • Consistent profitability and operating history (e.g. three years of results)
    • Strong recurring revenue (not required, but very desirable)
    • Market with logical, complementary acquirers

    As you can see there’s no reference to cool technology, innovative products, or hot ideas. Those things help, but most acquisitions are methodical and financially driven. While some acquisitions are emotional, most are not.

    What else? What are some other characteristics of a salable business?

  • The Magic of a $5 Million SaaS Run Rate

    After Defining a Successful Business several years ago for a Software-as-a-Service (SaaS) entrepreneur, the logical question is “what’s the next revenue milestone for a SaaS company after initial success has been achieved?” Things really start getting interesting once a startup hits the magic $5 million run rate mark. Here are a few reasons why $5 million is so important:

    • Product critical mass – $5 million often represents enough customers that the business will keep growing for several years to come
    • Team – There’s enough scale with 30-50 employees to have depth in each department, yet still move fast
    • Fundraising – Assuming a good growth rate (> 30%), it’ll be easy to raise money as a number of venture and growth equity funds exist with a minimum requirement of $5 million in revenue
    • Industry presence – There’s enough money for a marketing budget that enables attending all the conferences, being covered in analyst reports, and showing up in the key places online (SEO, PPC, etc)
    • Exit opportunities – Many acquirers aren’t interested in small startups, especially ones that are outside their hometown, so $5 million in revenue represents a minimum level where it’s worthwhile to look at acquiring a business

    While there’s no exact number, entrepreneurs that reach $5 million in recurring revenue with strong gross margins and a high growth rate have a tremendous number of strong options as well as enough scale to start spending more time on the business instead of in it.

    What else? What are your thoughts on a $5 million SaaS run rate being a major milestone for entrepreneurs?

  • Benefits of Price Transparency

    Earlier this week I was asked about my thoughts on publishing product prices and general price transparency. Whenever I visit a website, especially for a Software-as-a-Service (SaaS) product, one of the first things I do is go to the pricing page and try and understand how the company positions themselves in the market. Overall, I’m a big fan of price transparency on a SaaS site for a number of reasons:

    • Provides potential customers more information in an effort to empower them as much as possible
    • Creates an anchor for sales people to work with, and is especially great when combined with a no/limited discount policy
    • Makes it clear how customers are segmented by way of product functionality
    • Sets expectations around freemium products, if applicable (e.g. if the product is free, then the provider makes money off the users)
    • Allows for custom pricing options so as to capture more value and provide a different level of service to high-end customers

    Personally, I’m a practical personal that wants to empower buyers, and I think price transparency is a critical component of that.

    What else? What are some other thoughts on price transparency?