David Cummings on Startups

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  • Comparative Advantage, Or Why Entrepreneurs Should Hire an Office Manager

    One of my favorite classes in college was an introductory economics course taught by David Johnson. During a section, we got into comparative advantage, which is the idea that even though you might be able to do something yourself, your time is best spent doing what you’re uniquely qualified to do. From Investopedia:

    Comparative advantage is an economic law referring to the ability of any given economic actor to produce goods and services at a lower opportunity cost than other economic actors.

    Here, the key is opportunity cost, defined as the highest valued opportunity foregone. Meaning, doing a low-value thing takes away time from doing a high-value thing. For entrepreneurs, this is spending time writing code, selling product, leading the company, etc. and not tasks that are readily handed off to another team member.

    Entrepreneurs should recognize comparative advantage and hire an office manager after their first round of funding. An office manager is the perfect way to delegate tasks so as to focus time and energy on the most important tasks. Start with a key hire, start with an office manager.

    What else? What are some more thoughts on comparative advantage and hiring an office manager?

     

     

  • $136,000 Median SaaS Revenue Per Employee

    Once the startup begins scaling, leaders from each team start asking for more resources (e.g. we just signed 10 more customers, let’s hire another person to do ‘X’). Only, outside the budget, it’s difficult to assess the overall efficiency. One of the best metrics to track efficiency is revenue per employee.

    According to the 2016 Pacific Crest SaaS Company Survey Benchmarks, the median SaaS revenue per employee is $136,000:

    https://www.slideshare.net/AlexanderJarvis/2016-pacific-crest-saas-company-survey-benchmarks

    Over time, the revenue per employee changes as the startup scales from pre-revenue through to seed stage and beyond. Each milestone often has a higher revenue per employee with ones at the expansion stage typically having $200,000 or more in revenue per employee.

    Entrepreneurs would do well to track their own revenue per employee and benchmark it against other startups of similar size and scale.

    What else? What are some more thoughts on using revenue per employee to evaluate the efficiency of the startup?

  • Accountability in a Startup

    As the startup grows from a small group of co-founders to the first early employees and beyond, organizational accountability needs to scale as well. Co-founders, talking so frequently and being self-starters, often mind-meld on a daily basis and don’t need as much structure. Only, that doesn’t scale.

    Here are a few ideas for accountability in a startup:

    Accountability in a startup takes work. Make it a system with the right rhythm, data, and priorities.

    What else? What are some more thoughts on accountability in a startup?

  • Quick Notes from Marc Andreessen’s AMA

    Stripe has an excellent post up titled Marc Andreessen answers questions from Stripe Atlas founders. Andreesseen, as always, doesn’t disappoint (see the article about him in The New Yorker). Here are a few quick notes from the article:

    • On raising money:
      • At the seed stage, when a startup is brand new, the decision is driven almost entirely by the people.
      • At the venture stage, when a startup has a prototype or an initial product but not yet a fully functional business, the decision is some combination of the people, as with seed rounds, but also product/market fit
      • At the growth stage, when a startup is fully in market and building out sales and marketing efforts to expand, the decision becomes far more about the financial characteristics of the business
    • How many pitches annually:
      • Out of the 2,000 we see, we will make somewhere between 20 and 40 investments per year. So around a 1-2% hit rate.
      • The very best VCs in the US collectively make perhaps 200 investments per year. Out of those 200, about 15 of them will generate 90%+ of the investment returns for the entire year.
    • On SaaS pricing:
      • But if I were to give general advice, I’d say that we see far more SAAS startups underpricing their product than overpricing.
      • TLDR: When in doubt, double prices. 🙂

    Want to read more? Head on over to Marc Andreessen answers questions from Stripe Atlas founders.

  • 5 Strong Core Values from Godard Abel

    Godard Abel, co-founder of G2 Crowd, published an excellent blog post earlier today titled Home Again With My Entrepreneurial Family. After selling his last company Steelbrick to Salesforce.com, he rejoined G2 Crowd. In the post, he highlighted their five core values, referring to them as “mantras”:

    • Work with joy
    • Learn quickly and continuously
    • Buyers come first
    • Slap and tickle
    • Live at the peak

    Entrepreneurs should define their core values and ensure they’re deeply integrated throughout the company. These five core values are a great starting point.

    What else? What are some more example core values that you like?

  • Personal Loans for Founder Stock

    Recently I was talking to a successful entrepreneur that’s interested in some personal liquidity (e.g. selling startup equity for cash) but doesn’t want to send the wrong message to the board and investors by selling some of his founder stock. Generally, there aren’t many options in this case. I offered up that there’s likely a market — depending on the appetite for the private company stock — to get a high interest personal loan that’s collateralized against his equity that doesn’t require a personal guarantee.

    Here’s how it might work:

    • Startup was valued at $200 million post-money after their last round
    • Founder owns 15% (so, $30 million of value on paper, but not liquid)
    • Founder borrows $1,000,000 with the following terms:
      • 10% annual interest rate
      • Sale proceeds of 10% of the loan amount in equity at last valuation (like a warrant that increases or decreases in value as equity value changes)
      • 3 year term
      • Collateralized against $3 million of equity based on the last valuation

    Example exit scenarios:

    • If the startup exits 12 months later at a $300 million valuation, the founder would repay the loan as follows:
      • $1,000,000 in principal
      • $100,000 in interest
      • $150,000 in sale proceeds (the 10% of loan value was $100,000 and increased to $150,000 as the company value increased 50%)
    • If the startup exits 12 months later at a $100 million valuation, the founder would repay the loan as follows:
      • $1,000,000 in principal
      • $100,000 in interest
      • $50,000 in sale proceeds (the 10% of loan value was $100,000 and decreased to $50,000 as the company value decreased 50%)

    Obviously, this would be a very expensive loan. But, as an entrepreneur that’s looking for options, and optimistic that the value of the equity will increase substantially, this is a better way to get some liquidity now without selling the equity immediately.

    As more startups achieve scale and substantial valuations, look for new methods for entrepreneurs to get partial liquidity.

    What else? What are some more thoughts on personal loans for founder stock?

  • 4 Criteria for a 5-8x Adjusted EBITDA Software Exit

    Upland Software is a publicly-traded SaaS company based in Austin, TX that specializes in acquiring sub-scale SaaS companies and rolling them into the portfolio. To date, they’ve acquired 14 companies and are actively looking to buy more. With a market cap of $480 million and an annualized run-rate of $80 million (source UPLD), they’ve executed this strategy for 7+ years.

    Here are the four criteria for Upland Software acquisitions:

    • Financial Profile – Revenues in the $5-$25 million range
    • Recurring Revenue Base – Renewal Rates > 90%
    • Enterprise Applications – Built-for-purpose Enterprise Work Management
    • Geography – U.S., Canada and E.U.

    According to their press release from a few months ago they pay 5-8x pro forma Adjusted EBITDA:

    The acquisition is within Upland’s target range of 5-8x pro forma Adjusted EBITDA and will be immediately accretive to Upland’s Adjusted EBITDA per share.

    Long term, their target is an Adjusted EBITDA margin of 40%.

    Here’s how an acquisition might work:

    • $10 million/year SaaS business makes $3 million/year Adjusted EBITDA
    • Upland acquires the SaaS company for $21 million (e.g. 7x Adjusted EBITDA)
    • Upland cuts expenses and raises the Adjusted EBITDA from $3 million to $4 million (e.g. 40% target)
    • Upland’s stock trades at ~18x Adjusted EBITDA (e.g. $26 million Adjusted EBITDA expectation for 2017 with a valuation of $480 million ignoring current assets and debt – source)
    • $4 million of new Adjusted EBITDA increases the value of the business by $72 million, making the $21 million acquisition very profitable

    Entrepreneurs thinking through potential exit value for their startup should understand these values and how a financial buyer might value the business.

    What else? What are some more thoughts on this example with four criteria for a 5-8x Adjusted EBITDA software exit?

  • Find the Fastest Growing Markets

    When a potential entrepreneur says they’re seeking startup ideas, I like to ask a few questions regarding areas of interest and domain expertise. Then, after going through the importance of customer discovery and getting feedback during the product building process, I offer up my favorite piece of advice: find the fastest growing markets.

    Ideally, the market is small and fast growing with the potential to be massive — those are the best. Big companies ignore them because they aren’t worthwhile now but by the time the size is meaningful, it’s too late to get in. This is the perfect spot for entrepreneurs to build large companies.

    Looking for fast growing markets? Start with the 2017 Internet Trends (also, look at The best Meeker 2017 Internet Trends slides and what they mean). Timing is the most important startup consideration, so find the fastest growing markets as the starting point.

    What else? What are some more thoughts on finding the fastest growing markets?

  • Video of the Week – Founder’s Dilemmas: Equity Splits

    For our video of the week, watch Noam Wasserman share his research in Founder’s Dilemmas: Equity Splits. Enjoy!

    From YouTube: Lots of founders make decisions about equity splits very early in the life of their company. Professor Noam Wasserman says making these decisions without considering how things can change is a recipe for disappointment, and potentially failure.

    THIS VIDEO CAN HELP ANSWER:
    What can go wrong when you split 50-50?
    What are the pitfalls?
    How should you think about splitting equity?

  • Run the Annual Expenses Audit and Cut the Waste

    Recently I was talking to an entrepreneur that had just finished an exercise to get more efficient with his business and reduce the burn rate. After making a concerted effort over 30 days to cut waste they now save $200,000/year. Here are a few areas to analyze:

    • Credit Cards – Start with the biggie. Credit cards are so easy — almost too easy — to buy stuff that many entrepreneurs don’t scrutinize the purchases. Take last month’s statement and make the card holders justify each expense in a Google Sheet.
    • Amazon Web Services – Cloud platforms make it incredibly simple to scale services, and scale the bill. Walk through every line item of the last AWS bill and the corresponding usage of that item (e.g. do you need all those full-time EC2 instances when spot instances might work instead? what about reserved instances?)
    • Unused SaaS Apps – With so many interesting SaaS apps out there it’s easy to sign up and pay only to not truly integrate into the business process such that there’s little-to-no value. Go ahead and cancel it.
    • Unused SaaS App Users – Many SaaS apps are mission critical must-have products but that doesn’t mean paying for more than you need. How many users of Salesforce.com do you have? Do you really need them all? What other apps can be adjusted?

    Entrepreneurs would do well to audit expenses at least annually, if not more frequently, and cut the waste. Just because you need to move fast doesn’t mean you need to waste money.

    What else? What are some other areas to look for savings?