David Cummings on Startups

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  • Quantifying the SaaS Valuation Growth Rate Multiplier

    We know that Software-as-a-Service (SaaS) companies with a higher growth rate are much more valuable than other SaaS companies with a lower growth rate, all things equal, based on research of publicly traded companies. When looking at the value of a business internally for the purpose of raising money or selling the business, it’s an interesting exercise to quantify just how valuable growth is to the overall valuation of the business.

    Now, making the assumption that gross margins are in the 70% – 80% range, renewal rates are in the 80% – 90% range, and that there’s nothing else abnormal about the business from a SaaS perspective, here’s the proposed formula:

    Valuation = (2*ARR) + (ARR*(1+(GRM*GR)))

    ARR = Annual Recurring Revenue
    GRM = Growth Rate Multiplier = 2.5
    GR = Growth Rate

    So, if growth rate is 0 (e.g. the company isn’t growing), the company is worth two times revenue, which makes sense. Assume a business with 75% gross margins can have profit margins of 33% if it doesn’t invest heavily in sales in marketing. Take the 33% profit margins and multiple by six to roughly approximate the six times EBITDA valuation assigned to an arbitrary business (the common value of a private company is usually 4x – 6x profits). With .33 (for 33%) times six, you get a business value of two times revenue (e.g. .33 * 6 = 2).

    Here are some more examples with growth rates:

    • $300,000 annual recurring revenue
      100% growth rate
      Valuation = (2 * 300,000) + (300,000 * (1 + (2.5 * 1) = 600,000 + 1,050,000 = $1.65 million
    • $1,000,000 annual recurring revenue
      50% growth rate
      Valuation = (2 * 1) + (1 * (1 + (2.5 * .5) = 2 + 2.5 = $4.5 million
    • $1,000,000 annual recurring revenue
      200% growth rate
      Valuation = (2 * 1) + (1 * (1 + (2.5 * 2) = 2 + 8 = $8 million
    • $5,000,000 annual recurring revenue
      100% growth rate
      Valuation = (2 * 5) + (5 * (1 + (2.5 * 1) = 2 + 8 = $27.5 million

    Of course, these are the theoretical valuations for a strategic buyer or an investor with preferred shares. For a shareholder with common shares, there would be a 50% discount for lack of liquidity and other issues related to not having control. In the end, growth rates drive SaaS valuations and (2*ARR) + (ARR*(1+(GRM*GR))) is an example to think through a valuation.

    What else? What are your thoughts on quantifying the SaaS valuation growth rate multiplier into a simplistic formula?

  • Assessing Achievement of Product / Market Fit

    Yesterday I was talking to an entrepreneur about product / market fit. His startup is making good progress and has a minimum viable product in the hands of a couple friendly, paying customers. After getting an overview of the market opportunity, and digging deeper into the business, the question of assessing product / market fit came up. I asked if every customer so far has found bugs and run into issues. Yes, the friendly customers are happy, but they’ve all run into problems, which is normal.

    So, if a handful of friendly customers are using the product and getting value from it, how do you know when product / market fit has been achieved? Here’s what I recommended:

    • Sign up as many friendly-introduction customers as possible as they are key for helping identify issues, providing feedback, and acting as references for future customers
    • Start acquiring traditional customers that aren’t from warm intros and assess customer engagement (daily active users, breadth and depth of module usage, etc)
    • Calculate the net promoter score for both your friendlies and your traditional customers
    • Look for a pattern of 10+ new customers signing on to the system, receiving significant value, and not encountering any bugs or problems

    Product / market fit doesn’t happen immediately, but by paying attention to context clues it’ll gradually emerge that fit has been achieved and it’s time for stage 2 (building a repeatable customer acquisition machine).

    What else? What are your thoughts on assessing achievement of product / market fit?

  • Local Angel / VC Investing for Returns or as Civic Duty

    A few days ago I was part of a number of discussions around angel / VC investing and supporting local entrepreneurs. One of the recurring themes was between the desire to generate risk-adjusted returns vs investing as a civic duty to help grow the local economy with an understanding that returns might not be strong.

    Here are a few ideas on angel / VC investing for returns vs civic duty:

    • Generating market-rate returns with angel investing, regardless of scale, is difficult
    • One idea is to do a fund of funds where money is invested in angel funds as well as VC funds to diversify the money by spreading it across a much larger number of investments
    • Local economies with successful startups benefit from more high paying jobs, diversification of employment base, and wealth creation
    • Foundations, which usually can’t invest in startups with their grant making money, can invest their endowments in funds, which could be locally focused

    There’s no clear answer as it’s up to the goals of the investor. Regardless, investment returns and civic duty should be allowed parts of the conversation.

    What else? What are your thoughts on local angel / VC investing for returns or as civic duty?

  • Investors and Entrepreneurs aren’t Always Aligned

    Last week I was talking to an entrepreneur that was lamenting how they weren’t aligned with one of their investors, and it was causing serious challenges. It isn’t that they didn’t have a good working relationship — they have a decent relationship — it’s that the nuances of their equity, compensation, timelines, etc don’t match up.

    Here are a few items that can result in misalignment:

    • Vesting – When raising money, investors often require entrepreneurs to have some or all of their shares vest over a period of time, usually four years. This becomes a challenge if an acquirer comes forward to buy the business before vesting is done. Sometimes the acquirer wants the vesting to continue, or even extended, as part of the acquisition (accelerated vesting on change of control is something an entrepreneur can negotiate for at time of investment).
    • Timeline – Venture funds usually have an investing period of five years and a harvesting period of 2 – 5 years, such that a startup might be doing really well, but it’s the end of the fund’s life, and the investor wants to sell but the entrepreneur doesn’t.
    • Follow on Money – If a startup has a down round, or needs a bridge round on unfavorable terms, there’s a good chance the entrepreneurs get crammed down, resulting in a more difficult situation going forward.

    Even with the best intentions, investors and entrepreneurs aren’t always aligned. It’s important to keep communicating and pushing forward.

    What else? What are some other examples where investors and entrepreneurs aren’t aligned?

  • Digital Display Disruption with Android Sticks / Beyond Google Chromecast

    Yesterday I tried out the new Google Chromecast for the first time. For a $35 device, it packs a ton of power and is really useful. AirPlay via AppleTV is still much more flexible since the whole desktop display is broadcast wirelessly to the screen, but transmitting a browser window inside Google Chrome meets most of the needs in the market (as well as the custom apps like Netflix).

    I think the bigger transformational shift will come when there’s a small Android computer that plugs into any standard HDMI port, like a TV, so that you have the full computer attached to the screen. Dell is working on this now with the Project Ophelia $100 Android stick. Connecting a computer to a TV is possible now with Mac Mini or a little PC, but it’s cumbersome to maintain and configure.

    With the advent of a $100 Android stick, we’ll see more digital displays. Think of some of the common scenarios:

    • Metrics / KPI dashboards
    • Competitive leaderboards
    • Digital billboards
    • Restaurant menus
    • News / events / alerts

    Better, faster, cheaper — the digital display market is ripe for change and tiny, self-contained computers will be the catalyst.

    What else? What are your thoughts on the coming digital display disruption with Android sticks?

  • Atlanta Companies on the 2013 Inc. 500

    I love this time of year. It’s when Inc. magazine publishes the latest Inc. 500 for the 500 fastest growing companies in the United States. Hannon Hill was #247 in 2007 and Pardot was #172 in 2012.

    Here are the Atlanta companies on the 2013 Inc. 500 list:

    • #31 – Innovolt, $8 million (profile)
    • #64 – GSC Packaging, $112.6 million (profile)
    • #117 – Green Box Foods, $251.1 million (profile)
    • #142 – Cloud Sherpas, $75.3 million (profile)
    • #170 – TracePoint Computing, $4.9 million (profile)
    • #193 – S2Verify, $4.4 million (profile)
    • #237 – Xtreme Solutions, $8.6 million (profile)
    • #303 – Caduceus Healthcare, $4.1 million (profile)
    • #324 – MiLend, $14.2 million (profile)
    • #351 – Configero, $2.2 million (profile)
    • #364 – ClearLeap, $5.5 million (profile)
    • #404 – PalmerHouse Properties, $7.2 million (profile)
    • #428 – Careers in Transition, $5.3 million (profile)
    • #430 – VDart, $20.7 million (profile)
    • #440 – RePay, $12.8 million (profile)
    • #447 – StandBy Talent Staffing Services, $2.3 million (profile)
    • #470 – Mom Corps, $16.2 million (profile)
    • #479 – Hicks & Clark, $2.3 million (profile)

    Based on the list, 18 of the 500 fastest growing companies are in Atlanta. Congratulations to all the winners — great work!

    What else? What are your thoughts on the 2013 Inc. 500 award winners?

  • How it Works as an Investor in a Venture Fund

    With a great deal of focus on entrepreneurs raising money from venture capitalists, it’s important to step back and look at how it works to be an investor in a venture fund.

    Here’s how it works as an investor in a venture fund:

    • Venture capitalists can’t (yet) publicly advertise to solicit money so it’s done as a traditional sales process through the usual channels like warm introductions, cold calls, and emails
    • When an investor commits to invest in a fund there’s substantial paperwork to become a limited partner, especially regarding the type of accredited investor
    • Money committed to the fund by the limited partner, say $250,000, is requested in increments via capital calls over the life of the fund (typically 5 – 7 years)
    • Capital calls are usually once or twice a year, depending on frequency and size of investments as well as credit facilities (venture funds can usually borrow a limited amount of money to fund a deal while they wait for money from capital calls to come in)
    • Money committed by the investor isn’t always paid in if the fund has one or more exits early in the life of the fund as the money generated via the sale of a portfolio company can be used for future investments
    • Money invested in the fund is illiquid for the life of the fund until there are exits or dividends (rare)
    • Ultimately, the goal is to be completely done with the fund after 10 years, but some go on much longer than that

    As you can see, investing in a fund is very different from investing in the public markets. In return for a lack of liquidity for an extremely long period of time, the goal is to receive returns that are greater than and uncorrelated with the public markets.

    What else? What are some other thoughts on how it works to be an investor in a venture fund?

  • Big Numerical Goals for the Atlanta Startup Community

    Allen Nance tossed out some new ideas for the Atlanta startup community yesterday and John Melonakos followed it up with his thoughts on each of Allen’s ideas. Combine that with the Twitterverse commentary and comments on each of the posts and there’s been some healthy dialogue.

    To complement Allen’s post, I’d like to offer up some big numerical goals for the Atlanta startup community:

    • $1,000,000,000 of annual VC investment in the state
      According to the NVCA, VCs invested $383 million in GA in 2011 leaving tremendous room for increased investment and involvement in Georgia.
    • 1,000,000 square feet of startup-friendly office space
      Between the Atlanta Tech Village, ATDC, Hypepotamus, and others, Atlanta has about 150,000 square feet of startup-friendly office space. With a goal of one million square feet, the idea isn’t to have a big number for bragging rights, rather it’s to have much greater density of startups for serendipitous interactions.
    • 10 growth-stage startups on the annual Inc. 500
      In a good year Atlanta will have two tech startups on the annual Inc. 500 list of the fastest 500 growing private companies in the U.S. There’s no reason 10 isn’t achievable on a regular basis once the Atlanta startup community matures.
    • 1 eight or nine figure exit per month
      Currently, there’s about one eight or nine figure exit per quarter reported, so there’s probably one or two more that happen but aren’t reported. With a much larger, stronger community, one solid exit per month is attainable.

    Of course, this is in addition to Atlanta having 1,000 active startups at any given time. Atlanta has tremendous opportunities ahead and I’m excited to be involved.

    What else? What are some other big numerical goals for the Atlanta startup community?

  • 10 Ideal Customers are More Important than 30 Random Customers

    Earlier this week I was talking to founders of a local startup about finding product / market fit (stage 1). They had a minimum viable product that was rapidly approaching minimum respectable product but didn’t have any active users yet. We were talking through goals for the next six months and it was emphasized to me that they were going to do everything in their power to sign up 30 paying customers.

    After hearing the customer goal, I emphasized that signing 10 customers that fit their ideal customer profile was more important than signing a large number of random customers in the near-term. Here are a few reasons why quality is more important than quantity at the earliest of stages:

    • Customers will always ask for product enhancements, so it’s key that requests align with the entrepreneur’s vision of the future
    • Signing non-ideal customers is fine as long as you are prepared to say ‘no’ to feature requests that don’t fit the vision
    • Live customers represent oxygen for the product, so clean air is better than the alternative
    • Ideal customers are going to be happier customers and happier customers are going to provide testimonials as well as references for future customers

    Of course, some customers are better than no customers. As co-founders working hard to find product / market fit, it’s critical to bring on ideal customers as well.

    What else? What are your thoughts on focusing on signing ideal customers instead of random customers at the beginning of a startup?

  • Product Reports in Board Decks as Importance Indicator

    It was four years into the life of Pardot and I was talking to a local venture capitalist I didn’t know too well. The conversation went something like this:

    Me: Hey, how are things going?

    VC: Great, I was at a board meeting earlier today and Pardot kept coming up.

    Me: Pardot? What was the context?

    VC: Well, it’s completely transformed our sales and marketing. Everyone keeps referring to it. In fact, Pardot reports are now part of every board deck.

    Me: Wow, that’s great. Please let me know if I can ever help with anything.

    Of course, it’s flattering to hear a compliment about a product. What really excited me is that the product’s reports were so critical to the business that they were included in the package of materials supplied to the board of directors at every meeting.

    In the continuum of minimal importance to maximum importance, product reports that are used as part of board meetings indicate high product importance. Products can be important and have nothing to do with board decks but product reports found in board decks almost always indicate an important product.

    What else? What are your thoughts on board reports as an indicator of product importance?