David Cummings on Startups

Blog

  • Revenue Financing + Traditional Equity as the Future of Startup Funding

    Today’s standard startup funding model whereby entrepreneurs pitch angels, VCs, and family offices for money in exchange for preferred equity is mostly a challenged, broken process. Outside of the money regions that focus on grand slams, and startups generally with revenue traction and significant growth rates, investing in startups is a great way to lose money.

    The majority of angel investors I know have lost money investing in startups.

    Perhaps they aren’t good investors. Perhaps it’s the entrepreneurs’ problems. Regardless, this isn’t specific to our region. It’s the same in all regions outside the money centers.

    Stories of investors writing a check for $25k into Uber and turning it into $100M permeate the media, yet are so rare it’s laughable. Only, it fuels the stories and desire for more people to become investors.

    One potential angel investor described it to me as wanting to spend 1% of his net worth on angel investing so that he could generate a new income stream and be less reliant on his day job. Unfortunately, the chance of that happening is slim to none.

    There’s a perpetual cycle of regions trying to improve their local startup investing community. New angels come online and write some checks. They lose their money, and because of the poor outcome, will never do it again. Rinse and repeat each economic cycle.

    Well, what’s the solution?

    The funding model needs to change.

    Over the last few years a new form of startup funding has emerged, but still represents a tiny part of the market: revenue financing. Revenue financing is code for a loan that’s paid back via a percentage of revenue. If the startup does better than expected, it’s a super high interest loan. If the startup does as expected it’s a high interest loan. If the startup does worse than expected, it’s a high interest loan paid back over a longer period of time.

    Of course, a high interest loan requires the startup to pay back the debt, which takes cash away from growing the business. And, in the angel world, making 15% per year on the investment takes away the excitement and dream of making a 100x return.

    The future of startup funding outside the money regions should be a mixture of light revenue financing and traditional equity.

    Light revenue financing, such that the investor gets 1.2x their money back in five years, keeps startup money flowing in the community.

    Traditional equity, such that there’s the potential for huge upside, keeps the imagination dreaming.

    We’re near the peak of this cycle, and too much money is chasing too few high quality deals, making it a great time to be an entrepreneur. Only, this too will change — it always does.

    When we come out of the next trough, and it’s time to re-evaluate the startup funding model, a combination of returning capital to the community on a consistent basis and equity upside will result in a more sustainable and successful eco-system.

    A structural change in startup funding is needed. Light revenue financing plus traditional equity will improve the startup world.

  • When the Increased Startup Burn is Cooling Growth

    Recently I was talking to an entrepreneur that went through a challenging period of trying to force growth that never materialized. The playbook is fairly common: raise outside financing, hire a bunch of people, and expect growth to increase. Only, not only did growth not increase, it actually went down. What gives?

    Burn was increased with the expectation that more of the same would increase the growth rate. Only, it merely magnified an existing issue: customer acquisition wasn’t repeatable.

    Spending money to grow faster when a repeatable customer acquisition process doesn’t exist actually makes things worse. Much worse.

    New sales reps are ramped up but the playbook doesn’t work, and now making quota is more diminished with fewer leads and less help.

    New marketing programs are ramped up but the previous ones weren’t scalable, and now attention and expertise is spread over more initiatives.

    New roles and responsibilities are created throughout the organization in expectation of increased growth, only these require more management time and attention taking away energy from the critical functions.

    More isn’t always more. In cases where the fundamentals of the business aren’t working, more actually is a detriment and reduces the ability of the organization to execute.

    Before raising money and increasing burn, insure the repeatability of the model. Trying to accelerate something that isn’t working makes things worse.

  • Focus, Focus, Focus – An Entrepreneur’s Challenge

    Entrepreneurs see abundance in the world. An opportunity here, an opportunity there. This serves the entrepreneur well in the early days. Identify a need. Rapidly iterate. Earn product/market fit.

    Only, at some point, instead of chasing the next shiny object, it’s time to focus. Instead of a default ‘yes’ it needs to be a default ‘no.’ This is hard for most entrepreneurs.

    Famously, when Steve Jobs returned to Apple after many years away, he killed off most of the product lines and reorganized the company around a limited number of initiatives. Focus.

    Focus becomes even harder when your startup is ‘hot.’ Everyone wants your time. Investors constantly ask for meetings. Media constantly asks for interviews. Organizations constantly ask for appearances. Ultimately, these are more distractions that make focusing difficult.

    Take a few minutes every Sunday night and look at last week’s schedule and the upcoming week’s schedule.

    What meetings were worthwhile?

    What meetings weren’t worthwhile?

    What are you excited about on the schedule?

    What aren’t you excited about on the schedule?

    Regularly take time to evaluate where effort is spent. Then, ruthlessly cut out the distractions.

    Focus. Focus. Focus.

  • More Thoughts on the Next Level for Atlanta’s Startup Community

    After last week’s post on Next Level for Atlanta’s Startup Community, a number of people chimed in with ideas. Let’s take a look at a few.

    https://twitter.com/davidcummings/status/1150874838543695872

    eSports

    Ben Alexander highlighted eSports as a high potential opportunity for the region. Between Skillshot Media, Atlanta Reign, Hi-Rez Studios, KontrolFreek, and more, there’s real momentum. To achieve a critical mass, we’ll need 10x that many companies and thousands of employees in the industry.

    Inclusive Entrepreneurship

    https://twitter.com/rodneysampson/status/1150933476864155648

    Rodney Sampson offered a detailed analysis in his paper Building Inclusive Entrepreneurship Ecosystems in Communities of Color. Much is to be done in this area and Rodney should be lauded for his work.

    B2C

    https://twitter.com/thewordpainter/status/1150896549502836736

    B2C is much more difficult than B2B. Why? Human attention and desires are fickle compared to helping businesses do things better/faster/cheaper. With that said, a major B2C or DTC startup success story would do wonders to help the brand of Atlanta. Consumer products are always more exciting than business products.

    Funding

    This past quarter Atlanta companies raised $650M across 38 investments — the best Q2 ever — according to PitchBook – NVCA Venture Monitor. While the amount of funding fluctuates on a quarter by quarter basis, setting a new high bar with our best quarter ever is an indicator of progress. Funding is only one piece of the puzzle, but it’s an important one.

    Atlanta’s startup community is making real progress, and has much work to do.

    Keep the ideas coming.

  • Next Level for Atlanta’s Startup Community

    Last week I was talking to an entrepreneur and the topic of the Atlanta startup community came up, specifically ideas to grow the community faster. Looking back over the last seven years, we’ve made substantial strides by adding Techstars Atlanta, Atlanta Tech Village, Backed by ATL, Engage, Atlanta Startup Village (14,000+ members!), several seed funds, two IPOs, four unicorns, and much more. Only, even with our continued success, there’s a feeling we haven’t accelerated the growth of the overall community enough to reach the next level.

    In brainstorming what’s missing, several ideas came to mind:

    Diversity and Inclusion

    Programs like Startup Runway and It Takes a Village are helping address the diversity and inclusion challenges in the region but we need more, much more. Say there are 3-5 groups working on this for the startup community, we likely need at least 15-20 to make a big impact.

    Angels

    Looking at recent angel deals over the last 24 months, there are roughly 10 local angels that lead deals regularly (defined as 5+ deals historically). For every one that’ll lead and put a deal together, there are another 10 that participate because they trust the lead. With 10 lead angels and 100 secondary angels, there just aren’t that many regular angels. Many more startups raise angel money each year, but it’s almost always from a first time angel that isn’t a regular. We need at least 100 regular lead angels and 1,000 secondary angels — much work to be done.

    Seed Funds

    We’ve seen several local seed funds emerge including Valor Ventures, Knoll Ventures, and Tech Square Labs with a couple unannounced ones in the works. Seed funds are an important part of the community as they have committed capital that has to be deployed in a designated time period, as different from angels who might never do another deal. In addition, a strong seed fund community provides more support to angels helping them see a potential funding path forward, especially due to Series A rounds becoming what used to be Series B rounds. With 5-7 local seed funds today, we likely need 15-20 to achieve the next level of scale.

    Startup Hubs

    The Atlanta Tech Village is now seven years old and helped establish the startup center of gravity in Buckhead. The ATDC has been the startup hub in Midtown for decades. Downtown has the excellent Switchyards. Now, Atlanta is booming around the Beltline’s East Side Trail and growth in the Perimeter is robust, making both areas logical spots for more startup hubs.

    Peer Connections

    Atlanta is a very inviting, informal town for entrepreneurs. Groups like the Entrepreneurs’ Organization and Young Presidents’ Organization have strong local chapters. Only, there’s a gap in peer connections for tech entrepreneurs to network with and learn from each other, as separate from the long standing existing ones that focus on tech executives and service providers. The best example to emulate is Mindshare in Washington D.C.

    Entrepreneur Education

    Imagine you’re a first-time entrepreneur and have just quit your job to create a company. Where do you go next? Showing up at a startup hub and plugging into the community is likely the best answer. Only, it’s a hodgepodge of events and programs, serving a variety of audiences. We need stronger programs geared directly towards helping tech entrepreneurs get going — bootcamps that cover the most important topics.

    Storytelling

    Easily the most nebulous, and possibly important, is how to tell the Atlanta startup ecosystem story better. Lots of B2B successes across MarTech, cyber security, FinTech, and health IT is excellent, yet doesn’t paint a memorable picture. B2B is the strength, but how do you make it exciting? Austin and Boulder are regularly mentioned in the national press. How do we get Atlanta on those same lists for startups?

    What’s Next

    Atlanta has rapidly become an R&D hub for companies headquartered elsewhere, and that serves a roll in recruiting talent to the region, but the real opportunity is growing the startup community with locally headquartered companies. Local startups invest more in the community, build greater wealth, and develop the next generation of entrepreneurs at a faster rate.

    To get to the next level as a startup community, it’s going to take a substantial number of new success stories, many more organizations helping a variety of entrepreneurs, and a greater level of local investment. Atlanta has the basis of the platform, and with hard work plus a little luck, will be able to get there in 5-10 years.

    Let’s make it happen.

    What else? What are some more ideas?

  • Secondary as a New Primary Investor Capital Deployment

    Recently I was talking to an investor that lamented how hard it was to invest in startups the traditional way. Today, there’s so much money for the “hot” startups that rounds fill up quickly and investors are aggressive (read: more sharp elbows). Historically, that was the end of the story, but now there’s more capital that wants in. Over the last five years, there’s been tremendous growth in capital applied to liquidity for founders, early employees, and early angel investors.

    Secondary capital, where one shareholder sells equity to a new or existing investor, doesn’t directly benefit the company and used to be rare in startupland. Primary capital is when the company sells shares to put more cash into the business, usually to grow faster. Even today, primary capital is significantly more common than secondary capital for startups, but things are changing.

    When thinking about many of the growth stage startups in our region, secondary sales of equity occurred in a material number of their recent financing rounds. Investors, with larger funds and stronger deal competition, often negotiate to buy X dollars more of the common shares of the startup at a discount (e.g. buy up to $10M of common shares at a 20% discount to the preferred price). Look for more investors to employ this model of buying a large chunk of preferred shares from the startup and a smaller chunk of common shares for the early shareholders.

    Secondary sales, while rare in the past, are fairly prevalent today. Founders and early employees would do well to take secondary sales into account, especially when their startup hits escape velocity and reaches the growth stage.

  • Funding Climate Outside the Money Regions

    Whenever I talk to a startup person outside our region (investor, journalist, etc.) they like to ask about the current funding climate in our region. Money is always a popular topic, especially when the economy is hot and startups are en vogue (bonus: public SaaS valuations are at an all-time high). Only, the funding climate outside the money regions (CA, NYC, etc.) hasn’t appreciably changed in the last 2-3 years.

    More money is sloshing around on the sidelines waiting to be put to work. Limited partners have huge commitments in funds and venture investors are trying to put the money to work. Yet, this is primarily for growth/later stage investments when the metrics are solid and it’s clear the startup is going to win, simply a question of how much. For these growth/later stage investments, investors will travel. Distance is a pain but not that big a deal. If you can write a $50M check and underwrite a 3-5x return in 3-5 years, it’s a pretty easy ‘yes’, especially if there’s a direct flight (the money people still hate layovers).

    Early stage investments — primarily post-seed and Series A — are still quite limited. The number of investors that focus on this stage (say, $750k – $3M in revenue) hasn’t appreciably changed, thus the number of startups that raise rounds in this stage hasn’t change (without more investors, the quantity of these types of fundings won’t increase). Investors at this stage often write checks that are larger than angels can put together, so it isn’t possible to bypass this funding source with more non-institutional money.

    Seed/angel rounds are still the most challenging area. Idea stage startup are plentiful, but highly risk-loving capital is not. Local investors are still primarily wealthy people who didn’t make money in technology, and thus their appetite for startup investing is relatively low. To grow the angel community, we need to have more large startup exits. Today, there’s a strong cohort of local growth stage startups valued in the hundreds of millions and a few in the billions. Once this wave of startups, typically 5-10 years old, reaches exit maturity, expect the local angel community to ramp up and hit a new high.

    While the funding climate hasn’t changed recently, the overall tenor of the startup community is humming along nicely. Look for the funding climate in the idea/seed stage to grow nicely in the next 3-5 years once we have a wave of big startup exits.

  • Dilution Dance for Each Financing Round

    10 years ago when we went out to market to raise money for Pardot, potential investors talked about wanting to buy 33-40% of the business in the Series A. As an entrepreneur, the thought of selling that big of a chunk in one single round bothered us, and we ended up passing. Fortunately, we were able to get to a nice exit without raising institutional capital. Now, typical funding rounds are in the 15-30% dilution range (not counting growing the employee option pool, which usually adds 5% more dilution).

    Today, entrepreneurs have more choices. Options like revenue financing, investors that will do straight secondary (liquidity for the entrepreneur), and more varied pools of money (e.g. family offices doing venture-like deals, etc.) were unheard of in the past. It’s a great time to be an entrepreneur.

    Another feature of today’s market is that you can sell even smaller chunks of the business, especially if the startup is considered “hot.” Investors are sitting on so much cash, many of the rules like “I need to own 20% of the company” no longer apply. If you want to sell 10% of the startup, many more investors are likely interested, assuming it meets their criteria.

    Entrepreneurs would do well to find the balance between selling as little of their startup as possible and raising enough money to reach their next milestone or inflection in the business. Times are good, so it’s advisable to raise a little extra, but of course that’s extra dilution as well. There’s a dilution dance with each financing round, and entrepreneurs with desirable startups would do well to assume the standard “rules” are all negotiable.

  • ‘I’ vs ‘You’ When Giving Advice

    Back in 2008 I had the opportunity to join Entrepreneurs’ Organization (EO) and go through a day long program called Forum Training with the excellent Ellie Byrd. In addition to meeting a number of great people, the most valuable education to me was learning about the Gestalt Protocol.

    The Gestalt Protocol, in it’s simplest form, says to share personal experiences for the purpose of giving advice only using ‘I’ and never ‘You.’ Most often, when people give personal advice based on their experiences, it’s in the form of “You should do X because that’s what worked for me.” Instead, remove the use of ‘You” and reword it with ‘I’ so that it’s like “I did X and here’s what I learned.”

    When giving advice, especially from a person that’s in a position of power or more experience, it’s too easy to start telling the other person how to do things, even while they lack the details and context of the situation, beyond what they’ve been told. In addition, when receiving the advice, it becomes less valuable when the advice comes across as directives without the corresponding experience and learnings behind it.

    By following the Gestalt Protocol and using ‘I’ instead of ‘You’ when giving advice, it becomes more about experience sharing and letting the other person understand what did, and didn’t work, from a similar situation in the past, without passing judgement on the specifics of the current scenario. Personal experiences, delivered via the use of ‘I’ make for much better sharing and mentoring.

    Mentors would do well to follow the Gestalt Protocol and focus on sharing personal experiences.

  • The Struggling Executive Who’s Really a Manager

    One of the more common conversations I’ve had with entrepreneurs scaling their startup goes something like this:

    Me: How are things going?

    Entrepreneur: We’re having a hard time with leader X?

    Me: Why’s that?

    Entrepreneur: It feels like he’s always reactive.

    Me: What do you mean?

    Entrepreneur: Well, we keep having issues in his department and it feels like they’re things that shouldn’t be issues.

    Me: What should he be doing?

    Entrepreneur: He should be proactively spotting things that could be potential issues and addressing them so that they they’re non-events.

    Me: Sounds like the struggling executive is really a manager, not an executive.

    I’ve had this conversation with entrepreneurs numerous times and it’s always the same issue: a person was put in an executive position and they aren’t really an executive, they’re a manager.

    Managers see short-term, right in front of them, and are often reactive.

    Executives see long-term, around corners, and are proactive.

    Managers bring problems forward.

    Executives bring solutions forward.

    Now, not all managers are like this and not all executives are like this, but the key difference between and a manager and an executive is the ability to see further out into the future and proactively get things done.

    The next time you’re having an issue with a leader, ask the key question: are they a manager or an executive?