David Cummings on Startups

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  • Consider Blue Sky Opportunities When Pivoting in a Startup

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    Recently I met with a startup that has decided to pivot their business model. After six weeks of talking to prospects and potential business partners they realized it wasn’t going to work. Yes, a prototype was built, something even less than a minimum viable product, and the appetite for it was negligible.

    With a decision made to pivot, the initial thought was to do something around the original idea but in a different manner — something between a pivot (hard change) and an iteration (soft change). Once I heard this from them I pushed back. They have a clean slate, there’s no reason to stick with the original area, and they should spend some time doing unfettered brainstorming.

    My recomendation: come up with 100 blue sky opportunities on a white board, whittle them down to 10, and marinate on those for a few days. After that, compare the 10 with the initial idea, pick one, and move forward with customer development.

    What else? What other things should be done when pivoting in a startup?

  • What Percentage of Revenue Should be Spent on Marketing?

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    Today I had lunch with a successful marketing executive. Mid-way through the meal he asked how much we spent as a percentage of revenue on marketing. Not sales and marketing, just plain marketing. Not knowing the answer off the top of my head I did some mental calculations and came up with 15%. We spend 15% of our revenue on things marketing related (salaries, campaigns, trade shows, content, PR, etc). Being a marketing guy, he was impressed as 15% was much higher than what his company spends on marketing.

    The most successful SaaS companies spend significantly more on sales and marketing as a percentage of revenue than you would expect.

    It isn’t that SaaS companies aren’t investing in other aspects of the business. Rather, SaaS markets are growing so fast that there’s a disproportionate amount of money spent on customer acquisition to capture market share.

    Salesforce.com spends 54 cents on sales and marketing for every dollar of revenue (source). Growing fast and acquiring customers is expensive. Marketing for SaaS companies should be a meaningful percentage of revenue.

    What else? What are your thoughts on marketing as a percentage of revenue for a SaaS business?

  • The Power of Peer Groups and Startups

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    Peer groups are one of the many aspects of entrepreneurship and the startup world that took me years to appreciate. When I say peer groups I don’t mean networking groups. Rather, peer groups are small sets of people that often meet once a month, if not more, in an environment of trust and confidentiality. Peer-to-peer experience sharing and learning is incredibly powerful for entrepreneurs in all types of businesses.

    Here are some benefits of peer groups for entrepreneurs:

    • Most issues have already been tackled by someone else, so the same mistakes don’t need to be repeated
    • No more being lonely at the top as there are many people out there in similar positions
    • The emotional roller coaster of entrepreneurship has high highs and low lows that are best when shared with others
    • Life’s a journey and these peer groups provide a special setting to develop deep relationships

    The most common and popular non-profit for these peer groups is the Entrepreneurs’ Organization (EO) for companies greater than $1 million in revenue and EO Accelerator for companies between $250k and $1 million in revenue. I highly recommend these organizations as well as peer groups in general.

    What else? What are some other benefits of peer groups?

  • Rental Car Companies, Shady Consumer Tactics, and Company Values

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    Recently I rented a car from one of the major rental car companies, and just like every other time, they had their shady consumer tactics. Here are two of the most common shady tactics used:

    • They ask if you would like basic or premium insurance without letting you that ‘none’ is an option and most major credit cards provide rental car insurance at no charge (I know about this credit card coverage first hand as my wife got into an accident with our rental car a couple years ago and the credit card company took care of everything).
    • They offer for you to pre-pay for gas at a reduced rate and casually say to bring back the tank empty if you do. They mention this because they’ll charge you for an entire tank even if you have gas in it. Unfortunately, they aren’t straightforward that you’re pre-paying for an entire tank regardless of usage if you go with this option.

    As a startup, it’s important to articulate your values and outline it for everyone to see. If you want trust and respect, tactics found at this rental car company wouldn’t be part of your organization.

    What else? Have you seen other shady tactics used at rental car companies?

  • Factoring Liquidity Preferences in Startup Valuation

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    Great, so you’ve received a term sheet from an awesome VC, but it asks for 3x participating preferred equity. 3x participating preferred means that the investors get 3x their money back first, and then split the remaining monies based on their ownership percentage. So, as an example the investors might put in $3M at a $7M pre-m0ney valuation, for a post-money valuation of $10M and a 30% stake in the business. With a 3x participating preferred position, example exit outcomes are as follows:

    • Startup sells for $10M, investors get $9.3M (3x their investment (3 times $3M) and then 30% of the remaining value (.3 time $1M)), and other shareholders get $700k
    • Startup sells for $20M, investors get $12.3M (3 times $3M plus 30% of $11M), and other shareholders get $7.3M
    • Startup sells for $50M, investors get $21.3M (3 times $3M plus 30% of $41M), and other shareholders get $28.7M

    How do you factor that type of liquidity preference into the startup’s pre-money valuation? As you can see by the three scenarios participating preferred equity (sometimes called double dipping) makes for dramatically different outcomes. On the surface it appears the investors own 30% of the business and invested at a $7M pre-money valuation but the numbers above show that with an exit at $50M or less, the actually percentage investors get is really in the 40 – 60% range assuming a decent exit.

    One extremely simplistic way to think about participating preferred equity is that for outcomes less than 10x the pre-money valuation, every 1x of participating preferred takes the investors ownership position up 10-20% above their current position (e.g. from 30% ownership to 36% ownership for 1x participating preferred).

    What else? What are some other ways you factor liquidity preferences in the startup valuation?

  • Is the fifth employee of a startup an entrepreneur?

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    Recently I met a gentleman that said he was an entrepreneur. After talking for a bit he said he joined a startup as the fifth employee and hadn’t started a company. Does that make him an entrepreneur or an entrepreneurially-minded employee?

    Here are some ways I think of the difference between an entrepreneur and entrepreneurially-minded team member:

    • Low or no salary vs a salary slightly below market rate
    • Personal guarantees on the business loan and office space vs no personal guarantees
    • Sweated a payroll period vs not having the stress
    • Co-founder of the business vs an early employee

    Of course, entrepreneurs can be early employees in a startup they didn’t co-found. Differentiating between the two doesn’t matter nearly as much as being a valuable team member and helping make the startup a success.

    What else? Is the fifth employee of a startup an entrepreneur?

  • Inside Sales Rep Comp Model for Startups

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    Most B2B SaaS startups should start with an inside sales rep model. The idea is that a consultative inside sales model is significantly less expensive when compared to a traditional enterprise field rep model. Prospects still need to talk to a knowledgeable sales person to help them make a decision.

    When thinking about the inside sales rep compensation model, I like to have the majority of the comp be the commission with a common split being 40% salary and 60% commission. Here are some ideas when thinking about the inside sales representative compensation model in a startup:

    • Base salaries in the range of $25k – $50k
    • Commissions in the range of $25k – $60k (e.g. $40k base salary and $60k in commission for an on-target earnings of $100k)
    • Commissions would be 10% – 20% of first-year’s revenues (e.g. $1,000/month SaaS product is $12,000/year with a 15% commission would be an $1,800 commission)
    • Commissions should be paid out after the customer’s payment has been received by the startup

    Sales rep comp should align closely with the interests of the startup and be win-win for everyone.

    What else? What are some other thoughts on inside sales rep comp models in startups?

  • Equity Best Practices for Co-Founders in a Startup

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    An entrepreneur approached me recently to ask for advice around equity sharing with his co-founder. There’s no “right” answer for percent ownership but there are a few general best practices that all co-founders should follow.

    Here are equity-related best practices all co-founders should follow:

    • Require a four year vesting schedule where the equity vests monthly (another option is milestone-based vesting, which is also worthwhile — the key is to always have vesting)
    • Require a one year cliff where if any co-founder leaves in the first year they get no equity
    • Incorporate a buy/sell agreement that spells out what happens to equity owned by a co-founder once an owner leaves the business, if anything (e.g. does the startup have the option to buy back the equity? at what price?)
    • Document what each co-founder brings to the table in terms of time commitment, IP, networks/contacts, etc

    These best practices help set ground rules in the event things don’t go well or a co-founder decides to leave. People have the best of intentions when starting a company but it’s hard to know how personality styles and work ethics match or don’t match.

    What else? What are some other equity-related best practices co-founders should follow?

  • Determining When a Startup is Financially Ready for a New Hire

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    At today’s EO Accelerator accountability group, one of the discussion topics was centered around how to determine when a startup is financially ready for a new hire. Many entrepreneurs are concerned with increasing their cost structure and want to be prudent when adding new people, especially if they are bootstrapping the business. It isn’t always obvious when the financial wherewithal is in place for that next hire.

    There are two simple ways to determine when a startup is financially ready for a new hire:

    • Growth Plan Assets (GPA) – for companies that sell products or services with limited or no recurring revenue, growth plan assets is the ratio of current assets (e.g. money in the bank plus accounts receivable) divided by the average monthly operating costs over the past 90 days (e.g. all expenses in the past 90 days divided by three). The GPA should be in the three or four range (like a good GPA in college) to know that the business is ready to hire (the GPA can be lower as the percent of revenues that are recurring go up).
    • Recurring Revenue Greater than Expenses – for companies with most or all revenue recurring things are much simpler: once the recurring revenues are greater than the current expenses plus the expenses of a new hire, then the startup is good to go. This equation changes slightly if the startup has a bank line of credit and is able to hire in advance of revenue knowing that it will quickly catch up and surpass expenses.

    Determining when a startup is financially ready for a new hire is a combination of current financials, sales pipeline, and gut instinct.

    What else? What other factors should be included when determining financial ability for a new hire?

  • What’s in a Feature Name

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    After the startup’s name and the product’s name (which should usually be the same as the startup’s name) the next most important thing to name is individual features/modules in the product. Coming up with great names for features is critical because that value carries over into several areas like:

    • User experience / ease of use
    • Marketing content, especially for search engine optimization purposes
    • Other marketing content like blog posts, white papers, and social media
    • Sales demos and support

    The next time you go to name a new feature/module, stop and think through the many different ways it’ll be used and get feedback from a few people as to the best available name.

    What else? What are some other reasons the name of a feature/module is important?