David Cummings on Startups

Blog

  • Growth Stage VC with 3-5x Money in 3-5 Years

    Venture capital, in its standard form, is pretty well known. The story is as follows: invest in 10 startups, the majority go bust, two or three make a good return, and one is a huge success returning the fund and them some. Only, over the past decade, most venture funds haven’t made any money at all so there’s more emphasis on startups with traction and other measures that show risk has been removed from the equation.

    There’s another segment of venture capital that isn’t talked about as much due to the few number of startups that reach the targeted size: growth stage capital. Growth stage is typically companies with at least $5 million – $10 million in revenues growing north of 30% per year. Once a technology company fits this category, growth stage venture capitalists will pay a nice premium, making a bet that the business will be able to grow substantially more and that worst case scenario they can get their money back (based on a 1x non-participating preferred preference with their stock).

    The common refrain when asked for investment return expectations isn’t the 8-10x that early stage VCs talk about, rather the goal is to return 3-5x the money invested in 3-5 years. 3-5 years isn’t the 7-10 year horizon early stage VCs look at, but it’s still plenty of time to generate significant value above and beyond what’s already been created.

    The next time you’re talking to a venture capitalist, ask about their expectations and desired return on investment.

    What else? What are your thoughts on growth stage VCs looking to making 3-5x their money in 3-5 years?

  • SaaS Cost of Goods Sold for Startups

    Cost of goods sold for Software-as-a-Service (SaaS) startups seems like it should be a straightforward topic but there are a number of different conflicting reports online. According to Wikipedia, cost of goods sold “refers to the inventory costs of the goods a business has sold during a particular period.” Of course, due to the nature of software, there is no inventory but there are costs to deliver the application.

    Here’s what we include in our cost of goods sold calculation:

    • Hosting fees (our highest expense after salaries and benefits)
    • Third-party web fees like content delivery networks, embedded software, etc
    • Support personnel costs
    • Customer on-boarding costs (e.g. client implementation personnel costs)
    • Note: Credit card fees and other billing fees often are not cost of goods sold for SaaS companies and are instead general and administrative fees

    Notice things like software development costs, customer acquisition costs, and more aren’t included since they are not required once the customer has already been signed. SaaS cost of goods sold is an important metric so that gross margin can then be calculated.

    What else? What are some other items that should be considered as part of cost of goods sold for SaaS companies?

  • SaaS Customer Acquisition Costs Relative to Customer Revenue

    One of the core tenants of Software-as-a-Service (SaaS) economics is that the cost of customer acquisition needs to be commensurate with the revenue provided by the customer. As an example, if it costs $50,000 to acquire a customer and the customer only pays $1,000 per month, it’s likely that the business, in it’s current form, won’t work (save for an unusual up-sell situation). When looking at SaaS metrics, the ratio of customer acquisition costs to annual recurring revenue is one of the most important.

    Here are a few thoughts on SaaS customer acquisition costs relative to customer revenue:

    • A general rule of thumb is that the cost to acquire a customer should be less than the annual recurring revenue from the customer (e.g. if it costs $1,000 to acquire a customer, the customer should pay at least $1,000 per year in recurring revenue)
    • Length of contract and average lifetime of a customer are also important considerations, especially with products that have high switching costs (e.g. a content management system has much higher switching costs than an email marketing system)
    • Gross margin is another critical piece of the puzzle as SaaS companies with higher gross margins can afford to spend more to acquire a customer, everything else being equal
    • Cost of capital is another consideration when looking at customers that are expensive to acquire but will likely stay for many years

    As a SaaS entrepreneur, SaaS customer acquisition costs relative to customer revenue is one of the most crucial metrics for building a viable, high growth business. Many venture-backed companies burn significant amounts of cash to reach profitability, and many of the most successful ones don’t reach profitability until well after they’ve gone public. Regardless, the economics of customer acquisition need to make sense.

    What else? What are some other thoughts on SaaS customer acquisition costs relative to customer revenue?

  • Angel Investor Economics on a $30 Million Exit

    Recently a strong Atlanta technology company had a great exit with only angel investment and no venture investment. Not knowing any particulars of the deal, I think this is an instructive example to theorize on the economics of an outstanding angel investment. To make it simple, let’s assume a $30 million exit on $3.5 million of angel investment after six years in business.

    Here’s how angel investor economics might look for a generic, successful technology startup that exits for $30 million:

    • Series A – $500,000 invested at a $2 million pre-money valuation resulting in a $2.5 million post-money valuation and the investors owning 20% of the business
    • Series B – $1 million invested at a $4 million pre-money valuation resulting in a $5 million post-money valuation and the new investors owning 20% of the business from the new round (existing investors are diluted by 20% to 16% but likely participated pro-rata)
    • Series C – $2 million invested at a $8 million pre-money valuation resulting in a $10 million post-money valuation and the new investors owning 20% of the business (Series A and Series B investors get diluted unless they participate pro-rata with Series A owning ~13% and Series B owning 16%)
    • Total investor ownership: Series A at 13% plus Series B at 16% plus Series C at 20% for a total of 49% of equity
    • Exit values:
      Series A at 13% of $30M = $3.9M for almost an 8x cash on cash return
      Series B at 16% of $30M = $4.8M for a 4.8x cash on cash return
      Series C at 20% of $30M = $6M for a 3x cash on cash return

    Again, these is an outlier example that isn’t common — most angel investments don’t even return the amount of money invested, let alone a return. Generating a return of nearly $15M on a total investment of $3.5M in six years is an excellent angel investment.

    What else? What are some other thoughts on the this example angel investment and outcome?

  • SaaS Valuations and NTM Multiples

    Software-as-a-Service (SaaS) valuations continue to do well in the public markets even after other technology companies like Facebook and Zynga struggle. One valuation metric for SaaS startups that isn’t talked about as frequently as it should is a multiple of the next twelve months (NTM) revenue. One of the reasons a forward looking revenue multiple is so important is that there’s a large premium for high growth SaaS companies vs medium growth SaaS companies.

    Indy Guha has a great post on Quora titled Keeping it SaaS-y: Valuations for SaaS Companies. In article, the author shows examples for two buckets of SaaS company valuations:

    • Companies with at least 30% growth and 65% gross margins trade at seven times NTM sales
    • Companies with less than those percentages trade at 4-5 NTM sales

    As an entrepreneur, it’s instructive to think through rough company valuations based on factors like a multiple of the next twelve months sales as a function of growth rate and gross margins.

    What else? What are your thoughts on SaaS valuations and NTM multiples?

  • Death to the $700k Seed Round

    The $700k seed round, as it’s currently known today, needs to die. Here’s a common scenario: entrepreneurs scrape together $50k from friends and family, build a prototype, sign three customers or LOIs that are from warm intros, use the modest progress to raise a $700k seed round, spend all the money in 12 months, still don’t have product/market fit or a repeatable customer acquisition process, and now can’t raise more money resulting in a zombie startup. This happens again and again.

    Here’s a modest proposal for how to change it:

    • Raise $50k to build the prototype and get the first three customers or LOIs
    • Raise $250k and make it last 24 months
      – Forced to make the money last longer with a smaller team acknowledging that throwing more people at it doesn’t accelerate the time it takes to figure things out (much like The Mythical Man-Month for startups)
      – More time to find product/market fit and a repeatable customer acquisition process
      – Lower burn rate when/if it’s time to raise more money resulting in more flexibility
      – Decreased dilution since less money is raised at the same pre-money valuation
    • Raise more money or continue to grow organically from a position of strength

    The two main differences from the current model are that it’s planned to take twice as long and it’ll cost less than half as much each year to figure out how to make things work. This leaner, longer timeline approach increases the likelihood of startup success.

    What else? What are your thoughts on death to the $700k seed round and this alternative proposal for a smaller seed round designed to last longer?

  • 2012 Inc. 500 Companies in Metro Atlanta

    Today the 2012 Inc. 500 was announced. Impressively, 16 Georgia companies made the 2012 Inc. 500 list representing a variety of industries. There are several technology companies on there as well as many other types of businesses.

    I always enjoy reading about the fastest growing companies and learning as much as I can about them.

    What else? What are your thoughts on the Inc. 500 companies in Metro Atlanta?

  • Bottom-Up SaaS Revenue Forecast for Startups

    Bottom-up revenue forecasts are the only way to go for startups, especially for Software-as-a-Service (SaaS) startups. Too often, entrepreneurs will take a big number, like all the people in China, and say are going to get 1% of them to buy something, and thus have a big business. Alternatively, an entrepreneur will start with a small number, like their current revenue, and forecast that it will grow at some growth rate indefinitely (if only things were like the wise man who asked the king for one piece of rice and to have that piece doubled for every spot on a chess board). Unfortunately, top-down revenue forecasts should not be used for startups.

    Here’s an example bottom-up SaaS revenue forecast approach:

    • Take the number of sales reps expected to make quota (e.g. 2)
    • Multiply by the monthly quota per rep (e.g. $25,000 in new annual contract value (ACV) per month or $75k ACV per quarter or $300k ACV per year)
    • Multiply by the monthly renewal rate (e.g. between 97% and 99.5%)
    • Add in any consulting or one-off revenue
    • Arrive at the total monthly revenue

    Bottom-up forecasts are the only way to go for SaaS startups and should be used from idea stage all the way through growth stage.

    What else? What are some other thoughts on bottom-up SaaS revenue forecasts for startups?

  • The #1 Enemy of SaaS: Churn

    Software-as-a-Service (SaaS) continues to be one of the most popular tech-based business models as evidenced by the multiples for publicly-traded SaaS companies. It’s easy to get excited about the model due to the recurring revenue, high gross margins, and general growth of the space. One area that doesn’t get the attention it deserves is the #1 enemy of SaaS: churn. Churn is when a customer leaves and is a normal part of business, but with SaaS, it takes on more importance.

    Here are some thoughts on churn:

    • A leaky bucket can quickly form if the number of new customers equals the number of customers that churn (assuming no upsells and everything else is equal)
    • A killer amount of churn is often thought of as 3% or more per month, due to the huge number of new customers required to continue growing
    • Keep detailed records around churn reasons and analyze them on a regular basis
    • Monitor customer cohorts on a monthly/quarterly/annual basis to understand how churn rates are improving/declining over time

    Churn is the #1 enemy of SaaS and deserves more publicity. The next time you think about SaaS metrics, churn rate should be near the top of the list.

    What else? What are some other reasons churn is the #1 enemy of SaaS?

  • 7 Crazy Startup Workplace and Culture Things to Do

    Yesterday I was having lunch with a group of entrepreneurs and business leaders. One of them commented on us winning an award for being the #1 place to work and asked if I’d share any secrets or tips. I love talking about all the crazy things we do, so I jumped right in.

    Here are seven crazy startup workplace and culture things we do:

    1. Bottom up daily check-ins – everyone participates in a quick meeting at the beginning of the day with their manager and answers the following questions: what did you do yesterday, what are you going to do today, and do you have any roadblocks
    2. Scoreboard – a large LED scoreboard for everyone to see how the company is doing across key metrics color coded red, yellow, green, and super green
    3. Two page essays during the hiring process – all applicants for all positions have to write a two page essay as part of the hiring process and we’ve found that ones ability to write is highly correlated with the ability to do the job for all departments
    4. Culture check during the hiring process – we have several two-person teams that interview candidates exclusively for corporate culture fit and don’t assess things like domain expertise or ability to do the job
    5. Quarterly check-ins – each quarter every team member sits down with their manager for an hour one-on-one meeting and answers the following questions: what did I accomplish last quarter, what am I going to accomplish this quarter, how can I improve, and how am I following the values
    6. Four hours of monthly housecleaning – we pay for four hours of housecleaning per month for each employee to help simplify and improve their personal life
    7. Freestyle Fridays – we don’t allow recurring meetings on Friday and discourage any meetings or interruptions so that people get longer periods of time to concentrate and get in the zone (most people work from home several days per week as well)
    8. Bonus: No vacation tracking – we don’t track employee vacation or sick time as our focus is on delivering results and meeting expectations, not on how many hours someone worked

    One of the things I tried to emphasize at the lunch meeting is that the perks and benefits side of the equation reinforces the value we place on our people, but people love the company because of the other people they work with, and the perks are icing on the cake.

    What else? What are some other crazy startup workplace and culture things you recommend?