David Cummings on Startups

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  • Investor IRR on Paper to Raise Another Fund

    Recently I was meeting with a venture investor talking about the market and opportunities at the Atlanta Tech Village. He had just joined a new partnership, so, naturally, I asked what happened at his previous firm. He said the firm had made the targeted number of investments, but didn’t have the required internal rate of return (IRR) to raise another fund, and was desperately trying to make the existing investments more successful.

    Here are a few thoughts on investor IRR on paper to raise another fund:

    • Current boom times, where hot startups raise more money at ever higher valuations, makes the paper returns for the earlier investors excellent, even though some of those startups won’t be able to grow into their valuation
    • Investor returns, outside of exits or selling a piece of the investment, are measured via mark to market, such that the main way to get a new market price is by raising another round of funding, hence the VC desire to raise more money at a higher valuation
    • Some funds, that had poor overall returns, but good returns for a select number of the partners, market their next fund based on the returns on the partners that did well, and not the overall fund numbers
    • Most funds don’t achieve their stated goal of returning three times the money in seven years, which is 17% IRR (see Demystifying Venture Capital Economics), and thus can’t raise another fund

    When talking with investors, it’s important to understand the firm dynamics, especially where they are in their fund lifecycle. Also, note that returns on paper, not necessarily exits, are needed to raise another fund.

    What else? What are some other thoughts on investor IRR on paper to raise another fund?

  • More Vertical, Niche SaaS Startups

    Over the past few months I’ve talked to a number of entrepreneurs with vertical, niche Software-as-a-Service (SaaS) products. As expected, mainstream SaaS platforms are being carved up into small, specialized point solutions, while also providing a better experience to their customers. Most venture investors are looking for large, platform-like SaaS startups, but more entrepreneurs are going to build sustainable SaaS products that aren’t venture backable, yet very successful.

    Here are a few thoughts on more vertical, niche SaaS startups:

    • SaaS, with strong to recurring revenue, predictability, and renewal rates (hopefully!), makes for a sustainable business, even at limited scale
    • Costs to develop and deploy software has continued to drop due to open source and the cloud, making it easier to get products to market and carve out a niche (scaling a business is still capital intensive)
    • Depth of product functionality is going to be stronger the more narrow the market, and thus serve the customers’ needs better
    • Marketing and sales prospecting is more straightforward with a focused market, especially messaging and talking points

    Look for the SaaS cottage industry to continue to grow, especially as more more vertical, niche products reach a sustainable size.

    What else? What are some other reasons there will be more vertical, niche SaaS startups?

  • Sales Resources for Startups

    With so many startups reaching out and asking for help as they implement an inside sales team based on SalesLoft and the Predictable Revenue book, it’s a good time to highlight a few posts and notes for entrepreneurs. Building a successful inside sales team isn’t easy, but there are a number of proven strategies and tactics.

    Here are a few sales resources for startups:

    To start, most entrepreneurs should hire a sales assistant to get going and then expand from there. Sales and sales teams are the lifeblood of many startups, yet take time to understand and scale.

    What else? What are some other sales resources for startups?

  • Notes from the Shopify S-1 IPO Filing

    Earlier today Shopify announced that they had filed for an IPO and released their S-1 document with the SEC. Shopify is the top Software-as-a-Service ecommerce provider powering over 160,000 online stores. Personally, I’ve talked with a number of ecommerce entrepreneurs and Shopify always comes up as one of the best solutions.

    Here are a few notes from the Shopify S-1 IPO filing:

    • 900 apps in the Shopify App Store (pg. 1)
    • Revenues (pg. 2)
      2012 – $23.7 million
      2013 – $50.3 million
      2014 – $105.0 million
      2015 Q1 – $37.3 million
    • Net losses (pg. 2)
      2012 – $1.2 million
      2013 – $4.8 million
      2014 – $22.3 million
      2015 Q1 – $4.5 million
    • 162,261 customers with an annualized revenue of $1,000/year (pg. 3)
    • Company started September 28, 2004 in Ottawa, Canada (pg. 5)
    • 632 employees (pg. 13)
    • Accumulated deficit of $33.6 million (pg. 13)
    • Stripe powers the payments processing (pg. 15)
    • Separate Class A and Class B shares where the Class B shares have 10 votes, meaning the executives control the company (pg. 31)
    • Subscription revenue accounted for 63.5% of revenue (pg. 53)
    • Payment processing fees accounted for 36.5% of revenue (pg. 54)
    • Payment processing solutions are for both online and offline sales (pg. 54)
    • Most revenue collected is in U.S. dollars but most expenses are in Canadian dollars, so exposed to currency fluctuations (pg. 56)
    • U.S. represents 68.7% of revenues (pg. 61)
    • 85.5% gross margins (pg. 63)
    • Shopify started as an online snowboarding store and then became a software company when no ecommerce system could be found to the CEO’s liking (pg. 82)
    • Core values (pg. 97)
      Get shit done
      Build for the long-term
      Focus on simple solutions
      Act like owners
      Thrive on change
    • Founder ownership – 14.6% (pg. 127)
    • Bessemer Venture Partners ownership – 30% (pg. 127)

    To clear a $100 million run-rate while only having an accumulated deficit of $33.6 million is incredible — super capital efficient. Combine the capital efficiency with scale and a growth rate that’s still over 100%, and you have an amazing story that’s going to do well in the public markets. It’ll be interesting to see how public investors discount, or don’t, the payment processing fees as they aren’t as valuable as the subscription fees, but are still valuable nonetheless. Shopify is a major success story.

    What else? What are some more thoughts on the Shopify S-1 IPO filing?

  • Coworking as a Business Opportunity

    As the coworking space continues to gain attention, especially with the growth of the tech industry and reports of WeWork raising $335M at a valuation of almost $5B, more potential investors are drawn to the market. With the Atlanta Tech Village, we’ve had the chance to learn first-hand about coworking and flexible office space for over two years now, and have several thoughts on the market.

    Here are a few pros and cons of coworking as a business opportunity:

    Pros

    • Fulfills a growing desire for freelancers, entrepreneurs, and creative class employees to have a sense of community
    • Capitalizes on millennials entering the workforce and their expectations of a different office environment
    • Allows repurposing of existing office space into a higher value offering
    • Provides greater efficiency for business expenses like internet access, conference rooms, break rooms, etc. (e.g. with a direct lease, many items are dedicated that don’t need to be dedicated)

    Cons

    • No barriers to entry as office/retail space is abundant
    • High customer turnover due to a less stable target audience
    • Expensive renovations required for a high-quality, creative feel
    • Prevalence of hobby and labor-of-love coworking space providers (e.g. many coworking spaces are subsidized and have a social mission)
    • More labor intensive than traditional office space

    As a business opportunity, I don’t think coworking is a good place to make strong returns unless there’s a unique, differentiated brand whereby people are willing to pay significantly above market rates for the space. Most professional investors getting into the coworking market will fail. Coworking, in order to build community, is an amazing opportunity.

    What else? What are some other thoughts on coworking as a business opportunity?

  • When to Pitch at Startup Events

    With a number of startup pitch events scheduled over the next few weeks, it’s a good time to think through when it’s best to go on the pitching tour. Most events have an element of startup theatre, so the first thing to do is to evaluate the opportunity cost of attending another event vs. making more progress on internal goals and priorities. Assuming there’s an overall fit, here are a few items to think through when considering applying to pitch at a startup event:

    • Fundraising – Is there a desire to raise money and the corresponding metrics to warrant investment? Too often, entrepreneurs head to pitch events in an effort to raise money, but don’t have the corresponding business metrics. If the metrics are strong, pitch events are a good way to showcase them and tell a compelling story.
    • Lead Generation – With a broadly applicable product, pitch events can be a great way to generate leads. Similar to the idea of asking VCs for intros to portfolio companies, ask the audience for leads.
    • Recruiting – Finding great talent is always a challenge, especially during high growth stages. Pitch events can be a good way to spread the word and find new candidates.

    If you ask an entrepreneur why they do pitch events, outside of trying to raise money, the most common answer is networking. Entrepreneurs, generally, are pretty social and want to meet other people, especially other people that can help them achieve their dreams. Naturally, there are a number of other networking events beyond pitch competitions.

    For entrepreneurs considering pitch events, evaluate the current business goals, and make sure that the time commitment is worthwhile.

    What else? What are some other thoughts on when to pitch at startup events?

  • Comparing SaaS Against the 7 Better Business Model Ideas

    Continuing with yesterday’s post 7 Ideas for Better Business Models, I wanted to take it one step further and compare Software-as-a-Service (SaaS) to the seven ideas and see how it stacks up. I’ve been a huge fan of SaaS for 8+ years now since the co-founding of Pardot, and want to help other entrepreneurs understand why it’s such a great model.

    Here’s how SaaS compares to the seven better business model ideas:

    1. Switching Costs – This varies depending on the type of product. Basic email marketing tools have low switching costs whereas heavily customized enterprise resource planning products have high switching costs. Generally, this is neutral for the average SaaS product.
    2. Recurring Revenues – SaaS, by its very definition, has recurring revenue, making for tremendous predictability. This is a strong positive for SaaS.
    3. Earning vs Spending – Most SaaS products are monthly pre-pay with a good number of annual pre-pays. Monthly pre-pay is a slight positive for SaaS and annual pre-pay is a strong positive for SaaS.
    4. Game-Changing Cost Structure – Having one version of the product that’s automatically updated for all customers is more cost effective compared to installed software for engineering. But, most of the revenues are spent on sales and marketing, so it isn’t a large cost structure difference from the overall point-of-view. This is neutral for the average SaaS company (the cost structure for the buyer is much better for SaaS as it’s more of a pay-as-you-go model as opposed to a large lump sum up front).
    5. Get Others to Do the Work – This isn’t applicable for SaaS.
    6. Scalability – The nature of the SaaS is that it’s massively scalable and there are minimal marginal costs to add more customers. Market scalability is driven by the actual product and target audience, so this is neutral for the average SaaS product.
    7. Protection from Competitors – Products that have more customization and/or more of a network effect have greater protection from competitors. This is neutral for the average SaaS product.

    SaaS really excels in the recurring revenue and earning vs spending categories, and is often very scalable. Other better business model ideas are hit or miss depending on the actual product and market.

    What else? What are some more thoughts on comparing SaaS to the seven better business model ideas?

  • 7 Ideas for Better Business Models

    Strategyzer has a great blog post titled Why Some Business Models Are Better Than Others. 10 years ago I had a coffee meeting with one of the most successful tech entrepreneurs in town. At that meeting, he emphasized the importance of recurring revenue and suggested that I figure out how to build a business with a subscription element. I took it to heart and have been working on Software-as-a-Service companies ever since. Recurring revenue is one of the seven ideas for better business models.

    Here are the seven ideas for better business models from the article:

    1. Switching Costs – Higher switching costs decrease the chances of a customer leaving to go to a competitor
    2. Recurring Revenues – More predictable cash flow and easier to grow the business (assuming good renewal rates)
    3. Earning vs Spending – Models that collect payment before having to spend money to produce the goods or services are more desirable and valuable
    4. Game-Changing Cost Structure – Something priced 5% less than established incumbents isn’t that compelling. Something that’s priced 95% less than the established incumbents, and also sustainable, is incredibly compelling.
    5. Get Others to Do the Work – Think about the rise of the on-demand marketplaces and the ability to tap into under-utilized labor
    6. Scalability – Global reach and distribution provide for greater opportunities
    7. Protection from Competitors – Network effects, moats, and other strategies that make it difficult to enter the market

    The next time you hear an entrepreneur’s pitch, run through these seven ideas and see how well it stacks up in each area.

    What else? What are some other ideas for better business models?

  • Gestalt Protocol

    Back in 2008 I attended a new member forum training class for the Entrepreneurs’ Organization (EO). Being a little arrogant, and completely clueless, I thought it was crazy to go to a six hour training event just to join a group of entrepreneurs. Entrepreneurs are smart. Entrepreneurs are fearless. Entrepreneurs don’t need training. Naturally, I was wrong.

    Turns out, the training class was really a leadership and communication program, and was worth every bit of the six hours. One of my favorite takeaways was the Gestalt Protocol. With Gestalt, relevant first-hand experiences are shared in an effort to offer what worked, and didn’t work, in a manner that’s fact-based, as opposed to opinion-based.

    Often, entrepreneurs, when working with team members, provide advice and direction, regardless of whether or not it’s based on prior experience. From there, the team members, wanting to be supportive, run off and do it, even if they don’t have buy-in or context. Over time, the team members become less likely to offer their own suggestions, and rely more and more on the entrepreneur to make decisions. Not good.

    Instead, with Gestalt Protocol, the entrepreneur shares experiences, including what worked, and didn’t work, about a similar situation in the past. If no relevant experience is available, the entrepreneur simply says, “I don’t have any relevant experience. What do you think we should do?” Now, the team member will provide ideas and suggestions, thereby increasing buy-in and creating a culture of independent thinkers.

    If, when providing advice, the word “you” is used instead of “I”, think twice, and ask if that’s the best way to give the advice. Statements like “I found x when I did y” are much more powerful compared to “You should do x.” Gestalt Protocol works and is effective.

    What else? What are some more thoughts on the Gestalt Protocol?

  • The Non-Valley Valuation Discount

    One of the more frustrating concepts for entrepreneurs outside of Silicon Valley is the non-Valley valuation discount. With numerous high-profile valuation announcements, especially the excitement around unicorns (startups with a valuation of $1 bill or more), it feels like everyone is getting amazing valuations, especially as a multiple of current revenues. Only, if you peel back the layers, the startups outside the Valley that are getting the big valuations have either a) a successful, serial entrepreneur that’s already had a big exit (e.g. Josh James of Domo), or b) insanely fast growth and market adoption (e.g. Yik Yak).

    Here are a few reasons why there’s a non-Valley valuation discount:

    • Plane Travel – VCs usually invest in one or two companies per year, meaning the bar is already extremely high to do a deal, and getting on a plane, especially multiple planes (e.g. a city without direct flights to SFO), results in less competition for a deal, and thus a lower valuation
    • Talent Networks – VCs want to be value-add, in addition to money, and a major benefit is their network of potential employees, advisors, and industry connections, most of which are where they live
    • Swinging for the Fences – VCs that aim for homeruns pay higher valuations compared to ones that play more for singles and doubles, because the total addressable market weighs heavier in their decision making process

    Will every non-Valley startup get a valuation discount? Like my favorite economics professor at Duke, David Johnson, would always say: the answer is Bob Dole’s underwear — Depends. Like it or not, there’s a real non-Valley valuation discount that most entrepreneurs experience first-hand when out raising money.

    What else? What are some other thoughts on the non-Valley valuation discount?