David Cummings on Startups

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  • Economics of an Early Stage Venture Fund

    For tech startups out raising money, which is many of them, it’s important to understand the economics of an early stage venture fund or super angel. The model is very different from a retail investor approach where a mutual fund might focus on a specific segment of the market, e.g. large Fortune 500 companies that pay regular dividends. Early stage investing is a high risk, high reward proposition with unusual dynamics.

    Here’s how the economics of a $30 million early stage venture fund might work:

    • Receive commitments for $30 million from limited partners — usually endowments, family offices, pensions, and other sophisticated entities
    • 20% of the commitments are paid in immediately while the remaining 80% of the monies are requested as needed (capital calls)
    • Fund goal of returning three times cash on cash over the life of the fund (e.g. take $30M and turn it into $90M)
    • Timeline is to make all the initial investments in the first five years and invest the majority of the money while saving 1/4th to 1/3rd for follow-on or pro-rata participation in future financings with a goal of exiting all the investments in 10 years (usually there is an option to extend the fund an extra year a couple times for a max of 12 years)
    • Take $20M of the $30M for the initial investments, that might result in the following:
      – Five $1M investments
      – Five $3M investments
      – Remaining $10M saved to participate in the future rounds of those 10 initial investments
    • Financially, the majority of the profits would come from one of the 10 investments (e.g. hit a homerun) while a couple would return a modest amount and the majority would not return a profit
    • Compensation for the fund partners of 2% of the fund’s value annually plus 20% of the profits (carried interest)
    • Example economics for this fund with one general partner:
      – $600,000/year operating budget for the first five years then a smaller budget for the remaining years
      – $300,000/year salary and $300,000/year for expenses like legal, accounting, travel, office space, assistant, analyst, etc
      – Profits at the end of 10 years assuming returned 3x cash on cash: $90M minus $30M initial capital for a total gain of $60M. Now, take 20% of $60M and you get $12M less management fees taken out (e.g. $3M+ of management fees in five years) for a final profit for the one general partner of $9M.
    • Limited partners would receive $88M for their original $30M investment (assuming goals were met — the majority of venture funds over the past decade did not meet their goals, or make any money for their investors)

    The economics of an early stage venture fund show that it is much more difficult than many perceive for VCs to make great money. There’s a nice salary for a good lifestyle but to do really well, it’s much harder than it looks.

    What else? What are your thoughts on the economics of an early stage venture fund?

  • Next Generation Flex Office Space for Startups

    Continuing with yesterday’s post on how much money to spend per employe per month on office space, there’s a gap in the market for flexible office space that’s desirable for startups and creative companies. Firms like Regus provide a massive network of 1,200+ locations with executive offices and conference rooms for rent, but they aren’t desirable for startups due to ambiance (very traditional, plain offices), seating density (typically one desk rooms are $1,000/month), and the types of businesses already in there (mostly remote sales offices and traditional businesses).

    The best example of this type of next generation flex office space for startups and creative firms is the Cambridge Innovation Center on the edge of the MIT campus (see the TechCrunch write up). Here are some quick facts about the Cambridge Innovation Center:

    • Costs roughly $530 – $1,000/employee/month for the full service option which includes office space (shared space at the lower price and private space at the higher price), conference rooms, furniture, internet access, organic snacks, drinks, showers, etc
    • Co-working space with furniture and internet access but no postal address and fewer amenities is $250/month
    • Parking is $225/month
    • No contracts — everything is month-to-month
    • Over 450 companies and 160,000 square feet of space
    • 13 years in business and over $1.7 billion raised by companies in the facility

    Atlanta, and other up-and-coming tech hubs, would do well to emulate this type of facility. Of course, Boston is significantly more expensive compared to other regions in the country but there’s no reason it couldn’t be done in the $350 – $550/employee/month range for shared offices through to private offices with everyone having communal kitchens, conference rooms, and game rooms. For companies with 1 – 25 employees, the traditional approach to office space rarely makes senes unless the space is a great deal, and even then there isn’t the same community feel as being in a tech/creative centric facility.

    What else? What are your thoughts on next generation flex office space for startups?

  • What percentage of a startup’s revenue should be spent on office space?

    Over the last few months I’ve received the following question two times: what percentage of our revenue should we be spending on office space? Rarely do I like top-down approaches, rather I prefer doing a bottom-up approach whereby the most basic ingredients are analyzed to come up with a number. For office space costs, focus on the type of environment you want to have and the projected number of employees. Here are some examples:

    • Co-working environment or scrappy sublease — $100 – $250/employee/month (most desirable if it works for your startup)
    • Creative office or decent class B office building — $300 – $500/employee/month
    • Swanky office building with nice finishes and great views — $500 – $1,000/employee/month

    Generally, I like to recommend budgeting $500/employee/month for a nice office as I’m a big proponent of the office being a direct reflection of the company and its corporate culture. So, for a startup with 30 employees, $6,000/employee/year results in an office space budget of $180,000/year. There’s no perfect fit for all companies but for technology startups that are growing, I like investing in a great office.

    What else? What are your thoughts on the percentage of a startup’s revenue that should be spent on office space?

  • Thinking Through the Costs of an Initial Startup Office

    After an entrepreneur signs a critical mass of customers or raises a seed round of angel funding, it often becomes time to get a formal office and start hiring. Only, getting a traditional office is usually a big time sink and expensive. Here are some of the standard costs for a 3,000 square foot office designed to accommodate up to 15 people (e.g five people in year one, 10 people in year two, and 15 in year three):

    • Three year lease at $18/ft/year for a monthly rental cost of $4,500 resulting in a total lifetime cost of $162,000 (disregard a 3% annual rent escalation)
    • $10/ft tenant improvement allowance resulting in a $30,000 budget for paint, carpet, and moving a wall or two (paid for by the landlord and amortized over time)
    • 7% commission with 2% going to the building leasing agent ($3,240) and 5% going to the tenant leasing agent ($8,100) all paid for by the landlord
    • Wiring for ethernet and electrical at a cost of $3,000 (assume $200 per employee)
    • Fiber internet access providing 100 mb/sec for $1,000/month (so, $36,000 over three years)
    • Furniture and chairs at a cost of $15,000 (assume $1,000 per employee for desk, chair, and collaboration areas like conference room furniture)
    • Total for three years: $216,000
    • Optional: parking at $60/employee/month for a cost of $900/month or $10,800/year when at full capacity

    Now, this is a nice, semi-custom office designed in a relatively high density manner to support five employees per 1,000 and it costs over $200,000 for a small startup over three years. Costs, plus a serious amount of work over a 90 day period of time to put it all together, makes for a situation less than ideal in the volatile and time sensitive world of a startup.

    What else? What are your thoughts on this breakdown of costs and what would you add/change about it?

  • Startups and Financial Audits

    Annual financial audits are a cost of doing business for many tech startups. While they aren’t the most fun, they do provide great third-party validation of the books and oversight for how the business is being managed financially. Most entrepreneurs should not spend the $10k – $30k on an annual audit.

    Here’s when an annual financial audit makes sense:

    • Institutional investors (like VCs) or other sophisticated investors are involved — they’ll require it
    • A bank line of credit or senior debt in the business requires it
    • There’s a business goal to be able to sell the business in the next three years — most buyers will require three years of audited financial statements

    Most of the time an annual financial review, which acts like a lightweight audit, but without all the guarantees by the accounting firm, is a much more affordable way to engage a third-party to review the books. Entrepreneurs should understand when it does, and doesn’t, make sense to pay for an annual financial audit.

    What else? What are your thoughts on startups and financial audits?

  • The Learning and Earning Phases of an Entrepreneur

    Most entrepreneurs I know that have been successful tell me that their real success came on at least their second venture, and well after their learning phase. Phase one is learning from another successful entrepreneur or business leader and gaining serious domain expertise. This could be in the form of starting a company that doesn’t succeed or it could happen working with someone else — it doesn’t matter. What matters is that the entrepreneur works hard and learns as much as possible.

    Mark Suster has a great post up titled Is it Time to Earn or Learn where he outlines this phenomenon in greater detail. The earning phase of being an entrepreneur is when you co-found a company and have a serious equity stake. Most employees, even in a wildly successful startup, don’t make enough money to retire. As a co-founder that owns a meaningful chunk of equity, raises a modest amount of money, and the startup turns into a base hit or double, there’s a very real chance of making enough money to never have to work again. Now, making money isn’t always the goal, but it’s an important component for many people.

    The next time you talk to an entrepreneur, ask if they’re in the learning phase or the earning phase as there can be a serious disconnect between reality and wishful thinking.

    What else? What are your thoughts on the learning and earning phases of an entrepreneur?

  • How Would the Ideal Startup Village Building Work?

    Recently I’ve been exploring different buildings and areas for an Atlanta Startup Village (see Physical Atlanta Startup Village Idea and Physical Atlanta Startup Village Components). This is a nice-to-have type project that would be great to do but would have to be a no-brainer financially (e.g. a really good deal). So, assuming the area and building have the desired components, how would the actual structure work? Here are a few ideas:

    • Large co-working space with one interior conference room and one phone booth room for every 15 desks
    • Full event room that supports 100 attendees
    • Complete training lab with laptops and large screen TVs
    • Individual office pods with between 1,000 and 4,000 square feet per area including:
      – LED screen outside the pod entrance with company name and logo
      – Mini kitchen
      – Interior phone booths with glass walls (1 per 1,000 ft)
      – Interior conference room with glass wall and large LED screen (1 per 2,000 ft)
      – 5 desks on exterior windows
    • Moveable, large sliding glass doors between pods with locks on each side that can be opened to combine pods as startups grow (see moveable glass walls)

    Overall, the goal is to be a central village for the startup community as well as provide flexible space for startups to grow from one founder to dozens of employees, all with minimal effort and minimal customization. Too much money is wasted by startups on ill-fitting long term leases and heavy customization (most offices have traditional layouts that are inefficient and not startup friendly). The startup village building would have to be designed unlike any building currently available.

    What else? What are some other considerations for a building to be startup friendly and efficient?

  • Buckhead as the Heart of the Early Stage Atlanta Startup Scene

    Midtown is the undisputed king of the Atlanta seed stage startup scene with the ATDC, Hypepotamus, and Georgia Tech (see Rob’s post). ATDC alone has dozens of startups in the building. With the seed stage being defined as under $1M in revenue and under 10 employees, it’s especially helpful to be in an area with great startup density. As startups grow from the seed stage to the early stage (10 or more employees with $1M or more in revenue), the ATDC becomes more difficult due to space constraints (there’s a waiting list for space) and the three year term limit (startups have to move out after three years) resulting in the startups that are most likely to be successful long term having to leave and move out.

    Most ATDC startups that hit the early stage move north to the Buckhead, Vinings/Galleria, or Perimeter area — extremely large geographical areas with little startup density. Buckhead is the clear winner due to the central location between in-town neighborhoods and the northern suburbs. Here are some early stage and growth stage software companies in Buckhead:

    Unfortunately, even with those software companies and more, there’s little serendipitous interaction as there are so many office buildings and such little walking around. Buckhead has great resources like access to interstates, train stations, restaurants, retail, and residential that it should become the heart of the early and growth stage Atlanta startup scene. This is even more true since it is centrally located to the metro area, more accessible to the northern suburbs (tech professionals eventually get married, have kids, and want an affordable house in a good school district), and more affordable than Midtown (Buckhead has many buildings with free parking).

    What else? How can we make Buckhead more cohesive as an early and growth stage startup community?

  • Sources of Ideas Implemented in a Startup

    At Pardot, one of my favorite things to do is to show guests the office and talk about many of our quirky and unusual ways. As you might expect, most of the ideas were generated via R&D (ripoff and duplicate) from others. We continually look for new ideas, try out the ones we like best, and keep the ones that feel right.

    Here are ideas we like and their source:

    One of the reasons I enjoy reading and talking to other entrepreneurs so much is that there are always new ideas. Most ideas I encounter are ignored but many are tried out and a few stick — you never know when you’ll come across a new idea.

    What else? What are some ideas you like and their source?

  • Getting Started as an Entrepreneur

    Recently I was talking to a successful professional who’s looking to make a transition and wants to be an entrepreneur. Of course, as a person thinking about being an entrepreneur, the best thing to do is to just do it (see JFDI). In reality, most people are measured and won’t jump in unless they feel like they have the right idea, team, and timing.

    My recommendation is the same as Jason Fried’s of 37signals in his article How to Get Good at Making Money. The approach is super simple: test the waters of being an entrepreneur by going to local garage sales and spending $100 on stuff that you think will sell well on online followed by actually selling them on eBay. Here are a few of the benefits getting started this way:

    • It takes physical, manual labor to buy the products, list them on eBay, package them up, and ship them out — entrepreneurs have to roll up their sleeves and get stuff done
    • There’s a margin, or spread, between what the product costs and what it sells for, making it readily apparent what it takes to make a profit
    • Tools like eBay and Paypal aren’t hard but it takes time to learn them and make everything work
    • Spending $100 and 10 hours of time is a low cost way to test the enjoyment level of being in business for yourself
    • If you like it, try the whole process multiple times and see if you can make more money off your $100 each time

    There’s an infinite number of things an entrepreneur can do to get started. Building an actual micro business with products and revenues is one of the best ways to start the entrepreneurial journey.

    What else? What are your thoughts on how to get started as an entrepreneur?