David Cummings on Startups

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  • What Scale Does a Startup Need to be Independent of the Founder

    Two weeks ago a couple of entrepreneurs were in my office asking for advice on their startup. Their revenue has really accelerated in the past six months and they’re debating between investing more in the business or putting money aside for a rainy day fund. After asking how many employees they had (less than 10) I asked if the business was dependent on them. Yes, unequivocally.

    I sensed that growing the team to the point that it wasn’t dependent on them was a near-term desire. Of course, you could do a budget and come up with that number. From my experience with software/software-as-a-service startups, the business would be spending about $1.5MM on salaries, benefits, and infrastructure (e.g. office space) to be large enough to not be dependent on the founders. Here are some items to think about with respect to size of business:

    • Gross margins will influence whether spending $1.5MM on team member occurs at $2MM of revenue or $10MM of revenue
    • Founders are often decent at multiple things and really good at one thing — that one thing is often the last type of talent brought on the team, and typically expensive because the founder has high standards for the role
    • Redundancy or scale is needed for positions that are critical to operation of the business (e.g. number of software engineers, support people, etc) so that the founders and team members can take vacation without worrying if the business will continue to operate
    • One strategy for a founder is to take a two week vacation, forcing the issue of what is, and isn’t, dependent on them (banks like to make every employee take one two week vacation per year to see if any fraud is taking place with that person)
    • Depending on the size of the startup, some investment in people will have to take place in advance of growth to be self sufficient from the founder

    Reaching a size and depth of business to be founder independent is a huge milestone. I’ve found that ensuring the business isn’t dependent on the founder (e.g. through a long vacation) provides great peace of mind and sense of progress — it should be a goal on every entrepreneur’s list.

    What else? What are your thoughts on the necessary size of a startup to be independent of its founder?

  • Takeaways from The Launch Pad: Inside Y Combinator, Silicon Valley’s Most Exclusive School for Startups

    Two months ago I pre-ordered Randall Stross’s new book The Launch Pad: Inside Y Combinator, Silicon Valley’s Most Exclusive School for Startups in anticipation of his storytelling and insight into Y Combinator. Stross wrote one of my favorite books about the dotcom heyday titled eBoys: The First Inside Account of Venture Capitalists at Work, which is a must read for anyone interested in the crazy startup world of the late 1990s. The Launch Pad was a fun, quick read, but didn’t leave me in awe in the way eBoys did. Part of that is likely attributed to my level of understanding of Y Combinator from reading about it and talking with entrepreneurs who have gone through it. Nevertheless, for people that want to get a taste of the Y Combinator experience, the book is required reading.

    Here are a few takeaways from the book The Launch Pad:

    • Exclusivity is the norm with an acceptance rate of 3% of the applicants
    • Priority is placed on top flight technical skills
    • Co-founders are more important than the idea (a fair percentage of teams pivot during the 90 day process)
    • Grad school is the most closely related non-startup idea with self-starting and independence being a common theme
    • Alumni, cohort teams, and partners make up the bulk of the experience (not outside mentors like most other accelerator programs)
    • Fundraising is still hard for the majority of the teams in the cohort, beyond the $150,000 convertible debt everyone gets

    One message the book did drive home, that I didn’t appreciate before, is how much emphasis is placed on the founders, and not on the ideas. Codecademy was the result of a late-in-the-program pivot, and turned out to be one of the most successful by Demo Day. Y Combinator is a bet on people, knowing that ideas are plentiful.

    What else? What are your thoughts on the book The Launch Pad and Y Combinator?

  • The Critical Time Between Employee Offer Letter and Commitment

    Recruiting great employees who are corporate culture fits is one of the most rewarding, and most difficult, aspects of building a startup. Creating the best place to work with strong, aligned values does wonders for the recruiting process. Even so, there’s a part of the recruiting process that doesn’t get the attention it deserves: the critical time between employee offer letter and commitment.

    Here are some ideas to increase the chance of that great potential hire accepting their offer:

    • Provide a deadline in the offer to create a timeframe and expectations for a response
    • Talk on the phone and describe how excited you are for them to join your team before sending the written offer (delivering the message in person or over the phone is much more impactful)
    • Maintain an open and continuous dialogue while working hard to address any concerns they might have
    • Allow for negotiation of compensation but be weary of too much back and forth

    Changing employers, especially when joining a startup, is a big decision. Once an offer is sent to a potential employee, it’s critical to work hard to see the process through to a commitment to come aboard.

    What else? What are some other best practices around the time between an employee is given an offer letter to them signing on?

  • Scaling Corporate Culture in a Startup

    Earlier today I had the opportunity to talk to Charlie Goetz’s Emory entrepreneurship class. Every time I talk to a class I work hard to emphasize the importance of corporate culture, especially how it’s the only sustainable competitive advantage within the control of the entrepreneurs. Now, in an MBA class, all students have several years of work experience, and thus first-hand interaction with one or more corporate cultures. When I start talking about corporate culture to MBA students, they appreciate it more than students that haven’t had full-time jobs.

    One of the questions asked by a student today was “how do you scale the corporate culture as the business grows?” Here are a few ideas:

    • Implement culture check teams to provide checks and balances during the hiring process
    • Require unanimous consents from all interviewers when making a new hire
    • Regularly tell stories of positive corporate culture anecdotes
    • Include culture values in the quarterly check-ins
    • Physically embody the corporate culture through colors, objects, and visual cues

    Scaling a corporate culture in a startup is hard. Not scaling a successful corporate culture will make scaling the business 10 times more difficult.

    What else? What are some other ideas to scaling corporate culture in a startup?

  • Startups Should Use EchoSign for all Contracts

    An entrepreneur was recently asking me about an example employee handbook and what to include in it. After immediately sending over a copy of ours, I emphasized that the best thing to do was to use EchoSign and have each employee digital sign the current employee handbook once per year. EchoSign makes things so much easier, faster, and more maintainable compared to traditional signing of documents. In the United States, an electronic signature is viewed as the exact same thing as a normal signature in the eyes of the law (more background on electronic signatures).

    Startups should use EchoSign for all contracts, and here are some of the most common:

    • Employee handbooks
    • Customer deals / purchase orders
    • Partner agreements
    • Stock options
    • Investment docs (the last angel round I invested in was done entirely through EchoSign)

    E-signature and programs like EchoSign represent a much more efficient way of doing business and should be embraced by startups.

    What else? What are your thoughts on startups using EchoSign for all contracts?

  • Y Combinator and TechStars are Very Different

    Lately I’ve been reading The Launch Pad: Inside Y Combinator, Silicon Valley’s Most Exclusive School for Startups by Randall Stross. A future post will be a book review but I want to touch on a topic within the book first: Y Combinator and TechStars are very different. In fact, I know several people that have gone through each program, and their feedback and insight into the respective programs corroborates the differences.

    Here’s information on each program:

    Y Combinator

    • 60+ startups per class
    • Single city location (Mountain View)
    • No shared office space
    • No third-party mentors
    • ~$18k investment for ~6% of common stock
    • $150k convertible debt with no cap
    • Strong independent team orientation

    TechStars

    • 10 – 15 startups per class
    • Multiple cities (Boulder, NYC, Boston, and Seattle along with affiliates)
    • Shared office space
    • Third-party mentors
    • ~$20k investment for ~6% of common stock
    • $100k convertible debt with $3MM cap
    • Strong fraternity/group orientation

    Now, it isn’t that one is better than the other, only that they are very different. Y Combinator is more like grad students doing independent research projects and TechStars is more like a fraternity with everyone working on different projects in the house.

    What else? What are some other ways that Y Combinator and TechStars are very different?

  • Accelerated Second City Office Expansion Due to the Talent War

    With the ongoing war for talent in startups, especially in the money centers of California and New York, there’s going to be an increased focused on expanding to another city, with a separate talent pool, earlier in the startup lifecycle, when compared to historical standards. Traditionally, it wasn’t until a startup reached a critical mass in their scale that they would look for a second full office, not simply a light-weight sales office (e.g. Google has a massive engineering office in New York City). As for Atlanta, I know of at least two fast-growing software startups based in Florida, one based in South Carolina, one based in NYC, and two based in San Francisco (Square has an office in Atlantic Station in Midtown, Atlanta) that have full engineering offices in Atlanta. This trend is only going to accelerate.

    Here are a few reasons why startups with expand to a second city faster than historically:

    • Talent pools in a geographic area are only so large, creating excessively high demand for talent in the money centers like San Francisco and Silicon Valley
    • Money centers also have exceptionally high costs of living and housing prices, making it more desirable to have a significant office presence in a second city where costs are lower (Trulia is based in San Francisco but has hundreds of employees in Denver)
    • Video conferencing (e.g. Google Hangout) and cloud-based collaboration apps are better than ever, making it easy to work in separate physical locations
    • Acqui-hires are more common now, making it more likely startups will look for acui-hires in other cities to be the basis for a new office location

    Second city office expansion is already taking place faster for startups, but entrepreneurs aren’t talking about it as frequently as they should. Look for it to be even more commonplace over the coming years.

    What else? Do you think there will be accelerated second city office expansion due to the talent war?

  • Should Angel Investors Buy Common or Preferred Stock?

    One of the standard debates between angel investors and entrepreneurs is whether or not angel investments should be for common stock or preferred stock. Common stock is the same stock the founders have and usually doesn’t have any special rights. Preferred stock is senior to the common stock where in the event of a sale of the business, the preferred equity holders get paid at least their money back before the common shareholders. Unfortunately, this really only matters when the business sells for less than the post-money valuation when the capital was raised (downside protection).

    Here are a few thoughts on angel investors buying common or preferred stock:

    • Preferred stock, in the form of 1x non-participating preferred, the most standard type, really is for protecting the downside of a deal so that in a less-than-ideal exit there’s a better chance the investors at least get their money back
    • Preferred stock also has anti-dilution rules associated with it so that some level of protection is in place in the event more stock is issued later (e.g. for fundraising or more employee stock options), which again is protecting against the negative
    • Angel investors that have been successful, through luck or skill, will often say that protecting the downside doesn’t do much since all the success is through the huge winners, not the small losers (e.g. when a startup does great, everyone wins and it makes up for other losses)
    • Convertible debt often converts into equity once a certain amount has been raised, and this is usually for preferred stock

    Personally, I’ve invested in both common and preferred stock as an angel investor but I believe preferred stock is the way to go for angels. Providing extremely risky seed stage capital warrants getting paid back first in the event of a sale where the startup wasn’t successful. By at least getting some capital back, angels are slightly more likely to invest in future deals and continue to put capital to work. With the fact that most startups fail, returning some money keeps capital in circulation helping the greater good.

    What else? What are your thoughts on angel investors buying common or preferred stock?

  • Beware of Unnatural Acts Leading to Startup Team Burnout

    Recently I was meeting with an executive from a startup talking about lessons learned. She recounted the story of a startup she joined that was doing was well and kept raising more and more money. After a substantial series D round, the bar was set so high for revenue growth by the investors that the executive team knew it wasn’t attainable. Against the odds, the startup was able to deliver and meet the expectations for a short period of time.

    There was one major problem.

    She described their meeting revenue growth targets as requiring “unnatural acts” meaning the team was working 80 hours per week and rapidly approaching burnout. It wasn’t sustainable. Unfortunately, the entrepreneur had promised the investors they could achieve certain results. After two quarters of hitting the numbers, the wheels fell off. The startup’s growth slowed considerably, the market shifted, most of the executive team left, including the entrepreneur, and the venture-back startup is in zombie mode now.

    Beware of unnatural acts leading to startup team burnout as it isn’t sustainable.

    What else? What are your thoughts on unnatural acts resulting in burnout?

  • Looking at the 3-5x Return in 3-5 Years

    A month ago I wrote a post titled Growth Stage VC with 3-5x Money in 3-5 Years about the idea that once startups are in the millions of dollars of revenue stage, the venture investment criteria changes. Instead of VCs talking about getting 8-10x their money back in 5-7 years for the early stage, the growth stage investors still have aggressive return goals, but are more modest compared to riskier scenarios.

    A 3-5x return in 3-5 years seems simple and memorable enough but often it’s hard to visualize what that actually means in practice. Here are a couple scenarios:

    • Business has $5MM in trailing twelve months revenue
      Valued at 3x revenue for a pre-money valuation of $15MM
      Investor puts in $5MM for a post-money valuation of $20MM and owns 25% of the business
      Assume no other dilution or capital raised
      To get a 3x return, the business needs to sell for $60MM and be at $20MM in revenue (going from $5MM to $20MM of revenue is very difficult)
    • Business has $20MM in trailing twelve months revenue
      Valued at 3x revenue for a pre-money valuation of $60MM
      Investors puts in $15MM for a post-money valuation of $75MM and owns 20% of the business
      Assume no other dilution or capital raised
      To get a 3x return, the business needs to sell for $225MM (very few exits at $100MM+) and be at $75MM in revenue

    From these two slightly different scenarios, and a number of simple assumptions, you can see that one takeaway is that if taking the outside money helps get you to a revenue size equal or larger than the post-money valuation in 3-5 years, you’ll be in the money. The next time an entrepreneur with a growth stage business mentions raising money, ask them what pre-money valuation they are expecting and ask them how quickly they can get their revenue to the size of the contemplated post-money valuation.

    What else? What are your thoughts on the numbers for 3-5x return in 3-5 years?