Segment Customers, from Flies to Whales

For the last two days I’ve had the opportunity to spend time with entrepreneurs from around the world through Endeavor. In our group, we had entrepreneurs from Venezuela, Columbia, Greece, Argentina, and Saudi Arabia all sharing stories of challenge and opportunity. As part of the program, we spent time talking through their customers using a simple naming convention:

  • Flies
  • Rabbits
  • Deer
  • Elephants
  • Whales

Now, these names aren’t meant to degrade or belittle certain customers. Rather, they’re for the entrepreneur to understand what is, and what isn’t, working within segments of the business.

For each segment, here are some common metrics:

  • Cost of customer acquisition
  • Average revenue
  • Renewal rate
  • Lifetime value

Only, by looking deeper, new insights emerge.

Instead of investing resources to grow all segments, invest in the most important segments.

Segments are divided based on a variety of characteristics including:

  • Number of employees
  • Revenue
  • Potential usage (users, locations, etc.)

Initially, as the business is growing, it’s best to keep things simple. Once some level of scale is reached — say 100+ customers — it’s good to segment the customers and understand the business in a more fine-grained way.

What else? What are some more ideas on segmenting customers?

Scrappy First, Comfortable Financial Balance Later

Earlier this week I was talking to an entrepreneur that shared stories of a previous startup he’d joined a few years back. The now-removed leader of this previous company had a big-shot corporate executive background and was placed in this over-funded startup before it had product/market fit. As expected, their office was lavishly furnished, money was spent like they were already a profitable cash cow, and six months later the startup was bankrupt.

Boom, millions of dollars incinerated and nothing to show for it.

Starting lean and scrappy is an important part of the startup process.

When entrepreneurs raise a large round before a repeatable, scalable business model, most of the time bad things happen. Entrepreneurs are an optimistic bunch, so it’s only human nature to burn all the cash in 18 months, regardless of whether or not the business is working. When the cash is burned, and the business doesn’t make enough progress, investors are less likely to put in more cash, the cap table is often broken, and the startup usually ends in failure.

At Pardot, we never had institutional investors. From day one, we had to be scrappy — there was no other way. Every dollar we saved was a dollar to invest and grow the business. Even when we had over $10M in recurring revenue, Adam and I shared a hotel room on every trip. Little costs add up to big costs as the business scales.

Now, once the business model is working, there does come a time to ease up on the scrappiness — within reason, of course — and find a comfortable financial balance between spending too conservatively and being a spendthrift. But, like many things, as the financial purse strings are loosened, it becomes harder and harder to tighten them back.

Entrepreneurs would do well to ensure a scrappy, financially resourceful environment until a repeatable business model, and then slowly find a comfortable balance.

The Rise of Revenue Financing Loans for SaaS

Recently, several entrepreneurs have asked me about revenue financing loans. Revenue financing is a fancy way of saying a semi-complicated loan where payback is dictated by a number of elements including a percentage of revenue, not just a traditional interest rate. The good news is that it provides for a more aggressive, non-dilutive (usually) form of financing for Software-as-a-Service (SaaS) companies. The bad news is that it’s much more expensive than a bank loan, but still not nearly as expensive as venture capital.

Here’s how an example revenue financing loan might work:

  • Loan amount equal to 20% of current annual recurring revenue (e.g. $10M in ARR, $2M loan)
  • Loan covenant where one month’s operating costs in cash required on hand at all times (e.g. $800k of monthly expenses, with a $2M loan, only $1.2M can actually be used)
  • First 18 months interest-only monthly payments (on the full $2M, not the usable $1.2M) where the “interest” is 3% of the monthly cash receipts (hence the name revenue loan as the interest rate is directly driven by the revenue of the business)
  • 3.5 years of equal principle payments after the first 18 months plus the continued interest of 3% of the monthly cash receipts (so, the loan is paid back after five years and the interest payments keep rising assuming revenue keeps growing)
  • Additional 10% of original loan amount payment due after final payment or at time of next financing event (payment can be cash or equity)
  • Minimum of 1.7x the original amount back to the loan provider with a max of 2.5x (since the interest rate is a percentage of revenue, if the business grows faster than expected, the interest rate could be much higher and up to 2.5x would be paid back)

Wow, it is complicated! Net net, it’s roughly a 25% interest rate loan with variability based on how fast revenue grows. SaaS, with its amazing margins and cash flow predictability, makes this type of financing uniquely suited to both the investor and the recipient, especially compared to most types of other businesses.

SaaS entrepreneurs looking to grow faster, but reluctant to sell equity, would do well to talk to the newish crop of revenue financing firms out there.

What else? What are some more thoughts on revenue financing loans?

Avoid Judging an Entrepreneur’s Idea

Every week entrepreneurs reach out to me for feedback and advice. I like to start the conversation over email, asking different questions and requesting a Simplified One Page Strategic Plan. Inevitably, most of the entrepreneurs haven’t made much progress and are really just interested in feedback on their idea.

When the request to judge an idea comes in — and it always does — I politely decline and explain that I’m not the customer. I’m not the target. The only people that can judge the idea are the ones that need it, will pay for it, and want to sign up for it before it’s even ready.

Entrepreneurs are actually worse off when people who aren’t potential customers judge their ideas. Too often, people give feedback — positive or negative — that puts the entrepreneur on a path that isn’t helpful. In places that are polite and more supportive (hello, Atlanta!) the tendency is to be encouraging and tell the entrepreneur that their idea is great. When the idea isn’t great, which is most of the time due to a lack of customer discovery, the entrepreneur pats herself on the back and digs in even harder. Only, they’re extending their path to nowhere. Too many entrepreneurs continue to pursue ideas that should be killed based on customer feedback, not random person feedback.

While I don’t judge the entrepreneurs’ ideas directly, I like to share different frameworks and ways to think through opportunities. For example, team, stream, and “not a meme” is one of my favorite ways to evaluate a startup. The team, of course, is the entrepreneurs. The stream is the trend or inevitable change they’re riding. And, finally, “not a meme” means the solution is a “must have”, not a “nice to have” (every meme, no matter how funny, isn’t mission critical).

Fight the urge, don’t give entrepreneurs feedback on their idea. Instead, push them to talk to customers (customer discovery). Push them to talk to partners. Push them to talk to the experts in the specific industry, not a random person who’s been successful. Help an entrepreneur by not judging her idea.

The Startup Studio, Six Months In

Six months ago we launched the new Atlanta Ventures Startup Studio. A startup studio is just a modern way of saying we partner with entrepreneurs to create new companies from scratch. In addition to investing directly into startups, which we’ve been doing for years, we saw an opportunity to develop a more formal program around ideation, market research, planning, launching, and growing. With so many talented people in town, but a more limited group of entrepreneurs, the ability to take an idea to product/market fit and beyond is the core opportunity.

Ideas

As expected, ideation is the easy part. Everywhere we look there are opportunities and ways to make people’s lives better. To date, we have a Google Sheet of 80 ideas and are regularly adding to it as well as revising existing ideas. Of course, most aren’t any good but the goal is to focus on “what ifs” and just let the ideas flow. More importantly, having a stable of ideas ready makes it easier to match potential ideas with potential entrepreneurs based on their interests and personalities.

Entrepreneurs

Finding entrepreneurs to partner with is the hardest part. There are so many great people that want to start a new company, yet we’re very particular in our focus on entrepreneurs that are positive, self-starting, supportive, and have had a prior entrepreneurial failure. In the entrepreneurial context, we look for repeated examples of working through adversity and pushing the boundaries to get things done.

State of the Union

To date, we’ve launched one company (autonomous lawn mowers), are about to incorporate a second, and have a couple more that are progressing nicely. Frankly, it’s harder than expected, but we’re pleased with the progress. Building companies takes time, and we’re excited to be a part of the journey.

Want to take the next step in the entrepreneurial journey? Apply to be an entrepreneur in residence.

No Regrets Selling the Business

Entrepreneurs love asking me the question, “Do you regret selling Pardot?”

Pardot, as part of Salesforce.com, has done incredibly well ($250M+ in annual revenue!).

SaaS is much more valuable and established compared to when we sold the business.

Private equity is eagerly buying SaaS companies and often outbidding strategic acquirers.

So, if everything has exceeded expectations, are there any regrets?

No. None.

Adam and I made the best decision we could with all the information we had at the time.

Selling Pardot put it in the hands of a well capitalized public company that had a greater chance of realizing the product’s huge potential. Today, Pardot is one of the most widely used B2B marketing products in the world.

Selling Pardot chalked up a ‘win’ for us as entrepreneurs.

Selling Pardot enabled the Atlanta Tech Village to happen.

Selling Pardot enabled me to invest in dozens of startups and pay it forward.

It could have turned out differently.

But it didn’t.

Selling the business was a deeply personal decision and we made the right call.

Home, Sweet Home

This year, I’ve had the opportunity to visit entrepreneurs all across the Southeast, both in Atlanta and their hometown. Seeing the different entrepreneurial communities, and hearing success stories from each city, continues to grow my optimism for entrepreneurship as a force for good. In addition to an optimistic outlook, it also helps me appreciate what we have in our own startup community — great entrepreneurs, great talent, and great programs.

Yet, it wasn’t always this way.

In late 2008, Adam and I flew to Silicon Valley to pitch the full partnership of a Sand Hill venture capital firm (not one of the A-list firms that typically come to mind) on investing in Pardot. One of the senior partners really liked us and was working to convince the partnership that marketing automation was going to be a big market (most VCs thought the addressable market was too small — hah!).

Toward the end of the pitch, which had flowed smoothly, another senior partner, with a professorial look about him, shot out a question, “Do you have any software engineering talent in Atlanta?” Naturally, I offered him my best chamber of commerce response about Georgia Tech and the great engineering schools across the Southeast with heavy representation in Atlanta. Without even internalizing my response, he said, “Why don’t you just move to Silicon Valley?” To him, with a close-minded view of the world, there was no way to build an important startup outside of a 20 mile radius around his office — nevermind that his firm had just invested in an Atlanta startup earlier that year!

Thankfully, the partner who made that comment wouldn’t be the lead on our potential deal (we never raised venture capital), but that question and comment has already stuck with me for a decade, and I won’t forget it. Never criticize someone’s hometown or make them feel inferior to yours. Never.

John Howard Payne’s famous line came to mind:

Be it ever so humble, there’s no place like home

With that, we flew home, turned down their expression of interest to keep moving the process forward, and continued building the best company we could.

Encourage entrepreneurs.

Don’t belittle their hometown.

Celebrate the startup journey, regardless of location.