David Cummings on Startups

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  • Thiel’s Paradox

    The New Yorker has a fascinating piece on Marc Andreessen, a well known entrepreneur and venture capitalist, titled Tomorrow’s Advance Man. In addition to a number of excellent stories, the author mentions Thiel’s Paradox from early Facebook investor Peter Thiel:

    When a reputable venture firm leads two consecutive rounds of investment in a company, Andreessen told me, Thiel believes that that is “a screaming buy signal, and the bigger the markup on the last round the more undervalued the company is.” Thiel’s point, which takes a moment to digest, is that, when a company grows extremely rapidly, even its bullish V.C.s, having recently set a relatively low value on the previous round, will be slightly stuck in the past. The faster the growth, the farther behind they’ll be. Andreessen grinned, appreciating the paradox: the more they paid for Mixpanel—according to Thiel, anyway—the better a deal they’d be getting.

    Generally, entrepreneurs want to bring in new investors for each round of funding so that they can create an auction-like environment to get the best combination of valuation and value-add. Thiel’s Paradox is that for entrepreneurs of fast growing companies, an insider round from existing investors, no matter the valuation, results in a good deal for investors. The next time you read about a startup raising another round of funding exclusively from the existing investors, think about Thiel’s Paradox.

    What else? What are some more thoughts on Thiel’s Paradox?

  • Learning More Now than While in School

    Recently I was talking with an entrepreneur and he made a comment that really stuck with me: I’m learning more now than while in school. Yup, that’s right. The best entrepreneurs I know are the fastest, and most voracious, learners. Every time I talk with them, they’re sharing some new lesson learned or idea gleaned.

    Here are a few thoughts on learning more now than while in school:

    • While in school there might be more new facts learned weekly, but as an entrepreneur there are many more real-world, applicable insights and strategies learned weekly
    • Make a goal to learn something new every day (see one new insight per day)
    • Find a peer group of like-minded people that share your desire to learn
    • Surround yourself with team members that enjoy learning and want to share ideas

    Entrepreneurs would do well to make sure they’re always learning and instill continual learning as a value within their organization.

    What else? What are some more thoughts on learning more now than while in school?

  • The 27x Rule for Venture Fund Aggregate Investment Exits

    Jason Lemkin has a great post up titled Why VCs Need Unicorns Just to Survive. The idea is that even with a standard-sized venture fund, say $100 million, the aggregate exit values of the investments needs to be $2.7 billion. Here’s how the math works, from his post:

    • $100M fund
    • Goal is $400M in returns before fees
    • Average ownership stake of 15%
    • Roughly 15 investments
    • $400M / 15% = $2.7 billion

    So, the 15 companies need to sell for an aggregate of $2.7 billion with the fund holding a weighted average equity position of 15% to generate $400M in returns. The 27x rule for venture fund aggregate investments means that whatever the venture fund size, multiple it by 27 to get the rough scale of all exits combined required for the fund to do well. If it’s a $50M fund, it needs $1.35 billion in aggregate exits. If it’s a $200M fund, it needs $5.3 billion in aggregate exits. The big wildcard is the average ownership stake, but the 27x rule is directionally correct

    What else? What are some more thoughts on the 27x rule for venture fund aggregate investment exits?

  • Unicorn Valuations aren’t the Same as Public Market Valuations

    Fenwick & West, one of the top law firms for high growth tech companies, has a great new post up titled The Terms Behind the Unicorn Valuations. With so many tech startups raising money at valuations of a billion or more, it’s clear we’re in boom times, but it’s also clear that many people don’t understand that the valuations of these unicorns aren’t the same as the valuations we see in publicly traded companies. Why? The investors in these companies get special preferred stock that has a number of additional protections, and in exchange, they invest at a higher valuation. Put another way, if the stock was common, like is normally associated with a publicly traded company, the valuations would be significantly lower.

    Here are a couple terms that make the preferred stock more valuable than common stock, according to the survey:

    • Acquisition Protection Terms – If the company is sold at a value lower than the investment valuation, the investors get all their money back, even if their percent ownership represents a smaller amount of money (e.g. if an investor puts in $100M at a $1B valuation and owns 10%, then the company is sold for $500M, instead of getting $50M in the sale, the investor gets their $100M back, even though that’s 20% of the sale).
    • Future Financing Protection Terms – If the company raises money at a lower valuation in the future, the existing investors get an increased ownership position in the company that represents the previous investment amount relative to the new valuation (e.g. if the company raised $100M at a $1B valuation, that’s 10%, but then if they went out and raised another $50M at a $500M valuation later, the investors that put in the $100M in the previous round would now have 20% of the company instead of 10%, and the non-investors like the entrepreneurs and employees would be diluted).

    For a great story that shows how deal terms matter more than valuation, read Heidi Roizen’s How to Build a Unicorn from Scratch – and Walk Away with Nothing. Due to these specials terms, and others, the valuations for unicorns aren’t the same as public market valuations as the investors get a number of protections that aren’t normal.

    What else? What are some other terms tech startup investors often get that make the valuations between private and public companies difficult to compare?

  • The Value of Skipping a Financing Round

    A topic that’s been mentioned several times recently is the value of “skipping” a financing round. Generally, the idea is that every time an entrepreneur raises money, their equity is diluted, so “skipping” a round is basically achieving a greater revenue/user/valuation milestone without raising money in the interim.

    Let’s look at the math for four hypothetical financing rounds assuming two co-founders each have 50% and ignoring employee equity and option pools:

    • Seed Round – Raise $1 million at a $3 million pre and sell 25% of the business
      Entrepreneurs – Diluted from 50% to 37.5%
    • Series A – Raise $5 million at a $15 million pre and sell 25% of the business
      Entrepreneurs – Diluted from 37.5% to 28.1%
    • Series B – Raise $15 million at a $45 million pre and sell 25% of the business
      Entrepreneurs – Diluted from 28.1% to 21.1%
    • Series C – Raise $50 million at a $150 million pre and sell 25% of the business
      Entrepreneurs – Diluted from 21.1% to 15.8%

    As an example, if the entrepreneurs were able to get to the Series C equivalent funding amount and valuation, without having the equivalent Series B in the interim, they’d have each have 21.1% of the company instead of 15.8% — that’s a major difference. More success with less capital invested is always a great formula.

    What else? What are some other thoughts on the value of “skipping” a round of funding?

  • Product Pricing

    Earlier today I got into a pricing discussion with a fellow entrepreneur. We were talking about all the usual topics like number of plans, positioning in the market, and competitor pricing. Then, I shared the biggest pricing mistake we made at Pardot in the early years: our pricing model didn’t grow well with the account. Meaning, as our customers became more successful, and got more value from the product, there was little opportunity to capture more revenue. Eventually, we shifted from pricing based on email volume to pricing based on the size of the database, and that made a huge difference.

    Here are a few thoughts on product pricing:

    • Consider having two value axes: one based on functionality/modules and one based on usage (e.g. seats or metered)
    • Err on the side of being too expensive as it’s easier to give a discount to win a deal and customers are more likely to give pricing feedback when things are more expensive (no one ever tells you your product is too cheap and they’d pay more)
    • Balance capturing the most value with the pricing plans vs making them easy to understand (lean towards keeping things simple)

    Pricing is an area many entrepreneurs struggle with, especially if the product isn’t in the market yet or only has a few customers. As the business develops and more prospects consulted, pricing becomes more obvious. Even then, make sure and capture more value as product usage grows.

    What else? What are some more thoughts on product pricing?

  • Mentor Worksheet Idea

    Several weeks ago I was talking with a friend about mentoring other entrepreneurs. He shared with me that he’s been mentoring an entrepreneur for a little over a year now and follows a strategy where they meet monthly and go through a simple worksheet. The style of the worksheet comes from the monthly update section that’s popular in YPO and EO forums and highlight the highs and lows of the last 30 days and next 30 days across business, family, and personal spectrums.

    Here are the contents of the worksheet:

    • Ratings
      0-10 with 10 being the best, how are each of the following:
      Business
      Family
      Personal
      Overall
    • Business
      Best about last 30 days
      Worst about last 30 days
      Most looking forward to in the next 30 days
      Least looking forward to in the next 30 days
    • Family
      Best about last 30 days
      Worst about last 30 days
      Most looking forward to in the next 30 days
      Least looking forward to in the next 30 days
    • Personal
      Best about last 30 days
      Worst about last 30 days
      Most looking forward to in the next 30 days
      Least looking forward to in the next 30 days

    Reviewing this worksheet during each mentor meeting makes it easy to better understand the complete person – not just professional aspects – and provides a conversation starter to uncover deeper topics for discussion.

    What else? What are some more thoughts on using a worksheet to help with regular mentor meetings?

  • LinkedIn to Find a Co-Founder

    Over the years a number of people have reached out to me asking for help finding a co-founder for their startup. Much like the challenge of recruiting great software engineers, finding a co-founder is even harder, especially when considering the importance of the co-founder complement. Last week, an entrepreneur mentioned that he found his co-founder through LinkedIn. Brilliant. Recruiters use LinkedIn to find employees. Sales reps use LinkedIn to find prospects. Entrepreneurs use LinkedIn to find co-founders.

    Here are a few thoughts on using LinkedIn to find a co-founder:

    • Write out the desired personal and professional traits first, and then search for people that might have them (e.g. if you want a sales-oriented co-founder or an engineer-oriented co-founder as well as interests like sports or volunteering)
    • Seek out referrals through existing relationships (e.g. email your LinkedIn connections asking for help)
    • Allocate a serious amount of time to find the right person as it isn’t easy and doesn’t happen quickly
    • Building rapport and a trust-based relationship takes time, so don’t rush into things

    I’ve only met one person that found his co-founder on LinkedIn, but I’m sure there are many more examples out there. Finding a business partner is hard and LinkedIn is a great network to start the process.

    What else? What are some more thoughts on using LinkedIn to find a co-founder?

  • Entrepreneurs Drawn to Starting Incubators

    Last week I was reading an article about a successful entrepreneur that had started an incubator to work on multiple startups simultaneously. Incubators, now called studios or labs, were popularized during the dot com boom, and most failed to work, leaving a negative connotation for many people. Now, the cost to start is 10x cheaper and there are millions of people with mobile broadband connections, making for a different dynamic compared to 15 years ago. While it is still expensive to scale, getting started is easy.

    Here are a few ideas why entrepreneurs are drawn to incubators:

    • Timing a market is terribly difficult, so having multiple startups running simultaneously increases the chance of finding a fit
    • For many (most?) entrepreneurs, the starting part is more fun than the scaling part
    • Small, dedicated teams without a legacy customer base can innovate fast, making it more fun to see rapid progress
    • When a startup achieves initial traction, it’s much easier to raise money from investors, making the entrepreneur’s own investment go further by bringing in other people’s money

    Look for more incubators/studios/labs to popup as entrepreneurs have exits and want to work on multiple projects. Entrepreneurs know how hard it is to time a market and want to hedge their bets by taking more of a portfolio approach.

    What else? What are some more thoughts on the idea that entrepreneurs are drawn to starting incubators?

  • The Scrappy Virtue for Startups

    Back in the fall of 2007 we headed to our first Pardot tradeshow in Las Vegas. Not having any money, we got the cheapest place we could find at the Sahara Hotel on the old Vegas strip (it has since closed). After a long flight across the country, we were excited to be there and headed up to the reception desk in a dark, rundown lobby. After giving our names, the front-desk clerk said, “Wow! Four nights. No one ever stays here four nights.” We didn’t think anything of it as we thought the $40/night room was a bargain. And, for every trip of the five-and-half-years of the Pardot journey, including our last trip where we flew to Indianapolis to pitch ExactTarget, we shared rooms to save money.

    Here are a few scrappy ideas for startups:

    After raising a huge amount of money or having a very successful exit, being scrappy is much harder. Regardless, scrappy is a virtue startup founders should embrace. More money available for the right things and fewer frivolous expenses goes a long ways when building a company.

    What else? What are some thoughts on scrappy as a virtue for startups?