David Cummings on Startups

Category: Strategy

  • Example New Customer Usage Patterns

    Recently I was talking to one of the early employees of S1 Corp., a banking software company in Atlanta. S1 Corp started as the first online-only bank and pivoted into online banking software in the mid-to-late 1990s. Before being acquired by ACI Worldwide in February of 2012, S1 Corp. had a market capitalization of $577 million (NASDAQ: SONE). One of the many interesting things the early employee of S1 Corp. told me was how the first customers of the new online bank used the service.

    Here’s what new customers would do with their first online bank:

    • Send a $100 check to S1 Corp. to open an account (the minimum to start)
    • Month 1: The customer uses online bill pay to send $1 to themselves to see if the service works
    • Month 2: The customer uses online bill pay to pay for a non-critical monthly bill (e.g. lawn service)
    • Month 3: The customer uses online bill pay to pay for a standard monthly utility bill (e.g. electric)
    • Month 4: The customer uses online bill pay to pay all their bills

    This provides a useful example for entrepreneurs to think through and track how new users engage with a product. Product usage should be analyzed on a regular basis, especially new users of the product.

    What else? What are some other thoughts on the example new customer usage pattern?

  • Atlanta Needs More $1MM in Annual Revenue Profitable Companies

    Earlier this summer, Chris Dixon wrote a blog post titled Shoehorning Startups Into the VC Model where he argues most startups aren’t appropriate for venture capital (similar to the 4 Reasons to Raise Venture Capital). Joshua Baer, founder of Capital Factory (startup accelerator program) and several successful startups, wrote a comment on the post outlining his strategy to grow the Austin-area startup community:

    The first thing I usually do when I talk to a startup about raising funding is to try and talk them out of it and provide alternative options (customers paying in advance is the best!). At Capital Factory, we are focusing on tech startups that can reach $1mm in profitable annual revenue on less than $1mm of funding. They can get all of that from Angels and many won’t ever need to raise more funding from VCs (and many will go raise more money).

    This is a great strategy and applicable to Atlanta as well. With so few startup exits in Atlanta each year, we need more focus on building companies that are profitable on $1MM in annual revenue with less than $1MM in funding. Once a tech company achieves profitability on $1MM in annual revenue, there are many more options available like growing organically without raising more money, raising more money (money is easy to raise when you’ve derisked the model by hitting the $1MM in revenue mark), or paying dividends to owners (something that should happen more frequently in markets that don’t have many exits).

    Atlanta needs more $1MM in annual revenue profitable tech companies with less than $1MM of funding to help grow the startup community.

    What else? What are your thoughts on the value of $1MM in annual revenue profitable companies?

  • 4 Reasons to Raise Venture Capital

    At last night’s Venture Atlanta reception I had the opportunity to talk with a number of entrepreneurs that are out trying to raise venture capital. Naturally, I enjoyed asking the question “why are you raising venture capital?” The common refrain was that their business was doing great and that if an investor saw the potential in it, and bought in at a nice valuation, they’d raise money. Hmm, I thought to myself, that’s not a good answer.

    Here are four reasons to raise venture capital:

    1. 5x Exit Value Increase – You’re focused on making a significant amount of money, and believe the company will be worth at least 5x the value compared to what you can build without venture money (the 5x amount comes from expected dilution after several rounds of financing e.g. if you start with 50% of the business you’ll likely end up with 10% at the end of the process, thus needing a significantly greater exit to have a financial gain compared to what you can do on your own)
    2. Winner Take All – It’s a winner take all or most market such that the 2nd or 3rd place company is nearly irrelevant (think about eBay dominating the online auction market in the U.S.), which often requires raising a substantial amount of money and spending it ahead of growth
    3. Anchor Company – You want to build a large, anchor company in your city, as quickly as possible, and need to raise a substantial amount of money for the business to achieve escape velocity so that it can get big quickly
    4. Accountability – You value the accountability that having a board of institutional investors brings to the table on a regular basis helping you to execute at a higher level than you might do otherwise

    Other reasons for raising venture capital you might hear include wanting money to do a tuck-in acquisition, taking money off the table (that’s really growth equity or private equity and not traditional venture capital), or to help attract talent. These, along with raising money because of a good valuation, are not ideal as raising venture capital significantly changes the timeline and trajectory of the business.

    What else? What are some other reasons to raise venture capital?

  • Startups Should Simplify Everything

    A few weeks ago I was talking to an entrepreneur and he was showing me his web-based product. After 10 minutes of eagerly demoing functionality, I stopped and asked how much customization went into what he just showed me. Answer: 60 minutes. Not bad for B2B Software-as-a-Service (SaaS) application. I then asked to show me the behind-the-scenes admin section of the product to see exactly what customization looked like — it was painful.

    For a product with a free trial, there was no way their target audience was going to do a self-service signup and get value from the application without extensive hand holding and support. My recommendation was to simplify the product and have logical defaults such that with as little effort and friction as possible the end user could get value. It needs to be as close to zero configuration as possible.

    Here are some common things startups should simplify:

    • Customer sign-up and on-boarding process — use defaults that deliver 80% of the value
    • Bonuses — don’t have any
    • Commissions — make it so simple that the commission plan fits on a single page
    • Vacation — give unlimited vacation time and make it a results only work environment
    • Laptops — use MacBook Airs for everyone
    • Employee reviews — do them quarterly and only ask no more than four questions
    • Pricing — make it so easy it doesn’t require an Excel spreadsheet and publish the pricing online

    Startups win by staying closest to the customer with the quickest decision making process possible. Startups should simplify everything.

    What else? What are some other common things startups should simplify?

  • Entrepreneurs That Ride Major Trends

    Recently I was talking with a successful serial entrepreneur and he commented that he looks for major trends when deciding on his next business. He described it as finding a big sand box that he likes and digging around in it until he finds a great opportunity — I agree completely. I like to think about it as focusing on a small, fast-growing market doing a zig zag until you find the best wave to ride.

    Here are some big trends right now:

    • Cloud computing
    • Crowdsourcing
    • Social media
    • Mobile
    • Location-based services

    Those are some very generic trends. The idea is to find an angle or leading edge component within a trends and get ahead of the market. As for timing, 2-4 years early is often optimal.

    What else? What are your thoughts on entrepreneurs that look to ride major trends?

  • Growth Stage VC with 3-5x Money in 3-5 Years

    Venture capital, in its standard form, is pretty well known. The story is as follows: invest in 10 startups, the majority go bust, two or three make a good return, and one is a huge success returning the fund and them some. Only, over the past decade, most venture funds haven’t made any money at all so there’s more emphasis on startups with traction and other measures that show risk has been removed from the equation.

    There’s another segment of venture capital that isn’t talked about as much due to the few number of startups that reach the targeted size: growth stage capital. Growth stage is typically companies with at least $5 million – $10 million in revenues growing north of 30% per year. Once a technology company fits this category, growth stage venture capitalists will pay a nice premium, making a bet that the business will be able to grow substantially more and that worst case scenario they can get their money back (based on a 1x non-participating preferred preference with their stock).

    The common refrain when asked for investment return expectations isn’t the 8-10x that early stage VCs talk about, rather the goal is to return 3-5x the money invested in 3-5 years. 3-5 years isn’t the 7-10 year horizon early stage VCs look at, but it’s still plenty of time to generate significant value above and beyond what’s already been created.

    The next time you’re talking to a venture capitalist, ask about their expectations and desired return on investment.

    What else? What are your thoughts on growth stage VCs looking to making 3-5x their money in 3-5 years?

  • SaaS Customer Acquisition Costs Relative to Customer Revenue

    One of the core tenants of Software-as-a-Service (SaaS) economics is that the cost of customer acquisition needs to be commensurate with the revenue provided by the customer. As an example, if it costs $50,000 to acquire a customer and the customer only pays $1,000 per month, it’s likely that the business, in it’s current form, won’t work (save for an unusual up-sell situation). When looking at SaaS metrics, the ratio of customer acquisition costs to annual recurring revenue is one of the most important.

    Here are a few thoughts on SaaS customer acquisition costs relative to customer revenue:

    • A general rule of thumb is that the cost to acquire a customer should be less than the annual recurring revenue from the customer (e.g. if it costs $1,000 to acquire a customer, the customer should pay at least $1,000 per year in recurring revenue)
    • Length of contract and average lifetime of a customer are also important considerations, especially with products that have high switching costs (e.g. a content management system has much higher switching costs than an email marketing system)
    • Gross margin is another critical piece of the puzzle as SaaS companies with higher gross margins can afford to spend more to acquire a customer, everything else being equal
    • Cost of capital is another consideration when looking at customers that are expensive to acquire but will likely stay for many years

    As a SaaS entrepreneur, SaaS customer acquisition costs relative to customer revenue is one of the most crucial metrics for building a viable, high growth business. Many venture-backed companies burn significant amounts of cash to reach profitability, and many of the most successful ones don’t reach profitability until well after they’ve gone public. Regardless, the economics of customer acquisition need to make sense.

    What else? What are some other thoughts on SaaS customer acquisition costs relative to customer revenue?

  • Angel Investor Economics on a $30 Million Exit

    Recently a strong Atlanta technology company had a great exit with only angel investment and no venture investment. Not knowing any particulars of the deal, I think this is an instructive example to theorize on the economics of an outstanding angel investment. To make it simple, let’s assume a $30 million exit on $3.5 million of angel investment after six years in business.

    Here’s how angel investor economics might look for a generic, successful technology startup that exits for $30 million:

    • Series A – $500,000 invested at a $2 million pre-money valuation resulting in a $2.5 million post-money valuation and the investors owning 20% of the business
    • Series B – $1 million invested at a $4 million pre-money valuation resulting in a $5 million post-money valuation and the new investors owning 20% of the business from the new round (existing investors are diluted by 20% to 16% but likely participated pro-rata)
    • Series C – $2 million invested at a $8 million pre-money valuation resulting in a $10 million post-money valuation and the new investors owning 20% of the business (Series A and Series B investors get diluted unless they participate pro-rata with Series A owning ~13% and Series B owning 16%)
    • Total investor ownership: Series A at 13% plus Series B at 16% plus Series C at 20% for a total of 49% of equity
    • Exit values:
      Series A at 13% of $30M = $3.9M for almost an 8x cash on cash return
      Series B at 16% of $30M = $4.8M for a 4.8x cash on cash return
      Series C at 20% of $30M = $6M for a 3x cash on cash return

    Again, these is an outlier example that isn’t common — most angel investments don’t even return the amount of money invested, let alone a return. Generating a return of nearly $15M on a total investment of $3.5M in six years is an excellent angel investment.

    What else? What are some other thoughts on the this example angel investment and outcome?

  • Thoughts on the Trulia S1 IPO Filing

    Earlier today I saw the announcement that Trulia, a real estate listings site, had filed their S-1 with the SEC to do an IPO. Being a person that really enjoys technology, real estate, and learning how successful companies operate, I’m especially interested in the Trulia S-1.

    Here are some notes and thoughts on the Trulia S-1 IPO filing:

    • 22 million monthly unique visitors (pg. 1)
    • 360,000 active real estate professionals use the site with 21,544 paying subscribers (pg. 1)
    • 110 million properties, including 4.5 million homes for sale or rent (pg. 1)
    • 5 million unique pieces of user-generated content on homes, neighborhoods, and real estate professionals (pg. 1)
    • Revenues (pg. 2):
      2009 – $10.3M
      2010 – $19.8M
      2011 – $38.5M
      2012 first six months – $29M
    • Losses (pg. 2):
      2009 – $7M
      2010 – $3.8M
      2011 – $6.2M
      2012 first six months – $7.6M
    • $23.7 billion will be spent on real estate related marketing in 2012 (pg. 3)
    • Agents that pay the monthly subscription fees get more than 5x the leads (pg. 4)
    • 2.8 million real estate professionals in the United States (pg. 5)
    • Trulia was incorporated in June 2005 (pg. 6) – Note: Seven years from start to IPO is impressive
    • Accumulated deficit of $43.8 million (pg. 13)
    • Percent of revenue from subscriptions (pg. 14)
      2009 – 32%
      2010 – 47%
      2011 – 58%
      2012 – 68%
    • The primary reason for the decrease of advertising revenues in 2012 was due to a large customer going bankrupt (pg. 15)
    • Dependent on a listing aggregator to supply a substantial portion of the listings (pg. 16)
    • Revenue is seasonal with spring and summer the best (pg. 18)
    • Single data center with no failover (pg. 22)
    • They are using the recent JOBS Act to not have their auditor evaluate their internal controls (pg. 25)
    • $20M line of credit with $10M used from Hercules Technology Growth Capital, LLC (pg. 27)
    • Raised $32.6M selling preferred stock to venture capitalists (pg. 60)
    • ListHub provides a substantial number of listings (pg. 91)
    • 462 full-time employes (pg. 94)
      118 in technology
      303 in sales, marketing, and support
      41 in general and administrative
      267 in San Francisco
      165 in Denver
      16 in NYC
      14 work remotely
    • The follow the I.M.P.A.C.T. principles:
      Innovate
      Make a difference
      People matter
      Act with integrity
      Customer obsessed
      Trust and respect each other
    • 41,500 square feet of office space in San Francisco (pg. 95)
    • Ownership percentages (pg. 126)
      Co-founder and CEO – 13.5%
      Co-founder – 10.6%
      Accel – 23.6%
      Fayez Sarofim Investments – 19.6%
      Sequoia Capital – 10.9%

    From starting in mid 2005 to filing for an IPO in mid 2012 is very impressive. Trulia has all the ingredients for a strong IPO and I’m looking forward to watching them grow.

    What else? What are some other thoughts on the Trulia S-1 IPO filing?

  • Professional Services in Startups

    Startups should focus on finding product/market fit and building a repeatable customer acquisition process. While building new and innovative technologies, prospects will regularly ask for professional services. Professional services is a fancy way of saying custom or one-off consulting work. Assuming the bills can be paid and the lights kept on, professional services should generally be avoided until the core business is performing well so as to maintain focus on the product.

    Here are a few considerations around professional services in startups:

    • Some products require professional services for on-boarding clients or customizing functionality and that’s standard, but most should stay away from them when possible
    • Startups would do well to develop a network of other companies to provide professional services for the startup’s customers
    • Professional services can be a great way to help with client satisfaction and retention by offering a more comprehensive solution (again, when necessary)
    • Quality control with third-party professional services providers is another reason to offer them in-house

    Professional services are a standard part of the technology world but can get startups in trouble when too much work is custom and not part of the core product vision. Finding a balance is tough but it’s best to focus on the product and steer clear of one-time consulting work, if possible.

    What else? What are your thoughts on professional services in startups?