David Cummings on Startups

Category: Operations

  • What percentage of a startup’s revenue should be spent on office space?

    Over the last few months I’ve received the following question two times: what percentage of our revenue should we be spending on office space? Rarely do I like top-down approaches, rather I prefer doing a bottom-up approach whereby the most basic ingredients are analyzed to come up with a number. For office space costs, focus on the type of environment you want to have and the projected number of employees. Here are some examples:

    • Co-working environment or scrappy sublease — $100 – $250/employee/month (most desirable if it works for your startup)
    • Creative office or decent class B office building — $300 – $500/employee/month
    • Swanky office building with nice finishes and great views — $500 – $1,000/employee/month

    Generally, I like to recommend budgeting $500/employee/month for a nice office as I’m a big proponent of the office being a direct reflection of the company and its corporate culture. So, for a startup with 30 employees, $6,000/employee/year results in an office space budget of $180,000/year. There’s no perfect fit for all companies but for technology startups that are growing, I like investing in a great office.

    What else? What are your thoughts on the percentage of a startup’s revenue that should be spent on office space?

  • Thinking Through the Costs of an Initial Startup Office

    After an entrepreneur signs a critical mass of customers or raises a seed round of angel funding, it often becomes time to get a formal office and start hiring. Only, getting a traditional office is usually a big time sink and expensive. Here are some of the standard costs for a 3,000 square foot office designed to accommodate up to 15 people (e.g five people in year one, 10 people in year two, and 15 in year three):

    • Three year lease at $18/ft/year for a monthly rental cost of $4,500 resulting in a total lifetime cost of $162,000 (disregard a 3% annual rent escalation)
    • $10/ft tenant improvement allowance resulting in a $30,000 budget for paint, carpet, and moving a wall or two (paid for by the landlord and amortized over time)
    • 7% commission with 2% going to the building leasing agent ($3,240) and 5% going to the tenant leasing agent ($8,100) all paid for by the landlord
    • Wiring for ethernet and electrical at a cost of $3,000 (assume $200 per employee)
    • Fiber internet access providing 100 mb/sec for $1,000/month (so, $36,000 over three years)
    • Furniture and chairs at a cost of $15,000 (assume $1,000 per employee for desk, chair, and collaboration areas like conference room furniture)
    • Total for three years: $216,000
    • Optional: parking at $60/employee/month for a cost of $900/month or $10,800/year when at full capacity

    Now, this is a nice, semi-custom office designed in a relatively high density manner to support five employees per 1,000 and it costs over $200,000 for a small startup over three years. Costs, plus a serious amount of work over a 90 day period of time to put it all together, makes for a situation less than ideal in the volatile and time sensitive world of a startup.

    What else? What are your thoughts on this breakdown of costs and what would you add/change about it?

  • Startups and Financial Audits

    Annual financial audits are a cost of doing business for many tech startups. While they aren’t the most fun, they do provide great third-party validation of the books and oversight for how the business is being managed financially. Most entrepreneurs should not spend the $10k – $30k on an annual audit.

    Here’s when an annual financial audit makes sense:

    • Institutional investors (like VCs) or other sophisticated investors are involved — they’ll require it
    • A bank line of credit or senior debt in the business requires it
    • There’s a business goal to be able to sell the business in the next three years — most buyers will require three years of audited financial statements

    Most of the time an annual financial review, which acts like a lightweight audit, but without all the guarantees by the accounting firm, is a much more affordable way to engage a third-party to review the books. Entrepreneurs should understand when it does, and doesn’t, make sense to pay for an annual financial audit.

    What else? What are your thoughts on startups and financial audits?

  • What Scale Does a Startup Need to be Independent of the Founder

    Two weeks ago a couple of entrepreneurs were in my office asking for advice on their startup. Their revenue has really accelerated in the past six months and they’re debating between investing more in the business or putting money aside for a rainy day fund. After asking how many employees they had (less than 10) I asked if the business was dependent on them. Yes, unequivocally.

    I sensed that growing the team to the point that it wasn’t dependent on them was a near-term desire. Of course, you could do a budget and come up with that number. From my experience with software/software-as-a-service startups, the business would be spending about $1.5MM on salaries, benefits, and infrastructure (e.g. office space) to be large enough to not be dependent on the founders. Here are some items to think about with respect to size of business:

    • Gross margins will influence whether spending $1.5MM on team member occurs at $2MM of revenue or $10MM of revenue
    • Founders are often decent at multiple things and really good at one thing — that one thing is often the last type of talent brought on the team, and typically expensive because the founder has high standards for the role
    • Redundancy or scale is needed for positions that are critical to operation of the business (e.g. number of software engineers, support people, etc) so that the founders and team members can take vacation without worrying if the business will continue to operate
    • One strategy for a founder is to take a two week vacation, forcing the issue of what is, and isn’t, dependent on them (banks like to make every employee take one two week vacation per year to see if any fraud is taking place with that person)
    • Depending on the size of the startup, some investment in people will have to take place in advance of growth to be self sufficient from the founder

    Reaching a size and depth of business to be founder independent is a huge milestone. I’ve found that ensuring the business isn’t dependent on the founder (e.g. through a long vacation) provides great peace of mind and sense of progress — it should be a goal on every entrepreneur’s list.

    What else? What are your thoughts on the necessary size of a startup to be independent of its founder?

  • Scaling Corporate Culture in a Startup

    Earlier today I had the opportunity to talk to Charlie Goetz’s Emory entrepreneurship class. Every time I talk to a class I work hard to emphasize the importance of corporate culture, especially how it’s the only sustainable competitive advantage within the control of the entrepreneurs. Now, in an MBA class, all students have several years of work experience, and thus first-hand interaction with one or more corporate cultures. When I start talking about corporate culture to MBA students, they appreciate it more than students that haven’t had full-time jobs.

    One of the questions asked by a student today was “how do you scale the corporate culture as the business grows?” Here are a few ideas:

    • Implement culture check teams to provide checks and balances during the hiring process
    • Require unanimous consents from all interviewers when making a new hire
    • Regularly tell stories of positive corporate culture anecdotes
    • Include culture values in the quarterly check-ins
    • Physically embody the corporate culture through colors, objects, and visual cues

    Scaling a corporate culture in a startup is hard. Not scaling a successful corporate culture will make scaling the business 10 times more difficult.

    What else? What are some other ideas to scaling corporate culture in a startup?

  • Employee Equity in a Salary Multiplier Context

    Yesterday’s post titled Common Equity Grants for Startup Employees gave broad, simple amounts of equity for employees of a funded startup, which serves as a good starting point. In reality, things are much more nuanced with amount of salary being one of the biggest drivers of equity (e.g. more salary results in less equity). Another recommended way of determining the amount of equity for a position is to do it as a multiple of the market-rate salary in the context of the four year business goals.

    Here’s an example of employee equity in a salary multiplier context:

    • Employee position: $100,000 market rate salary for a software engineer with some experience
    • Startup raised $2 million on a $3 million pre-money valuation for a $5 million post-money valuation
    • Entrepreneurs decide the target equity goal for the employees is to make 2x their market-rate salary in value after four years (equity has four year vesting with a one year cliff)
    • Assume the startup doubles in value each year by executing well and growing revenue with these being example valuations (these are valuations, not revenue):
      Year 1 – $5 million
      Year 2 – $10 million
      Year 3 – $20 million
      Year 4 – $40 million
    • Assume 50% dilution from future funding rounds (so really need 4x their market-rate salary to get to 2x after dilution)
    • $200,000 as a percentage of $40 million is 0.05%
    • Double the 0.05% to account for dilution taking out half and you have 0.1% to start

    So a software engineer with a $100k salary would get equity amounting to 0.1% of the business for a startup that just raised a funding round, but still at an early stage. If the entrepreneurs wanted to offer a greater multiplier on salary, or if the business was more mature with respect to valuation, the percent ownership with be adjusted appropriately.

    What else? What are your thoughts on employee equity in a salary multiplier context?

  • Startups Should Have a Structured Discount Policy

    Recently I was talking to an entrepreneur and he asked how discounts worked for our sales team. I explained we have a structured system to remove ambiguity and maximize autonomy for sales reps (how often have you heard the refrain “let me go ask my manager for a discount”).

    Here’s how an example structured discount policy might work:

    • For every $12,000 in annual contract value (ACV) sold, the rep gets $600 ACV discount for future deals
    • Discounts are accrued in a discount bank and don’t expire
    • No deal can be more than 25% off the retail price
    • No deal can be below a certain floor
    • If a customer pre-pays for a year, they get an extra 10% discount
    • If a customer commits to a longer contract, each additional year gets a 10% discount

    So, the star reps that sell more deals get more money for their discount bank. Interestingly, the higher producing reps, with more discounts at their disposal, actually offer fewer discounts. Most startup discount policies are too vague and result in ambiguity (should I wait until my boss is in a good mood after his coffee to ask for this discount?). Startups should implement a structured discount policy and make everything easier for their sales team.

    What else? What are some other thoughts on a structured discount policy for startups?

  • SaaS Cost of Goods Sold for Startups

    Cost of goods sold for Software-as-a-Service (SaaS) startups seems like it should be a straightforward topic but there are a number of different conflicting reports online. According to Wikipedia, cost of goods sold “refers to the inventory costs of the goods a business has sold during a particular period.” Of course, due to the nature of software, there is no inventory but there are costs to deliver the application.

    Here’s what we include in our cost of goods sold calculation:

    • Hosting fees (our highest expense after salaries and benefits)
    • Third-party web fees like content delivery networks, embedded software, etc
    • Support personnel costs
    • Customer on-boarding costs (e.g. client implementation personnel costs)
    • Note: Credit card fees and other billing fees often are not cost of goods sold for SaaS companies and are instead general and administrative fees

    Notice things like software development costs, customer acquisition costs, and more aren’t included since they are not required once the customer has already been signed. SaaS cost of goods sold is an important metric so that gross margin can then be calculated.

    What else? What are some other items that should be considered as part of cost of goods sold for SaaS companies?

  • Bottom-Up SaaS Revenue Forecast for Startups

    Bottom-up revenue forecasts are the only way to go for startups, especially for Software-as-a-Service (SaaS) startups. Too often, entrepreneurs will take a big number, like all the people in China, and say are going to get 1% of them to buy something, and thus have a big business. Alternatively, an entrepreneur will start with a small number, like their current revenue, and forecast that it will grow at some growth rate indefinitely (if only things were like the wise man who asked the king for one piece of rice and to have that piece doubled for every spot on a chess board). Unfortunately, top-down revenue forecasts should not be used for startups.

    Here’s an example bottom-up SaaS revenue forecast approach:

    • Take the number of sales reps expected to make quota (e.g. 2)
    • Multiply by the monthly quota per rep (e.g. $25,000 in new annual contract value (ACV) per month or $75k ACV per quarter or $300k ACV per year)
    • Multiply by the monthly renewal rate (e.g. between 97% and 99.5%)
    • Add in any consulting or one-off revenue
    • Arrive at the total monthly revenue

    Bottom-up forecasts are the only way to go for SaaS startups and should be used from idea stage all the way through growth stage.

    What else? What are some other thoughts on bottom-up SaaS revenue forecasts for startups?

  • 7 Crazy Startup Workplace and Culture Things to Do

    Yesterday I was having lunch with a group of entrepreneurs and business leaders. One of them commented on us winning an award for being the #1 place to work and asked if I’d share any secrets or tips. I love talking about all the crazy things we do, so I jumped right in.

    Here are seven crazy startup workplace and culture things we do:

    1. Bottom up daily check-ins – everyone participates in a quick meeting at the beginning of the day with their manager and answers the following questions: what did you do yesterday, what are you going to do today, and do you have any roadblocks
    2. Scoreboard – a large LED scoreboard for everyone to see how the company is doing across key metrics color coded red, yellow, green, and super green
    3. Two page essays during the hiring process – all applicants for all positions have to write a two page essay as part of the hiring process and we’ve found that ones ability to write is highly correlated with the ability to do the job for all departments
    4. Culture check during the hiring process – we have several two-person teams that interview candidates exclusively for corporate culture fit and don’t assess things like domain expertise or ability to do the job
    5. Quarterly check-ins – each quarter every team member sits down with their manager for an hour one-on-one meeting and answers the following questions: what did I accomplish last quarter, what am I going to accomplish this quarter, how can I improve, and how am I following the values
    6. Four hours of monthly housecleaning – we pay for four hours of housecleaning per month for each employee to help simplify and improve their personal life
    7. Freestyle Fridays – we don’t allow recurring meetings on Friday and discourage any meetings or interruptions so that people get longer periods of time to concentrate and get in the zone (most people work from home several days per week as well)
    8. Bonus: No vacation tracking – we don’t track employee vacation or sick time as our focus is on delivering results and meeting expectations, not on how many hours someone worked

    One of the things I tried to emphasize at the lunch meeting is that the perks and benefits side of the equation reinforces the value we place on our people, but people love the company because of the other people they work with, and the perks are icing on the cake.

    What else? What are some other crazy startup workplace and culture things you recommend?