David Cummings on Startups

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  • Physical Atlanta Startup Village Idea

    Atlanta has an amazing resource in Tech Square, on the outer edge of Georgia Tech’s campus in Midtown. Tech Square has all the amenities wanted in a startup hub: highly ranked engineering school, great walkability for serendipitous interactions, easy proximity to public transportation including a subway station, many restaurants, tons of creative-class jobs, Starbucks, Barnes and Noble, the ATDC incubator, and the co-working space Hypepotamus (more Midtown benefits from @rkischuk).

    ATDC, the Advanced Technology Development Center (not the Atlanta Technology Development Center as many people think), has great office space that’s subsidized by the university and month-to-month leases — perfect for startups. In addition, the Tech Square area is an empowerment zone meaning it qualifies for a $2,500 tax credit for each new employee hired with a salary ~30% higher than the county average (a salary of approximately $65,000 or higher qualifies). With all this said, there’s a high quality problem in that there’s no office space left, a waiting list for future space, and you can’t get on the waiting list unless you’re an ATDC Select company (based on company progress and likelihood of building a sustainable business). Also, the space isn’t designed for startups that have broken through and are starting to scale (e.g. once you hit reached a certain employee size or have been there three years, whichever comes first, you usually have to leave).

    The solution is to buy the large, empty lot next to the parking deck that serves Tech Square and turn it into a physical Atlanta Startup Village. Much like an Olympic Village, this would be custom designed to help foster the goal of building a larger, more vibrant startup community.

    Here are some ideas for the physical Atlanta Startup Village:

    • Large multi-story complex like the American Tobacco Campus in Durham, NC
    • Loft-style space with tall ceilings and exposed bricks and beams
    • Communal outdoor space with a park-like setting
    • Several multi-purpose event facilities
    • Roof top balcony for tenants and events
    • Octane coffee shop
    • Mellow Mushroom restaurant
    • General Assembly-like education and co-working space
    • A mix of seed stage, early stage, and growth stage companies
    • Affordable gigabit fiber internet access and WiFi

    The physical Atlanta Startup Village is a complement to Tech Square and sets the stage for an even stronger and more vibrant tech startup community.

    What else? What would you add or change about the physical Atlanta Startup Village idea?

  • Entrepreneurs That Ride Major Trends

    Recently I was talking with a successful serial entrepreneur and he commented that he looks for major trends when deciding on his next business. He described it as finding a big sand box that he likes and digging around in it until he finds a great opportunity — I agree completely. I like to think about it as focusing on a small, fast-growing market doing a zig zag until you find the best wave to ride.

    Here are some big trends right now:

    • Cloud computing
    • Crowdsourcing
    • Social media
    • Mobile
    • Location-based services

    Those are some very generic trends. The idea is to find an angle or leading edge component within a trends and get ahead of the market. As for timing, 2-4 years early is often optimal.

    What else? What are your thoughts on entrepreneurs that look to ride major trends?

  • Employee Loyalty is a Strong Non-Valley Benefit

    Recently I’ve heard increased talk from entrepreneurs and venture capitalists that employee loyalty and retention is an even more serious issue in the Valley that isn’t as top-of-mind for entrepreneurs considering where to locate their startup. The idea is that in the Valley there’s a culture of people moving jobs every year to try and get in early at the next pre-IPO startup, and, of course, most startups don’t make it, so people keep changing jobs quickly.

    For us, we have over 100 employees, have been in business five-and-a-half years, and have only had five people voluntarily leave us (along with ~10 that have involuntarily left). Building a strong corporate culture and great place to work is an incredible competitive advantage anywhere, but especially powerful is markets outside the Valley that have greater employee loyalty and less turnover.

    The next time you think through pros and cons of your startup’s city, add employee loyalty as an important factor.

    What else? What are some other thoughts on employee loyalty as a strong non-Valley benefit?

  • 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?