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Last week, I had the opportunity to engage in two meetings with community leaders, where we delved into ways to foster the growth of our local startup ecosystem. Our discussions covered a variety of topics, from supporting entrepreneurs to identifying funding sources and implementing programs. One key takeaway I emphasized was the importance of envisioning the local startups in a funnel context, with a wide top and a narrow bottom representing the number of startups at each stage of development. To make an impact, it’s essential for the community to narrow its focus and concentrate on a specific segment of the funnel, ideally a niche one.

To better illustrate the concept, let’s consider the following stages of the startup funnel:

• Pre-Idea: At the broadest part of the funnel, numerous individuals aspire to become entrepreneurs, actively seeking ideas, co-founders, timing, and other critical elements before taking the plunge.
• Idea: The next section of the funnel comprises entrepreneurs who are working on their ideas part-time, as side hustles, attempting to validate the market, secure initial customers, and raise funds from friends and family.
• Seed: The middle of the funnel is occupied by startups with a full-time team, a modest customer base, seed funding or credit card debt, and active efforts to achieve product/market fit. This stage is particularly delicate for startups.
• Early: A small segment, featuring startups generating revenue ranging from hundreds of thousands to low single-digit millions, have achieved product/market fit, established a repeatable customer acquisition process, and often secured angel and venture capital investments.
• Growth: The final, narrowest segment of the funnel showcases startups with revenues exceeding $10 million, a substantial employee base, and a focus on scaling their operations. These startups significantly contribute to job creation, wealth generation, and overall community impact.

By using these stages as a framework, we can effectively categorize and prioritize various programs, events, and initiatives. Initiatives that attempt to address multiple stages often lose their effectiveness, as the needs and challenges faced by entrepreneurs differ significantly based on their growth phase.

For community leaders aiming to make a difference, it’s crucial to strategize with an awareness of the different stages within the startup lifecycle. Identifying a specific niche and offering tailored support for that segment can lead to more impactful and successful outcomes. Of course, these segments of the funnel can be further refined based on industry, vertical, founder types, and other sub-segments.

Enhancing the local startup community requires a targeted approach that aligns resources and initiatives with the specific needs of startups at various stages of development. By honing in on a particular segment of the funnel, we can foster an environment that nurtures thriving startups and promotes an entrepreneurial ecosystem for our community’s long-term growth and prosperity.

Last week served as a poignant reminder of the lasting importance of cultivating relationships over time. Three examples highlight the value. First, upon learning about the launch of a new Intown Golf Club in Columbus, Ohio (and Philly!), a friend immediately offered to facilitate introductions. Second, a different friend sought my assistance in resolving a technical matter, and I was able to provide an excellent referral. Last, a friend shared that they were on the verge of making a significant hire, and he noted it was someone I had introduced to them several years ago.

During my early years, I didn’t place much emphasis on expanding my network, engaging in only occasional networking activities. However, my perspective changed after reading Keith Ferrazzi’s excellent book, “Never Eat Alone” (summary). Ferrazzi helped me grasp and appreciate the true value of building relationships and connecting with individuals who share similar interests. To put these ideas into practice, I adopted a strategy of scheduling lunches with different people every day of the week. I also leveraged industry groups and leadership groups, such as the Entrepreneurs’ Organization (EO) and the Young President’s Organization (YPO), to establish a diverse network of people. Now, decades later, I find myself continually amazed by the ways in which I have been able to provide assistance to others and receive support from a wide array of people. 

My entrepreneur recommendation is to be deliberate in cultivating relationships and consistently paying it forward by helping others. By doing so, you not only enrich your own life but also create a positive ripple effect within your network. Start building relationships.

Recently a friend asked how things were going in startup land. With the continued overall economy still growing and the jobs report strong, he was curious how that translated to the startup sector. My summary: our industry is defined by lean times and inside rounds right now. 

On the lean times front, startups are a struggle as companies are still cutting budgets and reducing spend to handle slowdowns in their own industries. Things haven’t fallen off a cliff. Rather, business is OK therefore tech spend is OK. Only, this is compounded by higher churn from the small percentage of companies that are struggling. This is further compounded by layoffs that already happened, and now at renewal time, it’s a downgrade. Fewer new sales and more challenging renewals are a recipe for continued lean times. 

On the fundraising front, very few deals are getting done. Entrepreneurs are doing everything in their power to avoid having to raise money as valuations are still dramatically lower than 18 months ago. And, with interest rates expected to rise two more times this year, startup valuations have a chance of going even lower (higher interest rates make risky investments like startups less attractive). 

Modest angel and seed rounds are still getting done while later stage deals aren’t. The most popular rounds right now for startups that are performing: insider-lead financings. Many entrepreneurs want to keep burning cash, albeit at much lower rates, so as to continue investing in areas of the business. Existing investors know the business best. Instead of raising a big new round, they’re doing smaller inside rounds.

While there’s no timeline for return to normalcy, it feels like several more quarters of this. Today, it’s lean times and inside rounds for startups.

The post on Customer Value Financing from a couple months ago triggered several questions and comments from entrepreneurs, including quite a bit of interest.

Customer Value SaaS Financing

Fellow entrepreneur Jermaine Brown shared with me information on how customer value financing works via the business Lemonade and it’s filing.

Being publicly traded, Lemonade has to share some details, not just ones dressed up in marketing speak. From the Form 8-K:

Under the Agreement, the Investors will provide up to $150 million over a period of 18 months to the Company for the Company’s sales and marketing (“Growth”) efforts. Under the Agreement, subject to certain terms and conditions specified therein, at the start of each Growth Period, the Investors will provide an Investment Amount equal to up to 80% of the Company’s Growth Spend with respect to a particular Reference Cohort.

During each Growth Period, the Company will pay to the Investors an amount equal to the Investor Sharing Percentage of Reference Income generated during the Growth Period corresponding to such Disbursement Date for each Reference Cohort for every Growth Period until the Investors receive an amount sufficient to attain an effective Internal Rate of Return of 16% across all cash remittances associated with specific transactions, at which point all future Reference Income is retained by Company.

Loosely translating, this describes the following arrangement:

• Up to $150M available over 18 months
• Effective loan amount of 80% of sales and marketing spend per month (defined as a cohort and potentially a different time period like quarterly)
• Company pays back investors using the new revenue from each cohort until there’s a 16% internal rate of return (roughly an interest rate compounded annually)

In this high-level example, the costs assigned to customer acquisition and the percent of customer revenue that goes to pay back the investors is not described. As a guess, it’s likely some type of 90-day average of sales and market costs and the full gross margin as the answers.

As part of the deal, Lemonade put out a press release announcing the arrangement as a thank you to their capital provider, General Catalyst.

Finally, a corresponding blog post that provides more details titled Lemonade’s “Synthetic Agents”:

Lemonade’s “Synthetic Agents”

The term “synthetic agents” is an analogy to revenue sharing with insurance agents, and the thing they are pitting their model against, yet this also applies to other types of businesses that have a cash flow gap between the cost of signing a new customer and the gross margin received. David Skok captured this best in his SaaS Economics post showing how more growth requires more cash. Customer value financing is just as applicable to digital insurance companies as it is to SaaS companies.

Look for customer value financing to become more popular and common in all recurring revenue businesses. It’s a huge win for entrepreneurs and much needed in the market.

Recently I was talking to an entrepreneur about the changing startup landscape and the big slowdown in growth rates and funding. After initial frustration that the boom times were over, he’s now excited for this new era with a focus on excellence across the board. Many elements of the business were given less attention or hastily constructed due to the frenetic pace of growth.

Now’s the time to upgrade the startup’s functional areas.

While growth rate is still one of the biggest drivers of valuation, there’s a mind shift, albeit for a limited period of time, to focus on refurbishing core elements of the business in anticipation of the next level of scale. Internally, the trick is to frame it as a rebuilding or upleveling mission, one that’s aligned with the larger vision.

Many years ago at Pardot, we debated this intensely for product development. Our heavily funded competitors were constantly rolling out new features and modules while we were more resource constrained. We made the decision to alternate quarters between extensive new feature development and general product health (code cleanup, refactoring, technical debt, DevOps, etc.). Internally, we knew that if it was a “features” quarter, we’d be cranking out new product releases, and new features to help customers be more successful. If it was a “bugs” quarter, we’d put much more focus on fixing issues, cleaning up technical debt, refactoring clunky components, and many other important areas of the product. One quarter for aggressive new innovation, one quarter to upgrade the quality of the existing functionality.

When we sold the business, the acquirers commented that in most cases a startup’s sales and marketing is far ahead of the product’s robustness and reliability. In our case, the product’s technical underpinnings were ahead of our sales and marketing. We focused on technical excellence and delivered.

Now’s a great time to assess every functional area of the business and spend internal cycles leveling up people, processes, and technology. Cruft builds over time and needs to be revisited on a regular basis. Now is an exceptionally good time to upgrade functional areas.

For several months now ChatGPT has been one of the most popular, and profound, topics of conversation. It’s still mind-blowing to see it write an article, then change the writing style (make it sound like a pirate!), then give it feedback on what you like and don’t, via chat. From numerous conversations with friends and family, the big question keeps coming up: do you use it on a regular basis, and, if so, how?

Well, after signing up for it 6+ months ago, my weekly usage of it is for brainstorming.

Need a new product name? ChatGPT.

Need some ideas for a new blog post? ChatGPT.

Need insight for a new market? ChatGPT.

Need a starting point for a new initiative? ChatGPT.

Lack of effort to start brainstorming no longer exists. Let ChatGPT do it for you. Writer’s block no longer exists. Tell it what you want and it gives you something. Occasionally, it’ll hallucinate but the vast majority of the time it’ll give you value.

And, no, this wasn’t written by ChatGPT. Yes, I was tempted.

Time to brainstorm? Think ChatGPT.

As an entrepreneur who’s interviewed hundreds (thousands?) of people over the years for jobs, I’ve developed a set of “go to” questions that I like asking. Only, as with anything, the list has evolved over time as some become stale and new ones feel more effective. Having done it so many times, I’ve become a connoisseur of interview question and enjoy continually tweaking them.

Just recently, I heard a new one that I really like and added to the list:

How lucky are you?

I want to hear that the candidate believes some part of their success came from timing, other people helping, and/or other contributions that were lucky along the way. It’s also a form of asking if a person is humble and grateful without using those words. For these reasons, and more, I like this new interview question.

The most important interview question is related to the startup’s core values. Whatever the values, there should be one or more questions per value that pertains to it without asking about the value explicitly. With our people values of positive, self-starting, and supportive, we have a unique line of questioning that are traditional interview questions. Value-question alignment is the most important part of the interview process, even more than the subject matter competency.

Another set of questions I like is based on the chronological in-depth survey of the candidate’s past. The goal is to spend 3-4 hours with the candidate to understand their career arc and details that paint the most complete picture. Simple, superficial chats aren’t enough.

Entrepreneurs would do well to put together a Google Doc or Notion Doc with a running list of their favorite interview questions. It should be a living doc that’s visited regularly, and when a new question emerges, add it to the list and continually experiment with them. The better the interview questions, the better you understand the candidate.

One of the concepts I stress to hope-to-be entrepreneurs is that they’re best off starting something, anything, and learning from there. Today, one of the fastest things to start is an online store on eBay/Amazon/Etsy. Even though it’s turnkey, there are so many things to learn: inventory, shipping, taxes, SEO, advertising, gross margins/cost of goods sold, etc. Doing something is a forced learning experience that will help inform if you enjoy it or not, as well as spark new ideas. The best way to find a great idea is to work on any idea first. 

Personally, I’ve been starting businesses my entire life. Here are a few I did as a kid before I could be a full-time entrepreneur:

• Hamster Breeding
  One day I was talking to the local pet store owner about the dwarf hamster I had and he offered to buy any babies from me for $1. Well, the next thing you know I had dozens of them in my room at home and I was raising hamsters as a little business. Quickly, I realized the limitations and the amount of effort required for little payoff. The business lasted six months.
• Shareware Apps
  After a friend gave me the book “Teach Yourself C in 21 Days” in 8th grade, I was hooked on computer programming. I built a number of shareware apps and sold them on AOL, CompuServe, and Prodigy. This was a great lesson in dreaming up new product ideas and bringing little apps to market. Customers didn’t even know I was in high school! The business lasted three years and I sold hundreds of copies.
• Flea Market Dealer
  Back in the 90s there was a program known as the Columbia House BMG Music Club where you’d get a certain number of music CDs for a penny followed by monthly CDs at normal prices. Well, I signed everyone in my family up for the promo pricing at both the home and office addresses amassing hundreds of CDs. I’d then cancel the accounts and not continue the monthly program. Finally, to sell them, I’d rent dealer tables at the local flea market and sell the CDs for $5 each making hundreds of dollars of profit. This business helped me look for arbitrage opportunities. The business lasted one year and three trips to the flea market. 
• Sports Cards Dealer
  Sports cards were always a personal passion of mine as far back as I can remember. I would obsess over the prices in the Beckett magazine every month and memorize them all, especially the 1989 Upper Deck Ken Griffey, Jr. rookie card. One day, I realized that I could buy cards online for the hottest players in my area (Atlanta Braves stars like Chipper Jones) at half the cost of the local sports card stores using Newsgroups (think Reddit) and eBay. Well, I bought as many cards as I could afford and then became a dealer doing shows in Tallahassee, Pensacola, and Jacksonville. The online to offline arbitrage was a homerun. The business lasted two years.
• Website Development
  My final childhood business was building websites for local companies first in my hometown and then in college. This was the ultimate gateway business as I learned web development which lead to a number of “real” startups. I’d charge $1,000 for a site and marvel that I’d make $50/hour doing something I really enjoyed. The business lasted three years. 

While I’ve always loved entrepreneurship, these small endeavors early on set the foundation for a lifelong pursuit of startups and company building. 

Starting on an idea — especially something simple — is the best entrepreneurial training possible. There’s no perfect idea and too many people use searching for an idea as an excuse. Just like with anything new, the sooner you start doing, the sooner you start learning. Start now. 

Last week I talked to two different entrepreneurs working on side hustles. We talked about the big ideas, progress so far, what’s working, what’s not, etc. Then, I asked the hard question: what will it take to go full-time? Going full-time is a huge milestone, and rarely achieved. I’ve talked to hundreds of entrepreneurs over the years working on side hustles and it’s easily less than 5% conversion from part-time to full-time status. And therein lies the ultimate problem.

Working on a business part-time almost never provides for enough progress due to lack of rapid iteration.

Sure, you can make some progress. There are simple items to complete, basic infrastructure to organize. Things like customer discovery and business model canvas can be started. These are all worthwhile and part of the journey. Ultimately, startups are all about speed. The faster you translate market needs into solutions, the faster you find product/market fit. The faster you iterate on the customer acquisition process, the faster you find a repeatable, scalable business model. The faster you achieve these milestones, the faster you can raise capital (if needed!). Speed, speed, speed.

Startups require a herculean effort. A day job, plus a side hustle, plus a family, plus other obligations is often too much. If the vast majority of full-time entrepreneurs fail, what are the odds of a part-time side hustle? I realize not all entrepreneurs can go full-time and that other facets of life create their own opportunities and challenges.

Startups are hard. Doing it part-time makes it 10x harder. If possible, figure out a path to being full-time as quick as possible and improve the chance of success.

Continuing with the thread that there are a number of anomalies in startup land now, there’s another one worth discussing. While the vast majority of startups have slowing growth rates, many will reaccelerate. Yes, the new growth rates will be slower than during the pandemic, but these are excellent businesses where growth is masked by extenuating circumstances. In addition, reaccelerating growth rates improve a number of aspects of the business from morale to recruiting to valuation. 

First, let’s dive in why reaccelerating is imminent. COVID pulled forward a tremendous amount of demand taking companies from good growth to hyper growth in a span of 6-12 months. Today, a startup that might be at $50M of revenue would likely be at a much lower number if the pandemic didn’t happen — still a great business but a smaller business. In addition to growth being pulled forward, startups often sell to other tech companies as they’re early adopters. Of course, these tech companies had a COVID boost as well so they hired a huge number of new team members, resulting in even more software spend. Now, these tech companies and startups are doing many rounds of layoffs, and reducing their non-employee costs a corresponding amount. Finally, one more added challenge: the cost of capital went through the roof due to significantly higher interest rates and lower valuations. Startups that would have kept their burn rates up in the past cut even deeper to conserve cash, and that resulted in more layoffs. 

Bringing all these factors together results in higher churn rates and reduced consumption revenue that is worse than anticipated. Record high downgrades and cancellations translates into even lower growth rates. Premature increased customer growth plus premature downgrades and cancellations paint an incorrect picture. Startups would do well to take their historical gross and net renewal rates applied to their core business and project out potential scenarios. Core growth plus traditional renewal rates will likely result in reaccelerating growth in the near future.

The good news: once this painful series of adjustments works its way through the system and we’re at the new normal, growth rates will improve. Many startups have strong business models delivering tremendous value to their customers. The lack of growth is masked by remnants of one-time extra growth and one-time extra churn. Higher, renewed growth is on the horizon.