David Cummings on Startups

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  • 4 Year Projections With 100x Growth and 50% Profit Margins

    When meeting with entrepreneurs they often have a slide that shows their amazing projected growth. Most of the time it shows projected revenue amount for the current year (e.g. $200,000) and then goes out four years with a projected revenue amount in the 4th year that’s 100x this year (e.g. $20,000,000). Now, that might be doable, and entrepreneurs are an optimistic bunch, but they always have a corresponding profits bar to go along with the revenue bar and it typically shows losses in the first year (from the funding cash they’ll burn) and then massive profits in year four (e.g. $10,000,000 in profits on $20,000,000 in revenue).

    What’s always missing: massive losses and the funding rounds necessary to hit those growth numbers.

    Starting a startup is cheap. Scaling a startup is expensive. Entrepreneurs would do well to provide projections that show they’ve thought through the costs of scaling their business.

    What else? What are some more thoughts on startup projections not recognizing the costs to scale?

  • Video of the Week – Shawn Achor: The happy secret to better work

    With the annual TED Conference this coming week, let’s look at one my favorite TED Talks – Shawn Achor: The happy secret to better work. Enjoy!

    From the talk, here’s the happiness advantage:
    Better securing jobs
    Better keeping jobs
    Superior productivity
    More resilient
    Less burnout
    Less turnover
    Greater sales

    From YouTube: We believe that we should work to be happy, but could that be backwards? In this fast-moving and entertaining talk from TEDxBloomington, psychologist Shawn Achor argues that actually happiness inspires productivity.

  • The Rule of 3 and 10 – Everything Breaks When Tripling in Company Size

    Mid-way through the book Tools of Titans: The Tactics, Routines, and Habits of Billionaires, Icons, and World-Class Performers, the author Tim Ferriss interviews Phil Libin, the founder of Evernote. Phil shares a lesson he learned from Hiroshi Mikitani, the founder of Rakuten, the largest online marketplace in Japan, on “the rule of 3 and 10” where everything breaks when tripling in company size.

    From the book:

    He was the first employee at Rakuten, now they’ve got 10,000 or more. He said when you’re just one person, everything kind of works. You sort of figure it out. And then, at some point, you have three people, and now, things are kind of different. Making decisions and everything with three people is different. But you adjust to that. Then, you’re fine for a while. You get to 10 people, and everything kind of breaks again. You figure that out, and then you get to 30 people and everything is different, and then 100 and then 300 and then 1,000.

    The idea is that things break in the company at these multiples of 3 and powers of 10. Startups figure it out when smaller but then struggle as they grow without realizing they hit the next 3 and 10 milestone and haven’t adjusted.

    Entrepreneurs should think about the rule of 3 and 10 and be cognizant of what needs to be reinvented as the startup grows.

    What else? What are some more thoughts on the idea that things break at company sizes that are multiples of 3 and powers of 10?

  • When the Startup is No Longer Owned by the Founders

    After yesterday’s post on Raising Money as Forcing Function to Drive Towards an Exit, an entrepreneur brought up another point to me: raising money also starts the track towards the founders no longer owning the majority of the business, and, often, losing control. Many entrepreneurs start companies to be their own boss as they have a high internal locus of control. Only, after two, sometimes even one, round(s) of financing, the founders no longer have control.

    Here’s how the math might look:

    • Start – Founders own 90% with a 10% employee option pool
    • Series Seed – Sell 15% of the company and add another 10% to the option pool for 25% dilution taking the 90% for the founders down to 67.5%
    • Series A – Sell 25% of the company and add another 10% to the option pool for 35% dilution taking the 67.5% for the founders down to 43.9%

    So, in a “normal” scenario, after the second round of funding, the entrepreneurs no longer own the majority of the business. But, now the startup has the desired capital to execute against the plan and hopefully build a large, successful business.

    Entrepreneurs need to understand the trade-offs and determine how far they can go on their own vs going faster with outside capital. The long-time question investors like to offer up to entrepreneurs: would you rather own a slice of a big watermelon or the entirety of a small grape.

    What else? What are some more thoughts on the founders reaching the stage where they no longer own the business?

  • Raising Money as Forcing Function to Drive Towards an Exit

    Recently I was talking to an entrepreneur that was working on raising money for his startup. After asking the normal questions including “why do you want to raise money”, he volunteered something I don’t hear too often: I want to raise money to bring on a partner that will position the business for an exit in a few years. The idea is that raising money will act as a forcing function to drive towards an exit.

    Here are a few questions to think through:

    • Why not sell now? What additional value will be gained raising money?
    • What specifically is desired in a capital partner?
    • What’s the ideal timeline? What milestones need to be hit?
    • Are there any market dynamics at work that might improve or decline over the next few years?
    • How many more rounds of capital, and dilution, will be required to achieve the desired exit?

    Planning for an exit in a timeframe is never really doable unless the business is profitable with enough scale to know that there’s an exit based on an EBITDA multiple to a private equity firm or other financial buyer. Most startups want a buyer that pays up based on growth potential, and those are nearly impossible to plan for confidently. Raising money does create more pressure to eventually find an exit, but isn’t a guarantee.

    What else? What are some more thoughts on raising money as a forcing function to drive towards an exit?

  • Anatomy of a Successful Venture Deal – PetSmart’s Acquisition of Chewy.com for $3.35 Billion

    Recode published an article earlier today that PetSmart is acquiring Chewy.com for $3.35 billion in the largest e-commerce acquisition ever. This is a case where raising venture capital helped a startup grow significantly faster, resulting in a much larger and more valuable business when compared to growing organically. According to CrunchBase, Chewy.com started in the summer of 2011 and is less than six years old. Last year, Chewy.com did almost $900 million in revenue (source) and presumably will do over $1 billion in revenue this year.

    For a venture perspective, this is a homerun. Let’s look at how the economics might play out:

    • Volition Capital invests $15 million in the Series A in 2013 (source) and buys ~25% (a guess) of the company (typical venture rounds are for 20 – 35% of the company)
    • Chewy.com goes on to raise a total of $236 million in equity over multiple rounds (source) resulting in dilution to the Series A investors (depends heavily on pro-rata participation)
    • Assuming the original Series A investment was diluted down to ~10% (a guess), that $15 million investment would be worth $335 million now (depends on earn-outs and other behind-the-scenes factors)
    • Turning $15 million into $335 million is a 22.3x return and likely returned more than the entire Volition fund

    Congratulations to Larry at Volition Capital and the whole team at Chewy.com on the acquisition.

    What else? What are some more elements of this successful venture deal?

  • Investor Reference Call Questions for Existing Investors

    Several months ago I was talking to an entrepreneur/angel investor that was interested in investing in a startup where I’m an investor. As part of his due diligence on the potential investment, he wanted to talk to existing investors and get their thoughts on the startup. Naturally, I obliged.

    Here are some of the reference call questions from a potential investor to an existing investor:

    • What’s your experience been like working with the startup? What’s gone well and what hasn’t gone well?
    • What’s your experience been like working with the CEO? What’s gone well and what hasn’t gone well?
    • What’s your outlook on the business? How has that changed from your original investment?
    • What are the dynamics of the board like? How productive are the board meetings?
    • Are you participating in this next round? Why or why not?
    • What questions should I be asking as a potential investor?

    New investors want to hear that existing investors are bullish on the startup and have had a good experience. Of course, existing investors often want the money from new investors to help the company, so there’s an element where potential investors have to make a judgement call as to the quality and truthfulness of the existing investor responses.

    Entrepreneurs would do well to keep their existing investors informed and engaged for a number of reasons, one of which is that potential investors in the future will expect to do reference calls with them.

    What else? What are some more questions for potential investors to ask existing investors?

  • Interns in Startups

    Over the years I’ve hired dozens of interns with much success. In fact, the first summer at Pardot we had 11 full-time interns and only three employees. Interns are great in that they’re excited to learn, eager to prove themselves, and want to be there. But, there’s absolutely one trait that’s required for the employer to have a great experience: the intern needs to be self-starting.

    Self-starting is the most important trait when hiring an intern.

    Think about it. An internship schedule is one where there’s little time to ramp up and be productive before the internship is over. During that time, the employer has a number of existing day-to-day tasks that have to get done outside of coaching and training the intern. Interns who are self-starting are more resourceful, more likely to figure things out on their own, and more likely to have the right balance of productivity to management effort.

    Finally, interns are a great way to build a talent pipeline. Finding smart people that get things done is hard. By investing in interns there’s a continuous opportunity to find strong candidates for full-time positions as the startup grows. We’ve hired many interns into full-time roles.

    Entrepreneurs would do well to develop a program for interns, especially in the scaling phase of the startup.

    What else? What are some more thoughts on interns in startups?

  • When the Startup Path is Unclear

    One of the harder challenges in a startup is figuring out how long to stay the course. Traction almost always doesn’t happen overnight. Pinterest took four years before the media started noticing it. Incremental progress is often evident but it’s not clear that success is inevitable.

    Here are a few questions when the startup path is unclear:

    • Problem – How well is the problem defined? How many people have the problem? How painful is the problem?
    • Feedback – What type of feedback do prospects and users provide? How strong is the feedback? How consistent is the feedback?
    • Metrics – What are the weekly metrics? What’s the week-over-week growth? At this rate, when will the metrics look “good?”
    • Next Steps – How clear are the next steps? Are there several OK options or one or two excellent options?

    Staying the course or pivoting is a regular question for entrepreneurs when success is elusive. Often, there’s no obvious answer but asking these questions helps.

    What else? What are some more questions to think through when the startup path is unclear?

  • Video of the Week: How To Gain 1000 True Fans – Kevin Kelly on London Real

    For the video of the week watch How To Gain 1000 True Fans – Kevin Kelly on London Real. Enjoy!

    From YouTube: Kevin Kelly discusses his famous article ‘1000 true fans’.
    Kevin Kelly is the founding executive editor of Wired magazine, and a former editor/publisher of the Whole Earth Review. He has also been a writer, photographer, conservationist, and student of Asian and digital culture.