David Cummings on Startups

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  • Startup Valuations Outside the Money Centers

    Last week I was in San Francisco at the Dreamforce conference and I had the opportunity to catch up with several awesome entrepreneurs that I’ve known for a few years. It’s always fun to hear stories first-hand to see if they corroborate what’s being said in the news, especially with regards to acqui-hires, valuations, and fundraising. By all accounts it appears that things are frothy and that there’s a localized bubble around technology in that market. Valuations that have continued to be exceptionally high for Y Combinator companies, even after PG warned they would correct 12 months ago, but haven’t done so to date.

    As for other geographic markets, I’ve seen several angel deals for different parts of the country in the past few months. Here are approximate pre-money valuations outside the money centers of California and New York:

    • Idea with no prototype: $500,000 – $1,000,000
    • Working prototype: $1,000,000 – $2,000,000
    • Successful entrepreneur: add $500,000 – $1,000,000 on top of standard valuations
    • Accelerator program graduate: add $500,000 – $1,000,000 on top of standard valuations

    As you can see, these valuations are pretty generic and not based on revenue, profitability, or other factors since most things don’t exist at this idea or prototype stage. In the end, it’s likely to be a $1MM – $3MM pre-money valuation for pre-revenue technology deals outside the money centers.

    What else? What are your thoughts on these startup valuations outside the money centers?

  • Quick Method to Decide on Co-Founder Equity Splits

    One question I really like to ask idea stage entrepreneurs is how they’ve split up their equity. Now, for a startup with traction, investors, etc that question can be like asking how much money someone makes, so take it lightly. For two entrepreneurs that are just getting started on their idea, it’s usually no big deal. Almost always the answer to that question is that the equity has been split evenly among the founders.

    Joel Spolsky, who’s famous in the startup world, argues that equity should be split 50/50. When entrepreneurs ask for advice on splitting equity, I take the 50/50 split approach and add slightly more nuance to it as follows:

    • Start with a 50/50 equity split (rarely should there be three or more co-founders)
    • Add an employee stock option pool of 10% of the equity (so now the founders each have 45%)
    • Come up with an arbitrary valuation for the business, say $500,000, and use that to determine contribution values like:
      – Salary differences where one person needs $50k/year to live off of and the other person needs $30k/year, then that $20k delta for year one would count towards more equity at the valuation
      – Money invested in the business by each founder would take place at that valuation

    In the end, the founders, outside the stock option pool, might have a 60/40 split, which is a better representation of monetary contribution and extraction from the company.

    What else? What are your thoughts on this quick method to decide on co-founder equity splits?

  • The Rise of Enterprise Software Purchased Bottom-up

    Chris Dixon, one of the best startup bloggers out there, has a new post up today titled The Rise of Enterprise Marketing. In the post, Chris argues that a serious trend with enterprise (business) Software-as-a-Service (SaaS) is that of front-line managers and employees buying software in a bottom-up manner as opposed to the historical top-down manner. Some successful SaaS companies, including Yammer, which just sold to Microsoft for $1.2 billion, use a freemium model where the sales people only call on people already using the free edition — no more cold calls.

    Another key point is that instead of sales people leading the charge to the CIO or department heads, marketing is leading the charge reaching out to the end users. With the end users on board, they either buy directly in a low friction fashion (e.g. a credit card) or if enough people get involved they make a traditional enterprise type sale. The sales cycle and cost of customer acquisition is a magnitude lower in this model compared to the traditional model.

    As for the title of the post, “The Rise of Enterprise Marketing” isn’t the clearest headline to describe the content. Enterprise marketing has been around since the beginning of business software. This is really enterprise marketing targeted at the end user so that the corporate software can be purchased in a bottom-up manner. Regardless, this is a major trend deserving of serious attention.

    What else? What are your thoughts on the rise of enterprise software purchased bottom-up?

  • A Startup is a Scalable Growth-Focused Company

    Paul Graham’s most recent essay this week, titled Startup = Growth, argues that startups are companies designed to grow with a scalable business model. The idea is that a startup is different from most businesses, like a barber shop, in that they are high growth-oriented from the beginning. So, a startup can be in the early low/no growth phase as well as the rapid growth phase that eventually levels off, resulting in a regular, large business, if the startup is successful.

    Another prominent startup author, Steve Blank, argues that a startup is an organization formed to search for a repeatable and scalable business model. The idea is that once the new entity figures out product/market fit and starts building a business, the organization is now a company and no longer a startup. Now, these are fundamentally different: one says that startups are high growth-oriented companies from the beginning through rapid growth stage and the other says that startups are temporary businesses at the earliest stage.

    My personal belief is that startups are of the Paul Graham definition (and a superset of the Steve Blank definition). Here’s how I view a startup:

    • Large, scalable business potential that isn’t predicated on any one person (most businesses are replicative of an existing model instead of innovative with a new model)
    • Significant amounts of change and uncertainty on a weekly or monthly basis (companies like a healthcare provider have change and uncertainty, but it doesn’t manifest itself in such a short time frame)
    • Top line annual revenue growth of 30% or more once a modest level of product/market fit has been achieved

    To me, startups are about scale and growth with the later being the most important, as Paul Graham clearly articulates.

    What else? What are your thoughts on a startup being a scalable growth-focused company?

  • Salesforce.com’s Stock is Priced for Perfection

    At Salesforce.com’s Dreamforce conference this past week there were a number of hot topics like cloud computing, social media marketing management (a.k.a. the marketing cloud), and big data. One item I heard discussed on the show floor was Salesforce.com’s meteoric stock price and market cap. When I asked further about the stock price to one attendee, he described it as “being priced for perfection.” Having not heard that phrase before, I asked what it meant. Simply put, it means that the price is so high that there’s no room for error and Salesforce.com must keep exceeding analyst’s expectations. If Salesforce.com misses analyst’s growth, revenue, and earnings expectations in a quarter, expect a large correction in stock price.

    Here are some of the numbers for Salesforce.com now, as of September 22, 2012, from Google Finance for NYSE:CRM:

    • Market cap: $21.57 billion
    • Stock price: 155.20
    • Cash on hand: $1 billion
    • Total current assets: $1.85 billion
    • Total debt: $508 million
    • Last quarter’s revenue: $731 million
    • Run rate based on last quarter’s revenue: $2.92 billion
    • Enterprise value: ~$21.07 billion
    • Revenue run rate multiple: ~7x

    A revenue run rate top line multiple of 7x is incredible for any company, but especially so with a company that has 8,765 employees. Salesforce.com’s stock is priced for perfection and I hope they continue to exceed expectations.

    What else? What are your thoughts on Salesforce.com and their stock being priced for perfection?

  • Odds of Raising Venture Money and Selling for $100M+

    Bob Dorf, co-author of Startup Owner’s Manual, has a post on Steve Blank’s blog titled Why Too Many Startups (er) Suck where he cites a stat that between .2% and 2% of all venture-backed startups ever sell for more than $100 million. Think about that for a minute: with 1,000 venture-backed startups, somewhere in the 2-20 range reach a nine-figure exit.

    Let’s take the math further. Suppose, for simple analysis purposes, that only venture-backed companies sell for at least $100M+ (not true but it’s even more rare for a bootstrapped company to sell for $100M+ compared to a venture-backed company).What percentage of companies actually raise venture capital? According to a piece on Quora, .6% of companies raise venture capital.

    Taking all companies that are created, all companies that raise at least one round of venture capital, and all companies that sell for $100M+, you get between .0012 and .00012. That is, one in 10,000 – 100,000 companies will raise venture capital and sell for $100M+.

    The next time someone offers raising venture capital as a way to get a slice of a watermelon instead of owning a grape, ask them how many watermelons are grown each year.

    What else? What are your thoughts on the odds of raising venture money and selling for $100M+?

  • Free Doesn’t Help if the Market Isn’t Ready

    Recently I was talking to an entrepreneur who’s working on a new open source product for a small but fast growing market. After talking about it with him for 10 minutes, and learning more about the opportunity, I told him that I thought he was much too early. Free doesn’t help if the market isn’t ready.

    For our company Pardot, we could give away our software for free and we wouldn’t materially increase the number of active, successful clients. The challenge with our market, and the market this entrepreneur is going after, is that there’s a) a significant lack of market awareness and b) a significant lack of product understanding. The two are related in that the more people use a new technology the more awareness there is of it and a positive adoption cycle continues until it’s mainstream.

    Because so few people have used our type of technology, we spend thousands of dollars per customer making sure they’re successful and manually helping them out. 5-7 years from now enough people will have used our type of technology such that a lower cost entrant in our market will be successful by offering a simpler interface with only the most important features and they’ll be able to sign up companies that already have experience, and thus don’t need a comprehensive on-boarding experience.

    Free or open source works for an educated market. When the market isn’t ready, these types of distribution models don’t work as well as traditional models.

    What else? What are your thoughts on free or open source products in a market that isn’t ready?

  • Dreamforce 2012 Exhibitors as Proxy for Hot SaaS Categories

    Salesforce.com’s annual Dreamforce conference is here again promising to have over 80,000 attendees in San Francisco. One of the many interesting aspects of the show is to see all the different Software-as-a-Service (SaaS)/cloud companies exhibiting at the show (250+). In many respects, the exhibitors at the show act as a proxy for the excitement surrounding different SaaS categories. Booths at the show range from ~$30,000 for a bronze sponsorship to $1,000,000 for a diamond sponsorship.

    Using the sponsorship level as an approximation for company size, we can gauge different SaaS sectors on their size. So, Bronze = 1 point, Silver = 2 points, Gold = 3 points, Platinum = 4 points, Titanium = 5 points, and Diamond = 6 points.

    Here’s a quick analysis of the different SaaS/cloud categories based on the vendors at Dreamforce 2012 with at least a Silver sponsorship level and the points earned by that category based on sponsorships:

    • Cloud Consulting: 6, 5, 5, 4, 4, 3, 3, 3, 3, 3, 3, 3, 3, 3, 3, 2, 2, 2, 2, 2, 2
    • Marketing Software: 5, 5, 4, 4, 2, 2, 2, 2, 2
    • Contract/Quote Management: 4, 3, 3, 3, 3, 3
    • Document Collaboration: 4, 3, 2, 2
    • E-Signature: 4, 3
    • Accounting/ERP Software: 3, 2, 2, 2, 2
    • Business Intelligence: 3, 3, 3, 2
    • Forecasting/Pipeline Management: 3
    • Expense Management: 3
    • Data Quality Management: 3
    • Cloud Integration Middleware: 3, 3, 3, 2, 2, 2
    • Customer Service/Call Center Software: 3, 3, 2, 2, 2, 2, 2, 2, 2
    • Data Services: 3, 2, 2, 2
    • Mobile Software: 3, 2
    • Human Resources Software: 3, 2
    • Sales Compensation Management: 3
    • Billing Management: 3
    • Learning Management Software: 2
    • User Engagement Software: 2
    • Conferencing Software: 2
    • Project Management: 2
    • Ecommerce Software: 2
    • Sales Process Management: 2, 2, 2, 2, 2
    • Identity Management: 2

    The four clear winners in order of size: cloud consulting, marketing software, customer service/call center software, and contract/quote management software.

    What else? What are your thoughts after seeing the different categories of vendors and size of their investment in the Dreamforce 2012 conference?

  • Premature Scaling Worries in a Startup

    Recently I was talking to an entrepreneur about his startup. After about 10 minutes into his idea, I stopped him and said that he was having premature scaling and delivery worries. 95% of startups fail due to a lack of a sales and 5% fail due to a lack of being able to deliver what’s been sold (made up numbers but the idea is still true).

    Here are some common premature scaling questions to look our for as an entrepreneur:

    • Should I choose Zendesk or Help.com for my support software? Have you sold anything yet? Go sell something first and use plain email until you’re overwhelmed with support inquires.
    • Where will I find good operations people? Have you sold anything yet? Good people are readily available once you have revenue.
    • How much money should we raise for this idea? Have you sold anything yet? Investors are unlikely to invest in the idea until the startup has some paying customers.

    The next time you hear premature scaling worries, focus the conversation on building a repeatable customer acquisition process and defer the scaling conversation until it becomes a high class problem that’s on the near-term horizon.

    What else? What are some other premature scaling worries in a startup?

  • The Boulder Thesis Applied to Atlanta for Startup Communities

    Last night I finished reading a pre-release copy of Brad Feld’s new book Startup Communities: Building an Entrepreneurial Ecosystem in Your City. Brad does a great job of covering a wide range of topics and presenting a number of tactical ideas for community building, startup or otherwise. The book is closer to a how to manual with anecdotes than it is a strategy business book like you might find from Jim Collins. If you’re a hands-on, doer type, then it’s for you.

    Here is Feld’s Boulder Thesis for startup communities:

    1. Entrepreneurs must lead the startup community;
    2. The leaders must have a long-term commitment;
    3. The startup community must be inclusive of anyone who wants to participate in it; and
    4. The startup community must have continual activities that engage the entire entrepreneurial stack.

    Now, let’s take these items and go through them in an Atlanta context:

    1. Entrepreneur lead community (grade: B) – Many events, like Startup Lounge, Hypepotamus meetups, Startup Riot, and B2B Camp are entrepreneur lead. Several programs like Flashpoint, Venture Atlanta, ATDC events, High Tech CEO Council, and others have entrepreneurs within the leadership group, but aren’t purely entrepreneur lead as there is heavy government, university, and service provider involvement.
    2. Long-term commitment (grade: A) – Most of the core group of entrepreneur leaders in the city have lived in Atlanta 10+ years and show all the signs of a long-term commitment.
    3. Inclusiveness (grade: A-) – With ATDC opening up to everyone a couple years ago and the rise of massive events like Startup Riot, the inclusiveness of the community has gone up tremendously. There are still some invite-only events, but they are waning.
    4. Activities to engage the entrepreneurial lifecycle (grade: B) – The seed stage through the first part of the early stage is pretty well covered with opportunities to improve via more frequent pitch events (see the Atlanta Startup Village pitch night idea). The later part of the early stage as well as the growth stage and beyond don’t have much activity outside of Venture Atlanta (partly because there aren’t that many companies at those stages and partly because the companies at those stages aren’t as collaborative as you would hope).

    So, overall, I’d give Atlanta startup community a grade of a B+ when applied to Feld’s Boulder Thesis. I see an A- as readily achievable with an A on the long term horizon. Just in the past 12 months there have been several new entrepreneur-lead initiatives and the quality of the community continues to improve.

    What else? What are your thoughts on the Boulder Thesis applied to Atlanta for startup communities?