David Cummings on Startups

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  • Escalating Carried Interest for Venture Investors

    In a typical venture fund, the venture capitalists (VCs) have a 2% annual management fee and earn 20% of the profits (called 2 and 20). That is, 2% of the value of the fund (e.g. $2 million per year for a $100 million fund) is used for salaries, office space, administration, and other expenses for a period of time (e.g. seven years) before shrinking and eventually disappearing. Then, assuming the fund is successful, the VCs receive 20% of the money generated after the investors get their principal back, including the money spent on management fees (e.g. turning a $100 million fund into $300 million in returns results in the VCs getting $40 million in profits, or carried interest).

    Now, the ultra successful VCs know that there’s much more opportunity in earning a larger piece of the profits, and they often command 30% of the carried interest, while waiving management fees because they’re confident and have already been successful (e.g. this would be 0 and 30). Well, last month I heard of another wrinkle that I hadn’t encountered before: escalating carried interest for clearing higher return hurdles. Meaning, if the VC returns even more money, they’d get an even higher percentage of the profits. In the example I heard, the institutional investor received 70% of the profits after the fund returned five times the capital (e.g. a once a $100 million fund generates $500 million in returns, the VCs would get 70% of everything past that instead of 20 or 30%).

    For venture investors with a strong track record, and amazing returns, the opportunity to make even more money comes from escalating percentages of carried interest based on results.

    What else? What are some more thoughts on escalating carried interest for venture investors?

  • Creating a Competitive Fundraising Process

    Continuing with yesterday’s post Market Clearing Valuation for Entrepreneur’s Raising Money, the logical next question is “how do you create a competitive fundraising process?” That is, without a competitive fundraising process, there’s no way to know if the current leading investment option is truly the best one. Here are a few thoughts on creating a competitive fundraising process:

    • Ensure a sufficiently large number of investors are contacted (e.g. 100+)
    • Treat the process like a sales engagement and track everything in a CRM or Google Spreadsheet
    • Develop as many investor relationships as possible well in advance of needing to raise money (the best time to raise money is when you don’t need it)
    • Create all the necessary fundraising collateral like an executive summary, pitch deck, and financial model (if an operating business) before starting the process
    • Build a timeline, and once it’s officially investor fundraising time, work to coordinate as many pitches as possible in a short timeframe so as to generate interest simultaneously

    Raising money is hard, and it’s even more difficult to do it in a way that creates a competitive environment with multiple potential investors at the same time. Entrepreneurs would do well to create a competitive fundraising process to find the best investment partner.

    What else? What are some more thoughts on creating a competitive fundraising process?

  • Market Clearing Valuation for Entrepreneur’s Raising Money

    Earlier this month I was talking with an entrepreneur that needed to raise money. His startup was running out of money, and with almost no revenue, it was a matter of either raising more money or laying everyone off. As he went out to the market and pitched investors, there was some demand and a couple investors offered up term sheets. Only, the valuations came in much lower than desired.

    While the entrepreneur had one valuation in mind, the market clearing price was something entirely different. Unfortunately, as an entrepreneur in that position, there aren’t any other options. Of course, more investors can be pitched in an attempt to get a higher valuation, but there’s limited time before things fall apart.

    Entrepreneurs would do well to recognize that valuations offered by investors represent the market clearing price for the startup, and if time and money runs out, there aren’t any other options. Meeting with a large number of investors (100+) well in advance of needing the cash (e.g. > six months) is one of the best approaches (unfortunately this is a full-time job to create a competitive process).

    What else? What are some other thoughts on the market clearing valuation for entrepreneur’s raising money?

  • Why No Equity Component at the Atlanta Tech Village

    Earlier today I was talking to a business executive about the Atlanta Tech Village. He was asking a number of questions and got to the most popular one: is there an equity component at the Village? My answer, of course, is that there isn’t an equity component. The response is always “why not — you should get a piece of the action.” At that point I nod and change the subject as it can be hard to explain.

    There’s no equity component at the Village because we want to attract all types of entrepreneurs. Imagine a successful serial entrepreneur evaluating office space options for his or her next company. Since they have personal resources and a track record, there are a number of quality office buildings that would enjoy having them as tenants (assuming a personal guarantee on the lease). If there was an equity component, it would seriously increase the friction to attracting successful entrepreneurs. In turn, this would lessen the opportunities for successful entrepreneurs to help first-time entrepreneurs.

    In a similar manner, imagine there’s an entrepreneur that has a successful early stage startup (e.g. $500,000 in recurring revenue and a handful of employees), we also want them at the Village (assuming a good culture fit). Once a business is working and product-market fit has been achieved, the equity is worth significantly more, and an entrepreneur is less likely to part with it for a tech entrepreneurship community.

    At the Village, our goal is to bring together all types of entrepreneurs that want to increase their chances of success by helping each other. With a straightforward business model (see the pricing) and not having an equity component, we increase the odds of attracting the best entrepreneurs.

    What else? What are some more thoughts on not having an equity component at the Atlanta Tech Village?

  • Metrics Consistency in Conversations

    Two weeks ago I was talking to an entrepreneur about his startup. Early in the conversation he said that they had $200,000 in annual recurring revenue. We covered a variety of subjects and towards the end of the meeting he said that next week they’ll hit $150,000 in annual recurring revenue. Hmm, I thought, I just heard him say a different number 20 minutes ago, and I’m pretty good at remembering details.

    In fact, this isn’t the first time I’ve heard different key metrics in the same conversation with an entrepreneur, and that’s a problem. Here are a few thoughts on metrics consistency in conversations:

    • Don’t offer up a key metric unless you’re confident about it and have a good enough grasp to reference it consistently
    • If a metric was incorrectly referenced, explain that the wrong number was offered previously (as opposed to assuming the person didn’t realize that two different numbers were mentioned for the same metric)
    • Memorize the key metrics for your type of business (e.g. here are four important Software-as-a-Service metrics)
    • Citing different values for a key metric in the same conversation seriously diminishes credibility

    Entrepreneurs would do well to know their key metrics and not say two different things for them during a conversation — people listen and pick up on inconsistencies.

    What else? What are some more thoughts on metrics consistency in conversations?

  • The Push and Pull Between Sales and Engineering

    Early on in the life of a startup things are pretty straightforward: everyone in the company either builds stuff or sells stuff. As the business grows and starts to scale there’s an interesting push and pull that occurs between the sales team and the engineering team. On the sales front, there’s always a desire for more features and functionality with which to show prospects and close more deals. On the engineering front, as the customer base grows, so too does the desire to refactor code and re-architect subsystems of the product to accommodate new use cases as well as enhance scalability.

    Inevitability, the end result is a few months of what appears to be little to no new customer-facing features followed by a couple months of what appears to be heightened engineering activity with a variety of new customer-facing features. The engineering effort is the same but the areas of focus can make it seem like productive times and non-productive times. Sales continues asking for new functionality and engineering continues balancing time between new functionality and reworking existing functionality. It never ends.

    Entrepreneurs would do well to recognize the push and pull between sales and engineering and know that each team means well. Healthy discourse is required as there’s a tendency for each party to feel that the other group doesn’t understand what they do and how hard they work. This tension is normal and part of life in a tech company.

    What else? What are some more thoughts on the push and pull between sales and engineering?

  • Quickly Evaluating a Potential SaaS Investment

    Earlier this week a friend sent over an executive summary and financial model for a Software-as-a-Service (SaaS) startup and asked for my advice in evaluating it. While he hadn’t been an angel investor before, he was thinking about becoming one and this would be his first investment. After looking through the two PDFs, I told him that there’s nothing to evaluate other than whether or not he loves the market and the team. The startup had no revenue, no customers, and was working on building a prototype. It was simply an opportunity to bet on a market and team.

    Now, if it did have an operating history, even a modest one, there would be a number of different metrics to analyze. Here are a few items to look at when quickly evaluating a potential SaaS investment:

    • Annual Recurring Revenue (ARR) – How much money would be generated if no customers were added and no customers left
    • 12 Month Growth Rate – How does the ARR from 12 months ago compare to the ARR today
    • Monthly Churn Rate – How many customers that started the month renewed for the next month and what has churn been for each of the last 12 months
    • Cost of Customer Acquisition – How much money is spent on sales and marketing relative to a new dollar of annual recurring revenue generated in each of the last two quarters

    While there are a number of other metrics to analyze, these four quick items paint a clear picture of health and opportunity for a SaaS startup. SaaS is an amazing business model due to recurring cash flow, gross margins, and predictability of the business. And, potential investments can be quickly evaluated.

    What else? What are some more thoughts on quickly evaluating a potential SaaS investment?

  • Inevitability of Success with Near Initial Traction

    A few weeks ago I was talking to an entrepreneur about his Software-as-a-Service (SaaS) startup. After three pivots they arrived at an idea that’s taken hold and are starting to scale. While they don’t have Saastr’s Initial Traction (ARR of $1M of more, ARR growing more than 100% a year, and more than 50% of new revenue from zero-cost marketing) yet, it looks like they’ll achieve that this year.

    One of the great things about SaaS is that even with near initial traction, there’s a sense of inevitability that the business will be successful. Here are a few reasons why:

    • Signing the first 100 customers provides enough use cases to feel confident that the next 1,000 customers will be signed up
    • Engineering becomes more cohesive and stable with continued customer adoption and product development
    • Starting the marketing engine is incredibly difficult (e.g. SEO, content marketing, etc.), but once it’s working, it keeps on giving
    • Recruiting team members gets easier as the story and results are more developed

    SaaS companies with near initial traction have an inevitability of success. While it isn’t guaranteed, with continued growth and high renewal rates, the chance is very high.

    What else? What are some more thoughts on success being inevitable once a certain size and level of momentum is achieved?

  • Consulting to Fund Product Development

    Recently I’ve had the chance to talk with two different entrepreneurs who were building software consulting firms to fund product development. Software engineering is in high demand and a number of businesses, especially startups, are hiring contractors to rapidly prototype new products and ideas.

    Here are a few thoughts on consulting to fund product development:

    • Consulting work, with an emphasis on billing time and materials, is very different from product work
    • Whenever possible, team members who do product work should not also do consulting work so that they can iterate on the product and interface with customers
    • With new products, one of the most important early milestones is to decide if the product is worth continuing to pursue (e.g. a go/no go decision), and working on it part-time makes it difficult to achieve enough progress
    • Ensure that there’s not a have/have not situation where the engineers doing consulting are jealous of the engineers working on the product

    Consulting companies that turn into product companies can happen, albeit rarely. One of the most successful examples is Mailchimp, based in Atlanta (280 employees). Entrepreneurs building consulting firms to fund product development would do well to recognize the fundamental differences between the two types of businesses and plan accordingly.

    What else? What are some more thoughts on doing consulting work to fund product development?

  • Revenue Growth in the Early Startup Years

    Back in 2008 I was on a screening committee helping evaluate angel investment opportunities for a group of investors in town. Once a month we’d meet with 4-6 startups and pick two to present to the group. Well, one of the entrepreneurs delivered his pitch to the committee and did a great job.

    Everyone around the table was interested and liked the startup. Then, one of the investors raised his hand and asked about the financial projections. There, on the screen, the entrepreneur pulled up the dreaded slide: $0 in revenue today and $100 million in revenue by the end of year three. Ouch. All the excitement left the room.

    Here are a few revenue growth resources for the early startup years:

    The best financial models are built from the bottom-up based on actual metrics from an operating business. While startup metrics can be minimal early on, after a few years they become more meaningful and reasonable financial models with revenue growth can be built.

    What else? What are some more thoughts on revenue growth in the early years?