David Cummings on Startups

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  • Presenting the Possible Value of Equity Over Four Years

    One of the questions that came up from yesterday’s post on The 5x Rule for Salary vs Equity Trade-off is how to present the value of the equity in a thoughtful manner. Potential team members want to see, in detail, how the equity compensation is calculated. 

    Here’s an example of presenting the possible value of equity over four years:

    • Year 1 – Startup is valued at a $10M post money valuation. Potential new team member to receive stock options for 1%, which has a current value of $100,000 (ignore strike price and 409a valuation for now). 
    • Year 2 – Startup raises $5M at a $25M post money valuation selling 20% of the company. The 1% is diluted to .8% and is now worth $200,000. 
    • Year 3 – No fundraising and no valuation change. 
    • Year 4 – Startup raises $15M at a $75M post money valuation selling 20% of the company. The .8% is diluted to .64% and is now worth $480,000. 

    This is an example scenario to show how an equity grant now might be worth close to $500,000 at the end of four years, assuming everything goes according to plan. Of course, things could go much better or much worse, and that’s part of the excitement in the startup world. 

    What else? What are some more thoughts on presenting the possible value of equity over four years?

  • The 5x Rule for Salary vs Equity Trade-off

    Recently an entrepreneur was talking with me about recruiting a new, key team member from a big company. When it came down to compensation, the startup couldn’t afford the same salary, and so the entrepreneur was working on quantifying the value of the equity component. To determine the equity piece, I recommended following the 5x rule where the expected value of the equity is 5x more valuable than the salary given up. 

    Here’s how it works:

    • Potential employee currently makes $100,000
    • Job offer at the startup is for $75,000
    • Equity has four year vesting
    • Over four years, the potential employee is giving up $100,000 in salary, so the equity at the end of four years should be worth $500,000

    Intuitively, it makes sense that the potential value of the equity needs to be much greater than the salary reduction since there’s a good chance the equity is worth nothing or something substantially less than 5x. Follow the 5x rule and use it as part of the recruiting process. 

    What else? What are some other thoughts on the 5x rule for the salary vs equity trade-off?

  • Customer Success Managers

    One role in B2B tech startups that is incredibly important, but not talked about as much, is that of the customer success manager. Several years ago at Pardot we called them client advocates, and tasked them with making our customers successful, knowing that a comprehensive software product, no matter how cool the interface, still requires on-going training and help. Whereas the support team is reactive with customer issues, the customer success team is proactively reaching out to customers to make sure everything is going well and helping customers get more value out of the product.

    Here are a few thoughts on customer success managers:

    • A customer “touch” cadence should be used whereby customers are pinged once a month/quarter/year
    • Analytics and engagement tools should be used to track which customers are actively using the critical features in the product and which customers are at risk of leaving due to little/no usage
    • The old adage “It’s cheaper to keep an existing customer than sign a new one” is even more true for SaaS businesses
    • As major new product features are released, the customer success team should help customers incorporate the new product functionality
    • Some of the best customer success managers are sales people that loved helping prospects but didn’t like asking for the sale
    • Upselling and cross selling is usually part of the customer success team, so it’s often a revenue-generating function

    Customer success managers are critical and should employed earlier than expected in B2B tech startups. As a proactive, customer-facing team, they often develop some of the strongest customer relationships and add tremendous value.

    What else? What are some more thoughts on customer success managers?

  • Separating a Cash Flow Business from a Venture Backable Startup

    One of the on-going debates is whether a particular company is a cash flow business or a venture backable startup. Often, investors will pass on a startup because they feel the market is not big enough. Just this past week, Airbnb released seven rejection letters they received from investors when they were trying to raise $150,000 at a $1,500,000 valuation (today, that same 10% would be worth $2 billion). Here are a few thoughts on venture backable startups as different from cash flow businesses:

    • Small, fast growing markets can be the best when it’s clear that there’s a big opportunity ahead
    • Large, established markets work well if the product is truly 10x better, faster, and cheaper (if it’s only 2x better, the friction to switching is often too high to get much traction)
    • VCs want to believe that their portion of a potential exit is big enough to return at least 10% of their fund (so, the market opportunity must be 10x larger when taking investment from a $50M fund vs a $500M fund assuming the same round of financing)
    • Almost all new companies are not venture backable as the market size and dynamics aren’t conducive to the scale and value creation needed

    The next time you hear an entrepreneur say they want to raise venture capital, ask if the business truly warrants it based on the market opportunity and current traction. Most companies are cash flow businesses, and those are often some of the best out there.

    What else? What are some more thoughts on separating cash flow businesses from venture backable startups?

  • Quantifying Startup Quantity for More Ecosystem Success

    One area I spend a good bit of time thinking about is how to get more tech startups to a modestly sustainable level of success (e.g. $250k in run rate) as well as to a more sustainable level of success (e.g. $1 million in gross margin). As a community, we need more entrepreneurs taking more at-bats to get more hits, and more homeruns. Let’s assume we have a community goal of one new sustainably successful tech startup ($1 million in gross margin) per month (12 per year), how many companies need to be started? Here’s a guess:

    • 100 tech startups start
    • 10 achieve $250,000 in revenue within three years
    • 2 achieve $1 million in gross margin within five years

    According to this survey, only 4% of all business have $1 million or more in revenue, so it feels directionally correct that getting a tech startup to $1 million in gross margin (thus higher than $1 million in revenue) would be an even smaller percentage. To get 12 new sustainably successful tech startups per year, we need local entrepreneurs to start 600 new tech startups per year. My guess is that we’re halfway there in Atlanta and need to work harder to grow our ecosystem.

    What else? What are your thoughts on quantifying the number of startups to achieve a new sustainably successful company per month?

  • Benefits as a Percentage of Salary

    One of the strategies we employed at Pardot was taken right out of the Google playbook: lavish employees with great benefits. Internally, we focused on providing benefits that were in the 99th percentile of all companies and salaries in the 60th percentile. People would always comment, “your benefits must be crazy expensive — we can’t afford those because we’re a startup.” It’s true that our benefits became more robust as we went from the early stage to the growth stage, but we still had strong benefits as soon as we could afford them.

    One of the ways I like to think of benefits is in relation to salary. Let’s say these are the main benefits per person:

    • Health Insurance – $5,000/year
    • Dental Insurance – $600/year
    • Short and Long Term Disability – $600/year
    • 4 Hours of Housecleaning Per Month – $1,200/year
    • Catered Lunches – $2,400/year
    • Snacks and Drinks – $1,200/year
    • Total – $11,000/year

    Let’s assume the average salary is $80,000/year across all job functions. At $11,000/year for benefits, that’s roughly 14% of the average salary. We found that amazing benefits translated into stronger loyalty, more frequent employee referrals, and a better working environment. While these benefits might seem expensive, they were incredibly valuable to us.

    What else? What are some other thoughts on benefits as a percentage of salary?

  • Video of the Week: Drive – The surprising truth about what motivates us

    Several years ago I was introduced to the book Drive by Daniel Pink by a friend. After reading it, I thought that this would be great for all the managers at Pardot to read, so we included it in our Leadership Development Program. This week’s video of the week is an awesome explanation of several key topics in the book. Enjoy.

    From YouTube: This lively RSA Animate, adapted from Dan Pink’s talk at the RSA, illustrates the hidden truths behind what really motivates us at home and in the workplace.

  • Hero and Hassle of the Month

    Early in the life of Pardot we heard feedback from our team that we needed to do a better job acknowledging employees that had gone above and beyond as well as hassles in the company that were impeding people from being as productive as possible. To help with this, and increase the internal communication, we introduced the Hero of the Month and the Hassle (or improvement) of the Month.

    Here’s how it worked:

    • Every morning, as part of our daily check-in, we’d ask an additional question: are there any heroes or hassles? The idea is that recognizing heroes and talking about hassles would be top-of-mind for everyone in the company each day.
    • GetSatisfaction was used with a private idea exchange for the Hero of the Month and a separate one for the Hassle of the Month whereby employees submitted a hero or hassle and other employees voted on their favorite.
    • At the monthly all-hands meeting, we’d recognize the Hero of the Month and the Hassle of the Month by giving a $100 bill to each winner and talking through the submissions in front of the whole team. And, as a bonus, each winner got to keep a cool SkyMall lawn ornament at their desk for the month.

    Through this Hero and Hassle of the Month program, we significantly increased employee satisfaction and developed an environment focused on continual improvement. As startups grow, scaling the culture becomes more challenging, and this program worked well for us.

    What else? What are some more thoughts on the Hero and Hassle of the Month?

  • 3 Main Ways Investors Add Value

    Recently I was talking with an angel investor and we were going over different strategies and learnings, many of which are in the 26 Lessons Learned from Investing in 26 Startups. We started talking about ways investors can add value to a startup beyond the money, and simplified it down to three main areas:

    1. Strategy – Entrepreneurs have a tendency to work more in the business rather than on the business. One area investors can help with is strategy and getting the entrepreneur to think longer term.
    2. Sales – Introducing an entrepreneur to a potential customer is incredibly valuable. Reversing it, entrepreneurs should ask potential investors for intros to their portfolio companies.
    3. Talent – Finding great employees is hard and time consuming. A big benefit for entrepreneurs is connecting them with awesome people that can really add value.

    So, the next time an investor or potential investor asks how they can help, think about strategy, sales, and talent and take them up on their offer.

    What else? What are some more thoughts on the three mains ways investors add value?

  • The Power of Getting the Band Back Together

    Over the years I’ve read a number stories about entrepreneurs building great companies, having a nice exit, and then getting core members of their team back together for the next venture and achieving strong results. Now, this past year, I’ve see it happen a few times at the Atlanta Tech Village and can attest to the power of getting the band back together. Here are a few thoughts on reassembling successful teams:

    • Rapport and trust is already in place, making for stronger communication right away
    • Team members already know the strengths and weaknesses of the people they’ve worked with before, making for more effective team execution
    • Assuming a similar industry or type of product, the team knows the playbook that worked before and can apply it in the new venture
    • Investors love backing teams that were previously successful as many of the risks related to team dynamics and the ability to get things done are mitigated

    Successful teams that have come back together to do another startup are often successful again — not from doing the same thing over and over, but because of the human element that comes with intense shared experiences.

    What else? What are some more thoughts on startups that are formed from previously successful startup team members?