Category: Strategy

I know some people that focus on minimizing the potential downside of an initiative, project, idea, etc. It isn’t that they have negative personalities, it’s that they worry about what could go wrong as part of their core being. They can’t turn it off, no matter how hard they try.

I know some people that focus on maximizing the potential upside of an initiative, project, idea, etc. It isn’t that they are ignorant of the challenges, it’s that they focus on the potential and inherently have blinders on to all the nuances. They often hate the details.

The world needs all types of people. Startups often do well having both types of people on the co-founding team, with a healthy give and take relationship. Someone needs to think big and maximize the upside while someone else needs to counterbalance and look for ways to minimize the downside. Dreamers and worriers go well together.

What else? What are your thoughts on maximizing the upside and minimizing the downside?

Hockey stick growth curves are a desirable path for startups. The idea is that growth is slow and steady, much like the base of a hockey stick, and then at some point it really starts to take off, much like the long part of a hockey stick. There’s another concept, escape velocity, that isn’t talked about as much but is still important.

According to Wikipedia, escape velocity is the speed at which the kinetic energy plus the gravitational potential energy of an object is zero. You can think of it as the point where something breaks free from whatever is holding it back, and thus  carries on indefinitely. For startups, escape velocity has to do with becoming the dominant vendor and growing indefinitely. All too often, a startup goes through the hockey stick growth path, only the fast growth eventually plateaus and the startup has slow or no growth. The startup didn’t fully achieve escape velocity.

A company like Salesforce.com that’s still growing at double digit rates, even with billions of dollars of recurring revenue, achieved escape velocity and shows no signs of slowing down. Few startups achieve the hockey stick growth curve and even fewer achieve escape velocity. Pay attention to the growth paths of other startups and ask yourself if it achieved escape velocity.

What else? What are your thoughts on escape velocity?

Recently I was meeting with an entrepreneur who’s out raising a Series A round from VCs. He’s already raised an angel round, built an almost complete version one of the product, and has a handful of customers. Personally, his goal is to build a large successful company, on someone else’s dime, and then do it again on his own timeframe without investors in the future. The clock is ticking now.

When the founder started asking questions about raising money from VCs I quickly asked what his value multiplier was to raise VC money. That is, how much money would he make on his current growth path with an exit in five years vs raising multiple rounds of money from VCs and also exiting in five years. Now, I believe the best companies don’t have an exit strategy but I understand that’s not the standard view.

Here’s a super simple way I think about the value multiplier to raise VC money from a spreadsheet jockey perspective:

• As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
• At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
• As a co-founder that owns 40% of the business, assume you raise three rounds of VC financing (roughly one every 18 months). VCs buy approximately 33% of the business with each round of financing and assume the option pool grows by 10%, so multiply the ownership stake by .57 (representing the amount sold to the VCs and the amount for the new option pool, not taking into account liquidity preferences). Here’s the math: .4*.57*.57*.57 which equals 7.4%.
• Assume everything else is equal, which it isn’t, the value multiplier to raise VC money is 5.4. That is, it makes financial sense to raise VC money if the business will be significantly greater than 5.4 times more valuable in five years.
• A quick example: if you can build a company worth $10 million with no VCs, the same company would have to be worth $54 million for the personal gain to be financially equivalent.

Raising VC money creates a number of other opportunities and challenges and shouldn’t be viewed just as money. If it is viewed purely to create more personal wealth then the approximate value multiplier is 5.4 for a five year window.

What else? What are your thoughts on the value multiplier to raise VC money?

Have you ever worked on a project and felt like there wasn’t enough communication? Now, have 100 projects going on around you with a small group of people — that’s how it is in a startup. If there wasn’t enough communication with one project imagine how it is with 100 simultaneously. You should always over-communicate in startups.

Over-communicating is different than micro-managing. I’m a big fan of empowering people through autonomy, mastery, and purpose where autonomy comes partly from trust. Now, with so many things going on in a startup it can be difficult to find time to communicate. Don’t let that happen.

The most effective communication tool I’ve found is the daily check-in. Daily check-ins are simple — everyone on your team meets for 10 minutes in-person and/or over Skype Video to answer three simple questions. The questions are what did you accomplish yesterday, what are you going to do today, and do you have any roadblocks. Simple and powerful. And, yes, you do this every single day.

What else? What are your thoughts on over-communicating in startups?

In the book Drive: The surprising truth about what motivates us by Daniel Pink he talks about the three most important areas necessary to maximize success with knowledge workers: autonomy, mastery, and purpose. Autonomy and mastery are straightforward to promote in a startup whereas purpose is more complicated. Sure, the purpose might be to create great XZY software but I don’t think that’s inspiring to team members outside engineering.

A startup’s purpose is much more powerful when it involves improving society or making an impact beyond a profit. Here’s Starbuck’s purpose:

To inspire and nurture the human spirit – one person, one cup, and one neighborhood at a time.

A startup’s purpose doesn’t have to be as grandiose. For us we have a simple one: provide a platform for good work, good people, and good pay. Our purpose is centered more around being a great place to work and a great place to be a customer with corporate culture as the driving force.

Spend time on your startup’s purpose and make it relevant and motivating.

What else? What are your thoughts on a startup’s purpose?

ExactTarget had a very successful IPO last week pricing above it’s expected range and then promptly gaining 32% in value the first day. ExactTarget is one of the most impressive SaaS companies due to their strong corporate culture (Orange Culture), growth rate north of 40% at scale, and headquarters in Indianapolis (outside the Silicon Valley echo chamber). It’s a small group of Software-as-a-Service companies that have had successful IPOs and the market has rewarded them handsomely in terms of valuations (SaaS IPOs are sexy article).

Based on today’s stock price of $26.32 for ET, the company is valued at $1.7 billion. At a little more than $200 million in recurring revenue that puts them in the 8x revenue club (the company is valued at more than eight times their revenue, which is extremely high). Bill Gurley, a famous venture capitalist and long time blogger, has a great post All Revenue is Not Created Equal: The Keys to the 10x Revenue Club where he talks about factors that contribute to extremely high multiples of revenue (think LinkedIn, OpenTable, etc).

Here are the factors Bill Gurley lists:

1. Sustainable Competitive Advantage (Warren Buffet’s Moat)
2. The Presence of Network Effects
3. Visibility/Predictability are Highly Valued
4. Customer Lock-In/High Switching Costs
5. Gross Margin Levels
6. Marginal Profitability Calculation
7. Customer Concentration
8. Major Partner Dependencies
9. Organic Demand vs. Heavy Marketing Spend
10. Growth

ExactTarget has most the factors including #2 (The Presence of Network Effects), #3 (Visibility/Predictability are Highly Valued), #4 (Customer Lock-In/High Switching Costs), #5 (Gross Margin Levels), #6 (Marginal Profitability Calculation), #7 (Customer Concentration), #8 (Major Partner Dependencies), and #10 (Growth). A sustainable competitive advantage is there but not as obvious as lower cost providers continue to proliferate. In addition, there isn’t organic demand but rather very heavy marketing spend ($30 million in losses last year due to sales and marketing). With eight of the 10 factors readily identifiable, and the stock trading at 8x revenue, it’s squarely in the 8x revenue club.

What else? What are your thoughts on ExactTarget in the 8x revenue club?

Application Programming Interface (API) is the term to describe a way for computers to talk to other computers in an automated fashion. Imagine your accounting software talking to your payroll software to cut checks, pay taxes, and facilitate 401k matching — that would be done via an API. APIs open up a world of unbelievable power due to the ability to control other systems as well as consume data, and vice versa.

The famous Paul Graham of Y Combinator sent a tweet recently saying an API is self-serve business development:

https://twitter.com/#!/paulg/status/171840230373081088

Business development is traditionally slow, labor intensive, and often ineffective. With APIs acting as self-serve business development, companies can start integrating services or data from other providers and mashing it up with their own functionality. This way, they can build real enterprise value and let the market decide faster than humans trying to work out deals with other humans. APIs provide unbelievable power.

The next time someone talks about building a new feature or developing their own data source, do some Google searching and see if an API is already out there — you might be surprised.

What else? What are your thoughts on APIs?

Recently I started reading the book Thinking, Fast and Slow by Daniel Kahneman after an entrepreneur recommended it to me. Now the book is a tome packed with anecdotes and research by the author who won the Nobel Price in Economics. The idea is that the mind has two core systems as follows:

• System 1 – the instinctive response that you immediately know (e.g. 2 + 2)
• System 2 – the thinking that goes into a more detailed thought that takes time to answer (e.g. 17 x 12)

Even though Kahneman won the Nobel Price in Economics there’s a significant amount of psychological and human elements that are fascinating with a number of behavioral economics items thrown in as well. As an example, if a person gets the option to flip a coin and can win $13 if they guess right and lose $10 if they guess wrong, they are less likely to take the bet at all due to loss aversion even though the weighted average is clearly in their favor. This applies to the corporate world where people don’t take risks for fear of failure. As for startups, those are the people that like the bet.

If you enjoy psychology and economics I’d recommend the book.

What else? What were your thoughts on the book?

Last month LinkedIn ($9.3 billion market cap) bought Rapportive for $15 million, which according to LinkedIn (naturally), has less than five people (LinkedIn Rapportive search). Rapportive, which is a great product that I use daily, is a dedicated Gmail plugin that takes the email address of the To: or From: address and shows social information like profile photo, recent tweets, links to Twitter/LinkedIn/Facebook profile, and more. It’s an awesome tool.

Now, why would LinkedIn pay $15 million cash for a Gmail plugin that on the surface looks like the LinkedIn piece could be written in one week by a talented developer?

Here are some reasons why big companies on occasion pay good money for small startups:

• Time to market – Rapportive already has a raving fan base that loves the solid product
• Talent acquisition – The Rapportive co-founders have built a killer product and likely have ideas for many more ways to make the product better with additional resources supplied by LinkedIn (or LinkedIn wants the talent to spearhead the development of a new product)
• Competitive preemptive move – If LinkedIn didn’t acquire them someone else that’s trying to be more social (Google?) might pick them up
• Cost of capital – If LinkedIn is sitting on a ton of cash or has a low cost of capital, which it does due to the large market cap and lack of leverage, putting the money to use immediately, even at premium, helps the company grow faster and create more enterprise value

With engineering resources scarce, and new product development tough (I’ve seen it fail twice inside a small company), big companies buy small startups to get a proven commodity that is already successful.

What else? What are some other reasons why big companies buy small startups?